Q1. What is your opportunity? Why is it so attractive? The opportunity I propose is a REIT for redevelopment projects, focused on Mumbai.

Redevelopment is an attractive sub-class of real estate in Mumbai because of the impeccable economics that backs it: supply is severely limited, demand is rather inelastic and regulation is favourable. In the overcrowded city of Mumbai, land parcels are few and difficult to obtain, and being surrounded by sea on three sides, the city has limited area to expand. On the other hand, an ever-growing population, coupled with rising incomes translates into an increasing demand for housing. A pre-1970 building that is being redeveloped gets an extra FSI of 15%1. Developers are also allowed to purchase TDR upto 40% of the net plot area.2 The extra area he develops can be sold to yield an extraordinary contribution of $160 per sqf3. However, developers struggle to fund such projects on account of the tight monetary policy of the RBI4. They are thus forced to rely on informal sources to meet their funding needs.5 A redevelopment-focused REIT fund can provide the financing needs of such projects and participate in its returns.

FSI Floor Space Index, the ratio of built up area to plot area. Regulations may change depending on area. Figures in the essay refer to regulations for the Naupada area in Thane, a suburb of Mumbai 2 Transferable Development Rights, tradable to increase the built-up area. 3 $360 (Selling Price) - $110 (TDR price) - $40 (Construction Cost) = $210 per sq feet. All prices per sq. ft. of carpet area. 4 Reserve Bank of India, Indias central bank 5 On interviews, developers admitted that informal sources of funds can cost 18%-36% p.a. + security

Q2. How can an investor profit from this opportunity, and what returns can be expected? When will returns start materialising? If you feel equity is the best way to profit from this opportunity, which companies would you invest in and why? Or, if a more direct investment strategy is appropriate, explain why this is appropriate and how this can be accomplished. The best way for the fund to profit from this opportunity is through a SPV6 structure, allowing the fund to choose the projects it wishes to fund. The SPV is a JV between the developer and the fund, with management control in the hands of the developer with a few covenants. The SPV is further funded using debt7 provided by the fund, secured by the underlying assets under development. Developers start selling flats long before construction is completed: typically charging a proportion of the amount as construction progresses, allowing immediate realisation of returns. A return of 18% on debt and an IRR of 40%+ on equity can be achieved if the project is executed within time.8 A direct investment strategy into a company is not advisable since the SPV structure allows the Fund to pick and choose projects based on its own economic and financial analysis and is not dependant on the other projects of the developer. It also allows flexibility to exit investments after returns are realised.

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Special Purpose Vehicle, a company incorporated for each project. Alternatively, a tax efficient structure of a call-put option (the call to the developer and put to the Fund) may be used, which is effectively debt, but is treated as a tax beneficial capital gain. Refer Section 2(14), 2(29A) and 112 of the Income Tax Act, 1961. 8 Sale Price: $198 ($360*0.55) Construction Cost: $62 ($40*1.55) TDR cost $44 ($110*.4) = $92 Profit on investment of $ 106(Construction Cost + TDR cost). Assuming Construction and TDR costs accrue at t=0 and Cash inflows accrue evenly across 3 years @ $ 66 ($198/3), the project equity pre-tax IRR (without leverage/debt) is 39%. Use of debt within the structure with further increase these returns.

Q3. Evaluate the downside risks of your investment, sector, and market. How does your strategy overcome criticisms or issues that similar investments have faced? One risk a redevelopment fund would inevitably face is execution risk. The key to realising a successful exit from the investment is ultimately dependent upon the ability of the developer to execute the underlying project successfully and on time. Another risk that weighs down on the real estate sector in India is regulatory risk. A myriad of local and State regulations, several legal compliances and red-tapism must be taken into account while framing project time-lines. A minor change in a regulation can severely affect the cash flows of the project. The impact of the various federal laws including Company Law, Foreign Exchange Management and Income Tax law must be considered in light of the proposed structures. Perhaps, the most important risk is market risk and to some extent interest rate risk. The market must be able to absorb the capacity of the project at the expected rates to generate returns for the fund. If the fund is raised overseas, the manager faces foreign exchange risk in translation of returns. While it is impossible to avoid regulatory risk, it can be mitigated to an extent by ensuring that the proposed structures are in full compliance of the laws of the land. Further, execution risk can be reduced by ensuring full regulatory compliance as well as verifying the track record of the developer. Market risk can be mitigated by painstaking research of each project and its underlying economics. Investments must be limited only to projects that satisfy the strictest criteria of financial assumptions. Foreign exchange risk can be eliminated by using various hedges like forwards, futures or options, depending on expected cash flow.