While the developers' community is upbeat about foreign investments in smaller cities, international players are reluctant to enter markets which are of high risk, especially where infrastructure has yet not been developed.
The new government in its budget has announced reduction in built-up area threshold from 50,000 square metres to 20,000 sq mt and drop the minimum foreign direct investment limit to $5 million from $10 million.
"Already there is a shortage of over 18 million houses and Tier 1 cities are bursting at their seams. Given the current scenario, the opportunity presented by tier 2 and 3 cities are ripe, awaiting to be tapped by developers backed by foreign investors," Tata Housing managing director Brotin Banerjee told PTI in Mumbai.
He further said many private equity investors have ventured into Indian realty since the sector was opened to FDI in 2005.
"Given the further relaxation in FDI norms, the participation is only expected to improve in the near future," he said.
According to experts, FDI would flow in such tier 2 and 3 cities where the infrastructure is in place and the investors are assured of better returns.
"We may not see an immediate flow of investments in smaller cities where there is no proper infrastructure in place. Tier 2 and 3 cities may have land, but at the same time if basic infrastructure is not in place, they become high risk markets for investors. There is a need to create smart and social infrastructure," PwC executive director Anish Sanghvi said.
Among the tier 2 cities, Pune, Chandigarh, Ludhiana, Coimbatore, Bhubaneswar and Kochi, and tier 3 cities like Madurai, Baroda, Nashik and Trichy are likely to attract investments as they are "upcoming" in terms of social infrastructure and economic development, experts said.
According to experts, at least for the next 12-18 months, internationals investors may look at major 6-7 metros.
"Smaller towns are high risk markets, especially when we don't have the necessary infrastructure in place. For us, we will continue to look at 5-6 major markets like NCR, Pune, Mumbai, Bangalore among others," Embassy Property Developments chief executive-commercial real estate division Michael Holland said.
Milestone Capital Advisors vice chairman and director Rubi Arya said domestic investors will have an advantage as the sector is expected to improve.
"Domestic private equity players will be at an advantage as the sector is improving and we expect better valuations. Investors will continue to look for developers with good track records thus enabling improvement in the realty market in those regions," she added.