Investors need to take the previous year's audited profit and loss account and the taxable income declared and look at the price earnings multiple, rather than the land bank cliché. - Mr. Sushil Mantri, CMD, Mantri Developers
One of the first companies to attract strategic foreign investments in India's real-estate sector, Mantri Developers is focused on residential as well as commercial realty. In an interview to Business Line, Mr Sushil Mantri, Chairman and Managing Director of the company, dwelt on several issues of interest to investors in property as well as property stocks. What is the business model that works in the residential space? How should investors evaluate IPOs of realty companies? He also discussed the benefits that Morgan Stanley's investment has brought to the table for Mantri and the competencies required to tap such Private Equity (PE) investors.
Excerpts from the interview:
Why do you think Mantri was the preferred option for Morgan Stanley's first investment in India's real-estate sector?
We started our operations in 1999 and from Day One we had set some norms, including that we will do all the projects through one company. In real-estate development, typically a company is created for each project. But we felt it was better to bring projects under one company and build the track record over a period.
The second norm was doing large-sized projects. When we came to Bangalore, 25-30-apartment block was the market norm, but we went ahead with 200-300 apartments. This was because we thought scale will not only bring down cost but also provide more amenities for customers. Third, we acquired large properties on outright purchases and rarely took up joint development where the owners continue to hold the property.
These three practices turned out to be a sweetener. When the FDI (foreign direct investment) was allowed, there were two options available: One was to enter through a joint venture, which is not very profitable for PE (private equity) investors, as once the joint project is completed profits are shared and the venture is dissolved. Then there is the option of investing at the entity level, as is the case with Morgan Stanley's investment in Mantri Developers. Many realty companies are willing to accept PE at the entity level but do not have the competence.
What sort of competencies are required?
There should be a consistent track record. You cannot show that if you do every project through a different company. Second, you need a good management team. PE players don't invest in land, they invest in the management. They get the advantage of a share in our management team. Then comes the size of the project — large projects are preferred because the PE investor need not worry about the minimum area of 50,000 square metres as per the FDI rules. Companies need to demonstrate a consistent growth record, good management bandwidth and quality land bank. They don't mind paying more but cannot take too many risks. This being a limitation, they are willing to go for even a single-digit IRR (internal rate of return).
Would such a risk aversion prevent real-estate players with PE money to execute projects in locations other than in Tier I cities?
The risk is related to the rate of discount on the company's valuations and the stake involved. We were able to get the best possible deal because in our company, the risk was very low. Some PEs may not mind risk. But they would discount valuations by 30-35 per cent... whereas we were able to get the lowest possible discount. For instance, in our company Morgan Stanley has invested 10 per cent, so 90 per cent of the risk is still with Mantri. Now in the case of an SPV (special purpose vehicle), the risk of the PE investor may be about 50 per cent. Let us suppose tomorrow the local developer is no longer interested, then what happens to the PE investor? Risk is too high and therefore the discount rate goes up.
What you are talking about is a blind pool of assets wherein the local developer has no land and the PE offers funds and asks the developer to search for property. There, the risk is substantially high because nobody knows where the blind pool of assets lies. And without having assets, no PE investor will pump in the money. I don't think this possibility has materialised in India. But, yes, I have seen that happen in Europe. But then only a sanction letter is given and money is never transferred unless the conditions are complied with.
Why did you decide to go the PE way? Did you survey other options?
We had a few options. One was to raise debt. The second option was to come up with a strategic partner who could bring money and expertise. A third option was an IPO and finally to go for private equity. We decided on the last one. In real-estate debt is not the best option to fund business growth as it can backfire if there is a recession tomorrow. It is okay for completion of construction projects (working capital). The second option of strategic partnership can lead to demands of 50 or 51 per cent share by the partner, which may change the company's value systems. We did not see any point in that. For one, we knew India better than an outsider and, two, we were not comfortable with a local partner. We did not want an IPO until we built a larger company to demonstrate our strength in the capital market.
PEs carry lot of value benefits. Morgan Stanley, for instance, has sat on the board of a number of other companies. It also offered one or two of their members on our board, who come with professional management expertise and possess unlimited resources. They are financial engineers one can get free of cost. We considered a total of about 16 offers, out of which we selected Morgan Stanley. Why? First, it is the world's largest investor in real-estate. It has $74 billion in real-estate assets, which means its expertise would be far superior to others. Two, it knows India through the JM Morgan Stanley partnership. Third, it has 166 partnerships all over the world at enterprise level like ours. This opens up a phenomenal network for us in various countries. The Morgan Stanley Global CEO and Asia Pacific Head are Indians and hence understand India better.
There are some players, like Mantri, who maximise returns from a single project. There are others who quickly move from one project to another. Could you differentiate the two strategies?
The facilities for a 25-apartment project tend to be limited. For instance, the cost of a swimming pool of about Rs 20 lakh gets divided among 25 flats, so the effective cost goes up. While the effective cost of such facilities in a 500-600 apartment project is low and the client benefits. Number 2, it is like a community living which is preferred for a number of young buyers today whose jobs have also moved away from the city. Townships are going to be the future. Further, I do not expect roads to get widened by demolishing buildings and houses in cities, given our political set up. I don't think the cities are going to get less congested. Hence, moving out may be the only alternative. Small projects in the heart of city increasingly have cost issues and time restrictions. Hence, small players may increasingly find it difficult to do business and this may lead to consolidation. Bangalore may have 20-30 players instead of 1000.
Land prices appear to be running ahead of property (completed) prices in a number of places. Is this likely to lead to compressed returns?
We normally have three categories of projects — under construction, in designing stage and planned for implementation two-three years down the line which can be brought under the category of land bank. For the last-mentioned category, Mantri normally goes for property on the outskirts and not city property. Their value can be expected to appreciate tomorrow on the back of better infrastructure facilities coming up. Over two-three years, once the infrastructure is in place, the value of property goes up in such places. So, after three years we start the development and the process would take a minimum of two years. In five years, such a location is likely to become a semi-urban area. So the property value appreciation will be high and most likely to substantially beat the original land cost and also meet interest costs.
Are you planning an IPO?
Today, we are not in a liquidity crunch. I feel that today players who have gone to the capital market have gone there for liquidity, because they have not been able to raise any FDI. Many of them do not have large enough properties to attract FDI and had to resort to IPO. We felt why put ourselves on the treadmill today? Let's perform from quarter to quarter with Morgan Stanley. Maybe if we decide to go for an IPO two-three years hence, we can build a larger company, demonstrate a balance-sheet with continuous track record, go to the market with a partner like Morgan Stanley and get superior valuations. We want to come to the market when there are people of our calibre to compete with us.
Is land bank something that an investor should pay much attention to when assessing an IPO?
Coming from the developer fraternity, I can say that the land bank cliché does not make much sense when you make an MoU with a landlord by paying Rs 5 lakh and show such land on the balance-sheet. This is further valued by projecting some dream project in seven years and cash flows discounted at 10 per cent. The same land of Rs 50 lakh per acre will get valued at Rs 5 crore per acre. This kind of projection cannot sustain. How can profits grow from Rs 60 crore to Rs 600 crore in one year? It is time investors tracked the projections and the delivery from quarter to quarter. This percentage may throw up a 60-70 per cent failure in commitments. At the end of the day, investors need to take the last year's audited profit and loss account and the taxable income declared and look at the price earnings multiple. This may be a good reality check.
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