Legal Risks in the Indian Real Estate Sector
Team Leader: Marissa Vaillant
Main Contributor: Ryan McCuaig
The Indian real estate market is ranked fourth in developing Asia for foreign direct investment (FDI) and has attracted a global capital flow of $5.7 billion USD in 2016 alone.
With the intake of global capital predicted to increase further, there are clearly material arbitrage opportunities for investors. Risk mitigation strategies that account for the distinctive systemic differences are critical in preventing and hedging against capital losses.
Legal instabilities in India require heightened due diligence prior to allocation of capital. With a notoriously slow legal system, it is crucial to understand the most critical legal risks and develop a series of mitigation strategies. Research indicates that a lack of market transparency, lax financial reporting requirements, lower standards of monitoring market securities, and political corruption are the most significant legal risks in the Indian real estate market.
Lack of Transparency
The Indian real estate market has a lower level of transparency compared to the more mature and developed real estate markets of the West. Although market transparency has improved, reliable and consistent information on the Indian property market is still not easily available. This will evolve over time as the market becomes more sophisticated and the political situation stabilizes. Currently, investors require more professional due diligence and valuation institutions than in a typical foreign investment.
Financial Reporting Requirements
Indian laws related to the limited liability of corporate shareholders, fiduciary duties of officers, and directors do not insulate investors against many potential risks. This means that foreign investors may be liable during bankruptcy proceedings. Prior to making an investment decision, third-party auditing, and additional financial certainty are essential to avoid understated credit or systemic risks.
Indian issuers since they are not subject to the extensive accounting, auditing and financial reporting standards and practices relative to the requirements of their North American counterparts. This results in an increased risk due to the lack of verifiable information available. This means that the evaluation of investment fundamentals has a more important role in the real estate sector. Assessing the range of available opportunities, transaction records, irregular cash transactions, and stakeholder analyses are vital elements of fundamental analyses.
Financial Market Risks
The Indian securities market and its participants are subject to less regulation and monitoring than in other developed markets. With the recent availability of Real Estate Investment Trusts (REITs) in India, equity investment conduits in the Indian security markets are a great potential opportunity for investors to receive consistent dividends and growth that could offer better returns than their Western equivalents.
However, investors must hedge against systemic risks that could impede the recovery of cash flow such as a lack of regulatory requirements, material volatility spikes, and liquidity issues caused by the political regime. Additionally, it may be more difficult to obtain or enforce a judgment of the Indian courts. A foreign investor can mitigate this risk by taking proper legal precautions in advance of a capital investment to prepare for potential legal issues with local corporate partners.
Illegal Activity
Despite the efforts of the central government to bring transparency and limit government interference, bribery and corruption continue to pose a serious risk to the Indian real estate market. In particular, theft of physical assets, corruption, bribery, internal fraudulent financial behaviour, and information theft are most prevalent.
This risk has raised transaction costs as well as the operating cost for business in India, especially in the real estate, defence, and infrastructure sectors. Companies operating in India are likely to face bureaucratic red tape, petty corruption, and bribery when dealing with the local public administration, resulting in a higher level of investor risk in the real estate market.
