Real estate sector needs ₹6 lakh crore in debt financing

Driven by a need for substantial construction finance, the demand for real estate debt financing is projected to reach ₹550,000-600,000 crore by 2026, according to a report by JLL and Propstack. In fact, close to ₹10 lakh crore in debt has been sanctioned over the past six years with 80% of this debt concentrated in Mumbai, Delhi NCR, and Bengaluru, of which Mumbai alone holds the lion's share at 40%.

Over the past few years, the banking sector has been securing a larger portion of real estate debts sanctioned compared to non-banking sectors, with a notable increase of 31% since 2018. Following the crises faced by IL&FS and DHFL, non-banking financial companies reduced their exposure to the real estate sector. Loan sanctions from NBFCs and housing finance firms (HFCs) witnessed a significant decline of 24% and 52%, respectively, in 2019.

Banks, on their part, have shown an appetite for direct participation in the real estate sector, primarily through construction finance and the LRD route. However, there is potential for banks to increase their exposure while managing risks adequately. This cautious yet proactive approach can ensure that the sector receives the necessary financial support without compromising on risk management.

One of the areas showing immense potential is the Lease Rent Discounting (LRD) market, particularly within the commercial office segment. The current market size of LRD for commercial offices stands at approximately ₹472,000 crore. With robust demand fundamentals and sustainability measures in place, the LRD potential in this segment is expected to grow by 30% over the next three years. This surge underscores the sector's capacity to leverage rental income streams for long-term financing solutions.

However, the journey is not without its hurdles. The early stages of real estate developments, particularly pre-approval and land purchase phases, are capital-intensive and often underfunded. Traditional banks have largely remained absent from this phase due to regulatory barriers, paving the way for Alternative Investment Funds (AIFs) to step in. AIFs have emerged as crucial players in early-stage project funding, especially in the residential sector.

Alternative Investment Funds (AIFs) have played a crucial role in providing risk capital for high-risk project stages, with approximately ₹132,840 crore raised in real estate through the AIF route to date. Currently, 16 domestic real estate funds are in the process of raising an additional ₹16,400 crore, reflecting the sector's rapid growth and substantial opportunities for further expansion.

Despite the growing involvement of AIFs, there is a pressing need for greater participation from various players in this space. Increased involvement from more AIFs will not only enhance the availability of capital but also promote healthy competition, leading to more favourable terms and conditions for developers. This broader participation is essential for strengthening early-stage project funding and driving the sector's overall growth.

Recent developments from the Reserve Bank of India (RBI) could further influence the landscape. The RBI has proposed new draft guidelines on project financing, which require banks to set aside provisions of up to 5% of the loan amount during the construction phase of projects. This is a significant increase from the previous standard asset provisioning rate of 0.4%. Such a shift could lead banks to charge higher interest rates to cover these provisions, potentially impacting end users of these projects.

Despite these challenges, the diverse funding sources within the sector have provided much-needed flexibility. Most of the debt sanctioned in the past six years—53%—is in the range of up to ₹100 crore. The next largest segment consists of loans ranging from ₹101 crore to ₹200 crore, while loans exceeding ₹500 crore account for only 8%. This distribution indicates a preference for smaller to mid-sized loans, catering to a broader range of projects and developers.

The residential sector dominates India's construction debt market, accounting for approximately 70% of the total market size. The remaining 30% is led by the office segment, followed by retail, warehousing, hospitality, and alternative asset classes like data centres. Given the share of residential at 70% of the term loan market, the total sanctions to this sector amounted to ₹407,887 crore over the same period (2018-2023). However, there remains a significant funding gap, with around one-third of the total residential market that was seeking debt remaining unserved.

This gap primarily exists in the mid and small developer category, where lenders are more reluctant to lend and loan rates are comparatively higher. The need of the hour is to broaden the borrower base, curating innovative funding solutions and improving access to credit for smaller developers to create a level playing field and promote healthy competition in the residential sector.