The Hindu Business Line : A new `lease' on securitisation

Globalisation has fuelled the need for greater liquidity and granularity of investments in the real estate market. Securitisation — transformation of firm specific assets and prospects into marketable securities — has become an important part of financial intermediation, giving banks an opportunity to expand their services and boost lending.

AMONG the plethora of investment options, real estate commands a high position. However, its one major disadvantage is poor liquidity. Globalisation has fuelled the need for greater liquidity and granularity of investments in the real estate market. The need for earning higher yield and greater security has created a huge demand for more efficient markets.

In recent years, securitisation — the transformation of firm-specific assets and earning prospects into marketable securities — has become an important part of financial intermediation.

On the one hand, this has been perceived as threat to commercial banking, as it allows firms and individuals direct access to the markets for liquidity, instead of going to banks. On the other hand, securitisation is also an opportunity for commercial banks to provide new services thereby increasing lending.

Banks have always been the chief financiers of the real estate industry and also one of the major buyers. Today, they have a lot of instruments that make the financing of the real estate industry easy. Securitising real estate is one of the emerging methodologies.

Under this is the securitisation of future rent receivables, called Lease Rental Discounting (LRD), Construction of residential and commercial spaces is a largely unorganised market in India and the developer cannot raise the money from the market through equity. He would need to take a loan from the market and, banks are one of the major providers of loans to this industry.

The developer repays the loan either in instalments or at one go. Now, the money for these instalments comes from the rents the developer receives or from the proceeds from the sale of these properties.

In case he leases out the property, he receives rent on a monthly basis for long periods. Once a developer invests in a project, his money stays locked in it and he cannot raise fresh debt from the market. In such situations, it becomes almost impossible for him to pursue other projects, resulting in a major loss of opportunity.

This is where LRD comes to the rescue. The developer pledges his future rentals to a bank that disburses a loan. The bank discounts all the future rents depending on the lock-in periods, the profile of the tenant and other factors. The developer becomes the `lessor' and the tenant the `lessee'. The bank takes into consideration growth prospects, road infrastructure, law and order, water and power supply, medical facilities and presence of industries in the city.

While evaluating the real estate in question, banks look at accessibility of the building, aesthetics, surroundings and other such characteristics of the building.

Maximum care is taken in choosing the right lessor and lessee before entering into an LRD. The credit profile and assets of the lessor are studied carefully. The rent-paying capacity of the lessee, perhaps the most important factor of an LRD, is checked thoroughly, as the whole concept of LRD is based on the regular cash flows from the lessee.

Also, banks need to ensure that they are not converting any black money to white in the process. Since its introduction to India in 2000, LRD disbursements stand at a cumulative total of $2-2.5 billion. Of these, approximately $700 million has been floated in the secondary market.

The booming Indian real estate market registered the highest yield rates in the world in 2003 with three key markets — National Capital Region, Mumbai and Bangalore — ahead of London, Frankfurt, Hong Kong, Kuala Lumpur, Singapore, Bangkok, Sydney and Copenhagen.

According to one estimate, LRD business worth $1 billion is assumed to take place every year. The bar chart gives a rough estimate of the LRD potential for Mumbai, Hyderabad and Bangalore.

But the total market size pales in comparison with the US-based Commercial Mortgage Based Securities (CMBS) market, which totalled to a whopping $68 billion in 1999.

Clearly, there is an enormous demand for a secondary market for commercial mortgage-backed securities in emerging countries so that the risk in the real estate market can be distributed among various marginal investors.

(The authors are second-year students of the MBA programme at the Indian Institute of Management, Indore.)

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