Investing in the Indian real estate sector continues to grow, however the pace may be slowing just a little. Foreign developers as well as private equity funds remain bullish, long-term, on India’s property market.

Not only is investment flowing into the metro cities, but attractive real-estate deals are also being negotiated and signed in ’second-tier’ cities such as Indore, Jaipur and Cochin.

From a foreign investor’s perspective, the recent correction in real estate prices in some parts of India is good news in that it could result in land being available at attractive values.

But although Indian property may make an attractive investment for foreign investors, it is important that they address some of the regulatory issues prior to making an investment.

According to India’s current foreign direct investment (FDI) policy, 100% FDI is allowed under the automatic route – that is, without requiring government approval – for the construction and development projects that include housing, commercial premises, resorts, educational institutions, recreational facilities, city and regional-level infrastructure and townships.

But this is subject to certain conditions:

• Minimum area for development under each project should be:

i) 10ha in the case of services housing plots; or

ii) 50,000 square meter in the case of construction development projects.

iii) In case the project is a combination of the two, any one of the two conditions would have to be met.

• Minimum capitalisation of 10 million US dollars for wholly owned subsidiaries and 5 million US dollars for joint ventures with Indian parties.
• The funds have to be brought in within six months of commencement of business of the company.
• The original investment is subject to a lock-in period of three years from the completion of minimum capitalisation.
• At least 50% of the project must be developed within a period of five years from the date of obtaining all statutory clearances.
• Investors would not be permitted to sell undeveloped plots.

Though the investment policy seems straightforward, investors still need to address some key issues and comply with other regulatory requirements.

For example, when it comes to funding, India’s exchange control regulations permit external commercial borrowings (ECBs) – that is, commercial loans in the form of bank loans, buyers’ credits, suppliers’ credits, and loans from shareholders.

There are several restrictions on the end use of ECB funds. One of these is that the proceeds of ECBs cannot be used for the purpose of acquiring real estate in India. Accordingly, ECBs cannot be used for real estate development in India.

Preference shares are also considered as ECBs and, likewise, cannot be used to invest in a real estate project in India.

The only exception is the use of compulsory convertible preference shares or fully and mandatorily convertible debentures, which would be treated as part of equity and would be considered as FDI.

Therefore, apart from pure equity funding, only compulsory convertible preference shares and fully and mandatorily convertible debentures can be used. This would tend to minimise the options available for funding a project in India because all funds would have to be in the form of equity or instruments which can be converted into equity.

As per the FDI regulations, a foreign investor’s original investment ‘cannot be repatriated before a period of three years from completion of minimum capitalisation’.