âHow long can a sector survive which is borrowing at 48 per cent from private lenders to serve the interest of previous debt raised at much lower rate,â asks a banker. His concern is not without valid reasons. Developers experimented with all funding options but still many of them are now being forced to seek other sources of funding which not only comes at a significantly higher cost but also where the source of fund is unregulated.
Probably the last visible nail in the coffin has been the Reserve Bank of India (RBI) asking banks to link the disbursal of home loans to stages of construction to protect the interests of buyers and contain the fallout of âinnovativeâ housing finance schemes.
While developers of some repute are able to raise money at 2-3 per cent a month, the smaller ones are even paying close to 4 per cent a month with greater collateral. The desperation level, of course, varies from developer to developer which is being seen as an opportunity by several HNIs, exporters and even diamond merchants. Developers who have not been able to maintain a good and well balanced book have no other option than to fall in row to private lenders at ineffable interest rates.
Borrowing at rates as high as 48 per cent is not sustainable in any business and the sector had in the past made use of such options, if urgently required, to use for very short term periods. This situation is, however, not confined today to few developers who had over stretched themselves in good times, forgetting that real estate does not operate always in boom.
Requesting anonymity a private lender tells Track2Realty that rates are relatively higher to those developers with whom risk is equally higher. According to him, there are very few risk free developers today and everyone is looking for money. So, the sector has been exposed to the greedy HNIs, exporters and even diamond merchants looking for high risk and high returns.
âWhen lender is suspicious with the reputation of the developer, obviously he puts it in high risk zone to extract higher interest rate. Those with the ability to actually complete the project and the quality of the security on offer are still raising money at around 20-25 per cent interest rate,â says the lender.
Question over sustainability
Analysts maintain things can sustain as long as there is serviceability of the interest cost which looks unlikely in the near future. For example, top 20 listed companies hold inventory as of March 2013 of Rs.67,096 crore and the ratio of inventory to sales on an average, based on FY13 sales stands at more than 2x. This is really an alarming state for the sector, still the developers are not focussed towards clearing existing inventory rather than adding to it.
As a result, the sector is sitting over inventory that is neither sustaining prices for developers nor help in deleveraging of balance sheet which would lead to increased profitability and sustainability. Better option is to liquidate surplus land or non-core assets or reduce the price of inventory to come out of the liquidity crunch.
However, living on a wing and prayer the developers seem to be in no mood to reduce prices. âRaising money even at exorbitant rates, developers hope, will help them fend off this crisis situation and keep prices steady till the economy picks up,â says Ambar Maheshwari, Managing Director of Corporate Finance at Jones Lang LaSalle India.
Siddharth Rajpurohit, AVP, The Market Financial Intelligence says the sector is currently under significant cash crunch where the commercial real estate is facing maximum pressure. As per CREDAI, the total housing target in the 12thÂ Five year plan is 37 million and developers would face a funding gap of USD 70 billion for the same over next five years.
âThe current situation of the major developers, where they are unable to pour in the required equity, banks would definitely be reluctant to provide the additional funding. With RBI sucking out liquidity to control inflation, the situation of cash crunch would worsen. This would lead to increase in cost of fund which is already very high. With huge inventory we may witness a fall in real estate prices (particularly in commercial real estate) and on this a rise in cost of fund would dip the already crumbled margins making the projects unviable,â says Rajpurohit.
Viable funding solutions & blockades
Some believe construction Linked payment is the oldest plan in which the customer has been paying to the developer. This not only put pressure on developer to expedite the construction in order to get the payment but also acts as a safeguard for the customer since his outflow is linked with the completion of his dream home.
However, Gaurav Gupta, Director, SG Estates, has a caveat here. According to him, the problem has started now where in land component in total project cost is as high as 40-60 per cent. It means developer has already incurred more than 50 per cent to start with the project and getting payment in small trenches related to construction becomes totally unviable.
âThe best solution to the problem is flexi payment plans where in 40 per cent payment is released till excavation and balance is linked with the construction. This addresses the concerns of both the buyer and developer. However in flexi plans, it is to be ensured that the land is fully paid up.Â If any new curbs on construction loans are put in, then real estate industry is bound to die its natural death.Â Current market scenario is not very encouraging due to negative economic sentiment, global factors and falling domestic economy. In this situation of low sales and resultant liquidity woes, developers have been relying heavily on construction loans to ensure fast completion of projects and timely delivery,â says Gupta.
What has pinched the developersâ most this year is the RBIâs new guidelines asking banks to link the disbursal of home loans to stages of construction to protect the interests of buyers and contain the fallout of âinnovativeâ housing finance schemes. âIn view of the higher risks associated with such lump-sum disbursal of sanctioned housing loans and customer suitability issues, banks are advised that disbursal of housing loans sanctioned to individuals should be closely linked to the stages of construction of the housing project/housesâŠ,â an RBI notification said. Upfront disbursal âshould not be made in cases of incomplete/under-construction/green field housing projects,â it said.
With effect from June 21, 2013, the RBI has also revised the loan-to-value (LTV) ratio, which determines how much the banks can finance. For loans of up to Rs 20 lakh, banks can lend up to 90 per cent, while the borrower has to pay 10 per cent. For home loans between Rs 20 lakh and Rs 75 lakh, the LTV ratio is 80:20 while for loans above Rs 75 lakh, it is 75:25. The LTV ratio should not exceed the prescribed ceiling in all fresh cases of sanction.
Criticising the Reserve Bank’s decision to link disbursal of home loans to stages of construction,Â CREDAI says the move will harm developer sentiment and disturb business plans. CREDAI Chairman Lalit Jain says, âHousing finance institutions or banks normally safeguard their interest while devising such instruments. Abruptly issuing such circulars, advising bank against established practices only harm the sentiment and disrupts business plans. This will create setback for projects, affecting the end consumers.â
Method in RBIâs madness
Some analysts tracking the sector say RBI though has done a wonderful job in protecting the interest of the customers and has ensured safe landing but it is also expected that real estate be given the due hand holding that is required. The sector supports more than 100 ancillary industries and if real estate grows, so does economy.Â And hence, real estate should be treated at par with other industries and working capital needs of the industry should be addressed like any other industry.
However, liberal funding has often meant funds been routed for fresh land acquisitions than project completion. Critics have it that the developers have hurt their own cause. Not only the lending institutions but many developers have also burnt their fingers in the wake of 2008-09 slowdown. Buyers, of course, have been the first to suffer if liberal loans are not put into project execution. A check on fund flow is a must; otherwise opportunities often pull the profit centric developer towards unethical measures.
The current scenario of cities where availability of land becomes a major issue, it becomes obvious that funds via any route may be used to tap on any available opportunity to win on the cut throat competition. Hence, this is somewhat the nature of the business that has led to not only a highly leveraged book for developers but also an opaque industry.
Rising defaults add to developersâ woes
Rising defaults by short-term realty investors further add to developersâ woes. They were a source of quick funds for housing projects till recently, but in the wake of slowdown they are increasingly defaulting on payment to developers. Since exit routes for speculators are closing a large number of such investors, who generally buy multiple properties and sell them in six to eight months for quick gains, are approachingÂ developers for refunds, and in some cases even taking them to court.
On the basis of brokersâ inputs, Track2Realty assessed that such short-term investors have cornered even 50-60 per cent of newly built homes in the Delhi-NCR region, though they are not even half in number active in Mumbai market. While some speculators managed to exit these properties before the slowdown set in, a large number of them are still stuck for want of buyers. So, they maintain, artificial appreciation of property is not helping the cause of the developer either. Rather the developers are being arm twisted by greedy short-term investors to be a party in speculation of the property.
Real estate speculators generally pay 20-30 per cent of an apartment’s value over about six months. When the housing project developer increases prices, these short-term investors sell their apartments to either other investors or end-users at a profit. These were the investors who would bring in the much needed liquidity for the developer at the beginning of a project. Such has been the boom phase of property market that even some of the end-users got into the game of booking 3-4 flats, thus ensuring that the cost of one will be recovered by speculating the rest in the market.
Requesting anonymity a broker admits developers generally use such investors to increase prices. Many developers would offer special rates to them for coming in early, sometimes even before all approvals for a project are in place. The investor was happy because he entered the project at a much lower price than a regular buyer and exited with a good profit.
Emerging reality painful
But the new realities have forced the developers to be apprehensive of short-term investors. They, however, can not keep them out of their newly launched projects for want of funds. Analysts maintain they can not weed out such investors with possible options of running personal wealth checks on potential investor and asking them for their bank statements before selling homes. The desperation level for funds is so high that the developers are falling for any funding options which is actually creating a vicious cycle of fund mismanagement.
There seem to be no rational or acceptable funding formula that can pull the sector out of the financial mess. Some of the developers, after waking up with the reality of short-term investors, are now introducing a clause in the buyer agreement that they can not sell the project before the date of possession. But that again is proving to be a blockade for the developers who need to sell the project in order to get the desired construction funding. If they fail to continue the construction, the existing buyers would stop paying further. So, they are caught between the devil and the deep sea.
Developers meanwhile crib over the absence of proper financial modelling of the business. The prime grouse is the policy of non-funding for buying land, but the way sector operates it looks somewhat prudent as it filters out a lot of not so economically strong and serious developers.
Some independent financial analysts maintain that though the developers have hurt their own cause and self-inflicted poor perception and projection can not be over-looked, a curb on construction funding would not be prudent. In current scenario the cost associated with a construction project has increased by around 25 per cent Y-o-Y and pure equity funding would not be able to bring in any growth for the sector. Hence, a curb on construction funding would definitely increase the issue for the already cash crunched sector.
Having said this, to maintain discipline in this opaque sector the funding mode of construction linked seems to be the most prudent. Projects which have construction loans will do no harm to their cause if they follow escrow account system to avoid fund diversion. Also banks and financial institutions have tightened their mechanisms to check on the fund diversion and reputed players are focusing more on project completion than new acquisitions.
The developers demand there should not be any embargo with regards to funding to any particular sector. The credit assessment structure of the financial institution in India is competent enough to judge the viability of the project. The absence of financial modelling may be the right answer to address the issue of a seamless funding formula. Till that happens and a regulatory mechanism is evolved, funding will continue to be a debatable issue.