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Indian foreign direct investment (FDI) regulations allow FDI of up to 100% in the construction development sector under the automatic route, with certain conditions. Construction development sector projects include the development of townships, the construction of residential and commercial premises, roads and bridges, hotels, resorts, hospitals, educational institutions, recreational facilities, city and regional-level infrastructure. FDI in India can be made through equity shares or compulsorily convertible debentures, or compulsorily convertible preference shares.

In addition to FDI, India has witnessed a strong inflow of foreign funds in structured debt to real estate companies, with such debt being high-yield, coupon-bearing and mortgage-backed (with real estate assets). These debt investments came through foreign portfolio investors and through alternate investment funds that raised funds from foreign investors.

This article analyses the current regulatory framework for foreign investment, real estate investment trusts (REITs), insolvency, and structured financing in the context of the Indian real estate sector.

Foreign direct investment

In the construction development sector, 100% FDI is allowed under the automatic route. Investors are permitted to exit on completion of the project or after the development of trunk infrastructure (i.e. roads, water supply, street lighting, drainage and sewerage). While each phase of a project is considered a separate project, the investor is also permitted to exit and repatriate the foreign investment before completion of the project, subject to a lock-in period of three years, calculated with reference to each tranche of the FDI.

These exit restrictions are not applicable to investment in sectors such as hotels, tourist resorts, hospitals, special economic zones, educational institutions and industrial parks (which have been specifically defined for FDI purposes).

The transfer of a stake by one non-resident or foreign investor to another without repatriation of the investment is allowed, subject to neither any lock-in period nor any government approval.

No FDI is permitted in an Indian company engaged in the construction of farmhouses, trading in transferable development rights, or the real estate business. The term “real estate business” includes dealing in land and immovable property with a view to earning profit.

It does not include the development of:

1. 1. townships;
   2. construction of residential or commercial premises;
   3. roads or bridges;
   4. REITs;
   5. educational institutions;
   6. recreational facilities; and
   7. city and regional-level infrastructure. Further, earnings from rent or income on the lease of a property, not amounting to a transfer, are exempted from the definition of “real estate business”.

The 100% FDI under the automatic route is also permitted in “completed projects” for the operation and management of townships, malls and shopping complexes, and business centres. However, there is a lock-in period of three years, calculated with reference to each tranche of investment, and transfer of immovable property or part thereof is not permitted during this period. The regulations also allow 100% FDI under the automatic route in real estate broking services.

Real estate investment trusts

One of the notable developments was the introduction of REIT regulations, allowing the constitution and listing of them. There are five listed REITs in India, four of which are in commercial office space and one in retail mall space.

A REIT is constituted as a trust under the Indian Trusts Act, 1982, which is registered with the Securities and Exchange Board of India (SEBI), and generally comprises persons designated as the sponsor, manager, trustee and unit holders.

Such trusts require a minimum asset base of INR5 billion (USD56 million), and at least 80% of the value of assets must be invested in completed and rent and/or income generating properties, while the remaining 20% can be held in the form of stocks, bonds, cash or under construction commercial property. At least 90% of the rental income earned by REITs has to be distributed to its unitholders as dividends or interest.

Recently, the SEBI notified the regulatory framework for small and medium REITs, allowing smaller or medium-size value of at least INR500 million and not more than INR5 billion. Small and medium REITs can have commercial or residential assets and require at least 200 investors; at least 95% of the value of the scheme assets is to be invested in completed and revenue-generating real estate assets and properties. Only up to 5% is allowed to be held in cash, units’ liquid mutual fund schemes, or fixed deposits.

Small and medium REIT regulations are likely to be a catalyst for widespread unlocking of the values of commercial real estate in India.

Debt financing in real estate

Most debt financing by foreign financial institutions in the real estate sector is through subscription to secured non-convertible debentures of Indian companies, in accordance with SEBI regulations, which may or may not be listed on a stock exchange in India (foreign investor subscriber must be registered with the SEBI as a foreign portfolio investor [FPI]); or loans or debt by alternate investment funds (AIFs) set up in India.

There are no limitations on interest coupons or redemption premiums that can be paid on such financing by FPIs or AIFs. The security interest is created in favour of a debenture trustee, who is responsible for holding the security on behalf of the foreign investor and overseeing compliance by the borrower. Another financing option would be external commercial borrowings from foreign entities for the construction and development of integrated townships, special economic zones and industrial parks, and also for the infrastructure sector under the “harmonised master list” approved by the government of India, with limitations on all-in cost.

Insolvency of real estate

Another key regulation in India is the Insolvency and Bankruptcy Code, 2016 (IBC), which sets the framework of insolvency and bankruptcy laws and streamlines the processes for insolvency and liquidation of corporate persons in India.

The IBC enables any financial creditor, operational creditor, or the corporate debtor itself to initiate an insolvency resolution process in the event of a default by the corporate debtor, which must be resolved within 180 days from the submission of an application for the initiation of the process, although practically it takes far more time than that.

The IBC has a crucial impact on the interests of all stakeholders including homebuyers, lenders and real estate developers. It allows developers with financial capability and delivery records to salvage incomplete real estate projects that promoters have no financial means to complete.

Homebuyers have been afforded greater rights through amendments of the Supreme Court. While initially their role was limited to being recognised as “other creditors”, homebuyers are now recognised as “financial creditors” and given a right to initiate the insolvency process against defaulting real estate companies, and also a seat on the committee of creditors. The right to initiate insolvency is subject to a threshold on the minimum number of homebuyers.

Real estate developers have also been afforded greater flexibility in seeking and passing resolution plans of real estate companies. IBC regulations allow a “resolution plan” in respect of one or more projects of the real estate corporate debtor, where no resolution plan was received for such a corporate entity as a whole.

Another significant reform allows for the handing over of possession of units and facilitates registration in favour of homebuyers who have fulfilled their contractual obligations, even while the corporate insolvency resolution process is ongoing. This provision addresses the practical concern of stalled projects, where construction may be complete but formal transfer to homebuyers is delayed due to insolvency proceedings.

Enforcement of security interests

Apart from the IBC, another prime avenue for lenders to recover their debts is governed by the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act). If a borrower fails to repay a secured debt, the secured creditor may classify the borrower’s account as a non-performing asset and initiate proceedings to enforce its security interest, take possession of the secured real estate assets, and monetise the assets without any intervention of the court, which is a faster process for debt recovery compared with the ordinary civil court process.

The present regulatory framework of the SARFAESI Act enables banks, financial institutions, asset reconstruction companies, and the SEBI-registered debenture trustee holding listed debt securities to enforce security interests under the act.

A prior notice in this regard must be sent to the borrower to discharge the liability in full within the stipulated period, on failure of which the enforcement proceedings under the provisions of the act may commence as per the process set out under the SARFESI rules.

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