PE Firms Eye Tier-II and III Cities for Investments

With the slump in the country’s economy, private equity (PE) firms are thinking twice before investing in Tier I cities. Mumbai and Delhi are, as such, offering lower lucrative investment opportunities for international PE firms. Hence, the PE players are now eyeing the Tier II & III cities that are relatively untapped and are offering huge investment opportunities.

Tier-II and III cities offer opportunities

Big cities such as Mumbai and Delhi are nearing saturation in terms of available land parcels. This has made real estate very expensive in these cities. On the other hand, cities such as Chandigarh, Lucknow and Coimbatore are witnessing rapid growth in infrastructure and commercialization. These cities are also less expensive compared to the big metros.

According to Jones Lang LaSalle (JLL) India, most of these markets are suited for local builders than big ones because the former understand the geographies and customer tastes better. However, they are small and often need external funding to support them. They also face problems with capital generation due to the strict lending norms followed by the banks. Hence, raising funds from external PE firms becomes an alternate option. This is where private equity firms have huge opportunity.

PE firms are professional financial organizations and bring in clean money. They have realistic expectations about profits. For PE investors, investing in real estate helps them in diversifying their portfolio as well as hedge them against other financial uncertainties.

Last year, PE investments in the Indian realty had gone down by 15% due to the economic slump and lack of government policies that were supporting investments in the Indian realty sector. Most of these firms were desperately trying to exit the real estate markets. However, tier-II and III cities have been promising in terms of growth. They also offer good returns and quick exits, unlike tier-I cities. This has rekindled the interests of the PE firms to invest in the Indian realty sector, especially the residential real estate segment.

Indian realty continues to attract PE firms

With commercial growth in Tier II & III cities, there is an increasing demand for residential projects. Hence, the residential segment is the most lucrative segment for PE firms. Demand in this segment is majorly driven by the mid-income segment within these cities as well as the spill-over demand from tier-I cities. An additional driver for growth are the households that cross-over the mid-income segment and aspire for better living. A healthy growth in the residential sector indicates a good growth in commercial sector.

The PE arm of Morgan Stanley has invested approximately $65 million in Alpha G Corp, a developer active in tier-II and III cities. Another US-based firm, Trammell Crow is in a joint venture with UK-based Meghraj Properties and is looking at investing in tier-II and III cities such as Kochi, Pune, Coimbatore, etc.

While some of the PE firms are trying to pull out of the Indian real estate sector, some firms have realized the potential of the Indian real estate market. Several PE funds invested a total of $911 million in SEZs last year. For example, US based Blackstone Group believes that the Indian realty market needs foreign direct investment (FDI) at this point of time. Hence, there is no shortage of opportunities here. The firm invested in 28 million sq.ft. of office space in the country and is continuing to invest.