Elevated Expectations in India
Chinese President Xi Jinping travelled to India in mid-September with a stated goal of bolstering political and trade ties between the world’s two most populous nations.
The relationship between the countries has always been uneasy. In the modern era, their territorial and geo-political ambitions have rarely found alignment; as they have jockeyed for regional influence, friction over issues such as the disputed territories of Kashmir and India’s easternmost frontier with Tibet have stymied efforts at cooperation elsewhere. Even as the pomp of the latest state visit was getting underway, Indian and Chinese troops were posturing on their respective sides of the shared Himalayan border. And though there was no indication of conflict in New Delhi’s more civilized environs, the leaders did agree that the region would be well served by an updated perspective on these sources of conflict.
The practical relationship between China and India is far less balanced than it is made to appear in diplomatic discourse. Just a few decades ago, the two nations were toe-to-toe in measures of economic activity and the daunting tasks of poverty alleviation and women’s empowerment. Their growth trajectories have decoupled as China has liberalized its markets; India’s existing free market system, free but beset by gross inefficiency and corruption, is today just one-third the size of China’s economy. To be sure, India’s domestic and expatriate business communities are replete with stories of success and wealth creation. And in the scientific realm, India demonstrated its prowess and competitive advantage in September, when it placed a satellite in orbit around Mars at a fraction of the cost of similarly ambitious space projects.
In spite of its tally of exceptional business and scientific achievements, India’s big picture nonetheless reflects more modest, practical success than anecdotes project. For significant economic development to progress, India needs China. One of the former’s binding constraints is a relative shortfall in capital that is easily observable in the nation’s weak infrastructure, ranging from congested roads, to unreliable supplies of power, to the abysmal condition of essential and sanitation services. While India is unlikely to discriminate overtly between the West and China in welcoming foreign investment, their shared geographic theatre and China’s seeming surfeit of capital make a stronger economic relationship between the two an obvious choice. Access to the Indian market is important to China as well, as it enjoys a $40 billion trade surplus with its southerly neighbor.
American investors thinking today for the first time about how to make money in China are behind the curve. On the real estate front, respondents to the Association of Foreign Investors in Real Estate’s annual survey rank China atop the list of emerging markets. On the other hand, the more reserved impression of the Indian opportunity has meant a relatively less crowded marketplace. That is partly the result of India’s own fears about loss of domestic control, which have severely constrained entity-level foreign investment and undermined foreign investors’ property rights. Over the last decade, foreign direct investment into India has been roughly one-tenth of the flows to China.
India’s lower investment profile will not persist indefinitely. The signs of change are everywhere, even if the durability of the current inflexion is uncertain. The election earlier this year of Narendra Modi to the post of prime minister may be a watershed moment for the Indian economy. While the ascendance of Mr. Modi and his somewhat nationalistic party has stoked concerns about sectarianism in a country that can ill-afford a departure from its secular commitment, voters, and now investors, have been swayed by the economic record. Mr. Modi presided over the state of Gujarat during a period of rapid expansion. It remains to be seen if he can parlay that success into a broader acceleration, while keeping a lid on inflation. The market anticipates that he will do exactly that, even if India is a notoriously difficult ship to steer.
In the arena of real estate, indications of change writ larger are also observable. From the perspective of market fundamentals, the long-term demand drivers for space are well entrenched in a growing population and a rising middle class. Burdensome regulatory regimes at every level of government temper the connection between underlying growth and space demand. Even so, the supply of space meeting the needs and expectations of key market segments is constrained. The office inventory has grown sharply over the last decade and polycentric models of urban development feature visibly across the map. Still, neither the multifamily sector, nor office or retail, can be characterized by a superfluity of high quality space.
Contributing to the shortfall in the built environment, India’s real estate capital markets have been disorderly at the best of times. Matching equity and debt capital sources to risk-equivalent projects is inefficient by any measure. That leaves room in the market for investors with a stomach for the vagaries of Indian real estate and its exaggerated value cycles, particularly if those investors demand gains in market efficiency and informational transparency. With that in mind, the highly anticipated introduction of real estate investment trusts to the Indian marketplace has far-reaching implications if it goes the distance this time around. Historically, Indian real estate markets have been constrained by an absence of diversified equity and debt sources, as well as exit strategies. Developers that have borrowed heavily over the last cycle have had few places to turn, and face higher costs of capital as a result.
In contrast with today’s norm, a thriving REIT industry could enhance the liquidity of India’s real estate markets dramatically. That is widely recognized in the domestic setting, and is now drawing the attention of foreign investors. Even Air India, the nation’s stodgy flag carrier, is reportedly considering a spinoff of its real estate assets through the newly available platform.
As of mid-September, the Securities and Exchange Board of India had yet to clarify the finer details that will define the REIT market. It could all come to naught if there are devils in the details. And there are risks even if the program moves forward without burdensome regulations, in part because new undisciplined money can foment the disruptive price bubbles that are all too common in this emerging marketplace.
But that is not a reason to stand in the way of progress. In the best case, REITs will not only serve as new conduits for capital inflows to real estate, but also as a disciplining force across India’s widening real estate investment landscape.