Realty bubble waiting to burst

Slowdown, higher interest rates and exit of black money from the sector before elections could bring down property prices.

The real estate market is fast approaching the eye of a perfect storm. Demand has slowed down considerably and inventories have been building up. New regulation and market conditions, both global and domestic, will soon make access to land and capital more difficult. To weather this storm, builders need to let house prices fall. And the government needs to eliminate bureaucratic hurdles to make development a viable business at lower prices.

Indian real estate saw a gold rush-like craze in recent times because its vested interests had carefully planted the idea that property prices “never go down”.

To validate this notion, prices and price information were kept high and opaque high through implicit collusion. Media sound bytes were more often either from developers or financiers, who had everything to gain from sounding positive and optimistic.

Just the other day, the chairman of a large housing finance company went on record saying that he doesn’t feel there is a bubble in real estate prices. You don’t have to be a rocket scientist to figure that something is wrong when a similar-sized apartment is more expensive in Mumbai than in Manhattan.

Unfortunately, both the government and the academia have remained largely silent, letting vested interests rule the public debate on this issue. As a result, price speculation has been left to grow for too long, despite signs that it is no longer sustainable to do so.

STALLING ECONOMY

The Indian economy is no longer expected to grow at the heady rates of 8-9 per cent. Except for a few sectors such as IT, most of the economy faces dim prospects for job and earnings growth. High inflation will reduce the amount available to service home loans, while inflated house values increase EMIs and reduce the amount available for consumption. Unless house prices fall, it is hard to see how this vicious cycle can be broken. For businessmen and the self-employed, the slowdown will directly lower the surplus they can invest in a property.

Financing for both builders and buyers has also become more difficult in the last several months. Already, banks have been slowing down their exposure to this sector, leaving builders to depend either on the shadow economy or on private players such as non-banking finance companies and private equities (PE).

The hit on the currency has scared overseas PE players as their returns got reset by 10-20 per cent. Moreover, the volatility in the currency would make anyone think twice before committing to a longer term investment. Builders will also no longer be able to borrow using buyers’ credit quality after the RBI woke up to shut down the dubious 80:20 and 75:25 schemes.

TOUGH RBI TALK

The new RBI Governor has shown that he can walk the walk, by not lowering rates in his first policy review. The State Bank of India has already hiked its lending rates and it is a matter of time before other banks follow suit. Buyers will face higher EMIs just when builders push for sales during the festival season. With both builders and buyers facing higher costs, the appetite to build and buy new homes will be muted in the coming months.

The government, through its passage of the land acquisition Bill, has also made it more difficult for large developers by diminishing their bargaining position vis-à-vis land owners, especially farmers. The pro-consumer Real Estate Regulatory Bill, which is in the offing, will further curtail the freedom that builders have, such as being able to move funds from one project to another. While these Bills address a long-felt need, it is yet to be seen whether their rules are clear and transparent, and can encourage new thinking and capital into the development business.

BLACK MONEY FACTOR

There is another surprise factor that could impact builders in a big way. Real estate has always attracted people with dubious backgrounds, partly because of the opaqueness surrounding it and partly the lack of sensible regulation. We all know that black money is rampant in this sector. It is also known that black money surfaces during elections to fund party objectives.

Therefore, it would not be inconceivable to imagine that black money may be sucked out of this sector in the months leading up to the election, which may further reduce financing options for developers or force them to sell their inventory at a discount.

There is one prior academic study — done by the Centre for Global Development — that is consistent with this hypothesis. The authors of the study looked at cement prices and election cycles, and found that cement prices (proxying for construction activity) have fallen systemically during elections.

The macroeconomic situation and builders’ own practices have now put them in a deep hole. To dig themselves out, they need to consider bringing down prices to make houses affordable once again. A two bedroom apartment in a Mumbai suburb is priced today in the range of Rs 1.5-2 crore. The few who can afford them are willing to buy and lock them up, expecting future price appreciation. Such investment demand-led price increases can lead only to asset price bubbles. Natural demand — those who buy to live — has been driven away from this market.

PRICES DIPPING

Bubbles grow fast but also eventually pop. Already, there is some indication that this is happening. The National Housing Bank’s Residex, which tracks residential prices in a few cities, had started to decline even before the crisis set by a chain of global events erupted. But the decline in real estate prices is happening at a slower rate than expected if the market was more transparent. A significant price correction is needed to sustain this industry in the face of declining demand and increasing cost of capital.

It would be unfair to expect builders to lower prices without eliminating some of the root causes that ail them. The government should seek to streamline the processes that burden land development today. Many developers, including those in the affordable housing segment, complain about the maze of approvals that need to be sequentially obtained before the shovel can hit the ground. Delays in project completion have a direct impact on house prices. The government can capitalise on the grim situation and force through changes like a one-stop approval window that will help attract capital. Only a structural change can attract serious, long-term capital to this crucial industry.

(The author is Associate Professor of Finance and Coordinator of the IIMB-Century Real Estate Research Initiative, IIM-B.)

http://www.thehindubusinessline.com/opinion/realty-bubble-waiting-to-burst/article5157096.ece

An attempt to gain a firmer grip on realty

Acquisition of land could become more onerous and time-consuming for private developers.

The regulatory regime in the real estate sector has for long attracted criticism related to the land acquisition process, transparency of the developer community during the project development cycle, and the marketing and sales process among others.

Government authorities and organisations such as CREDAI and NAREDCO have been working on reforms through regulatory changes. The introduction of two Bills in Parliament — the Real Estate (Regulation and Development) Bill, 2013 (RE-Bill) and the Land Acquisition, Rehabilitation and Resettlement Bill, 2011 (LARR) — is a step in the right direction. While focusing on various aspects of real estate, the common objective of the proposed legislations is transparency and protection of all stakeholders.

RE-Bill introduces new layers of regulation such as mandatory registration of projects with the prescribed authority. This authority has procedures in addition to those under existing regulatory authorities, without demarcating the respective spheres. Further, a developer should inform the buyer about the time schedule for connecting the proposed project with various municipal services. The Bill attempts to clarify ambiguous terms such as carpet area, super area and so on, to help buyers make an informed decision.

LARR — which replaces the century-old Land Acquisition Act, 1894 — proposes a unified legislation for land acquisition and adequate rehabilitation mechanisms for those affected. While ensuring that people losing land are adequately compensated, it will also safeguard the land acquirer against unwarranted claims.

A key challenge is to obtain consent of at least 80 per cent of the project-affected families, which includes farm labour, tenants, sharecroppers and those working on the land for three years prior to acquisition and whose primary source of livelihood may be affected. With this requirement, land acquisition would become more onerous and time-consuming for private developers. Moreover, the developers have to provide compensation, rehabilitation and resettlement for the landowners and affected families whenever the land purchased exceeds the prescribed limit. The compensation policy calls for payment of four times the market value of land in rural areas and double in urban areas. This will substantially increase the project cost as land cost constitutes a sizeable component of the total project cost, which will ultimately be passed to consumers.

In addition, the acquisition process involves undertaking a Social Impact Assessment (SIA) study, for which no minimum threshold is prescribed and applies even for minor acquisitions. This would delay developers looking for smaller parcels of land for small- to mid-size projects. The SIA will be evaluated by multi-disciplinary expert groups, and the absence of unified parameters can result in inconsistent assessments by different groups. There is also no time-frame for the completion of SIA.

The positive elements in the Bills include greater transparency and uniformity, which might attract more global players and give buyers reasons to cheer.

Although there are some practical challenges in the implementation of these regulations, they will hopefully be resolved in the interest of stakeholders (customers, bankers, investors, government authorities and developers).

In a country where the real estate sector is already proving to be a key driver of economic growth, with potential to contribute significantly to the GDP, the Government should take a pragmatic approach and a balanced view of the much-needed reforms.

(The authors are chartered accountants)

(As told to Grant Thornton)

http://www.thehindubusinessline.com/features/taxation-and-accounts/an-attempt-to-gain-a-firmer-grip-on-realty/article5154231.ece

Real Estate Regulatory Bill: Any ‘Real’ Comfort?

The Real Estate Regulatory Bill 2013, which the Union Cabinet approved after a long hiatus in June 2013, was touted to be a game-changer for property buyers as well as the industry as a whole. The aim of the bill clearly was to provide buyers with a level playing field in an industry that is perceived as chronically non-transparent.
 
Many clauses proposed under the bill are clear meant to protect property buyers from the malpractices that have often resulted from information-asymmetry. However, some of the clauses under the bill are also viewed as hurdles by the industry’s stakeholders, particularly developers. One such clause is the mandatory procurement of all construction approvals prior to project marketing / sales.
 
Why This Clause Hurts
For developers, the biggest concerns when it comes to obtaining approvals from the various approval authorities are:

Approvals have to be sought from multiple civic authorities – the local municipal body (separate approvals required from departments in charge of sewage, environment, water, urban planning, etc.), the Electricity Board, traffic authorities, the fire department, airport authorities and do on. This is extremely time-consuming.

Because of the long periods involved in obtaining approvals, the cost of construction and finance rises and naturally gets passed on to the end-users. Increased purchasing prices dampen demand.

The Bill is silent on the approval authorities coming under the ambit of this clause (or the penalties for causing delays).
 
Seen in this light, the concerns of developers are genuine. The Government - or the market - will have to come up with some workable solutions for conundrums in order to avoid escalation of cost.
 
The Impact On Property Prices
Firstly, we need to consider how clarity the policy offers with regards to what these mandatory pre-launch approvals would include. Significantly, as per World Bank’s statistics on Dealing with Construction Permits, a developer in India has to procure 34 different approvals for a residential project to materialise.
 
This is a massive procedural burden when compared to developed economies, where not more than 15-16 approvals are needed. In fact, it is high even by emerging markets standards - in Brazil it only takes 17 permits, in South Africa 13 and in China 28. There is a need to define at what stage of approval will the developer be able to start marketing his project to consumers – is it after obtaining the Intimation of Disapproval (IOD), a Partial Commencement Certificate, the Commencement Certificate, or otherwise?
 
Estimates suggest that the approval process in India usually takes around 1.5 to 3 years, and that it could account for 5-10 per cent of the total construction cost of the developer on a conservative basis. With the increased delay-induced holding cost to developers, financing cost increases as well - and is passed on to the buyer.

Is There A Solution To This?
The central authorities have identified the factor of administrative delays as crucial, and have formed an expert committee to suggest ways to provide single-window clearances to developers. As per the central government’s expert committee’s estimates, the right kind of decisions could possibly bring down the approval timelines from the current 196 days to 60 days.
 
However, this is easier said than done, considering that land in India is a state subject, and states having authority over this may want to make some changes in the bill specific to their states. Only time will tell how this arrangement will pan out.
 
Ways To Stem The Rising Cost Of Financing
In order to balance out the rising cost of financing due to approval delays and due to proposed condition about guidelines of utilising accrued money from a project towards that specific project only, the central authorities can open up new avenues of funding for developers. One such possible avenue is the fast-tracked introduction of Real Estate Investment Trusts (REITs). REITs will not only provide institutional exits to funds that have invested in realty projects thus encouraging them and newer funds to invest as new sources of project funding – they will also help the industry to become more transparent due to the REITs model’s stringent disclosure norms.
 
Another area of funding could emerge if banks are allowed to capitalise land acquisition in India, with suitable conditions imposed on developers to launch and complete projects a reasonable period. This would directly compensate developers who were hitherto partially dependent on funds from pre-launch sales to make new land acquisitions.
 
There is no doubt that the Regulatory Bill will help the industry mature and create transparency in the long run. However, it may not hold immediate benefits for end-users after its enforcement. In the near term, we can only expect the fine print to become clearer. That said, the authorities have at their disposal certain policy tools that could be effective in dampening any negative side-effects that the bill could generate.

Ashutosh Limaye, Head – Research & REIS, Jones Lang LaSalle India

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‘Finance cost of developers may go up’

HYDERABAD, SEPT 20:  

With the proposed Real Estate Regulatory Bill, where developers are expected to keep considerable portion of sales in escrow account for a majority of the construction period, finance cost for developers is expected to increase, according to Anuj Puri, Chairman and Country Head, Jones Lang LaSalle India.

This, along with the increase in cost of construction and the already challenging economic scenario, is expected to affect the profit margins of developers, In such a scenario, the real estate industry is obviously hoping for relief from RBI by way of reduction in financing cost, he said in a statement.

With RBI increasing the repo rate by 25 basis points, this will increase the borrowing cost, he felt.

“While the real estate industry has reason to be somewhat disappointed on the increase in borrowing cost, the RBI has made provisions for increased liquidity in the system. Considering the current economic situation, I believe that the new RBI Governor has acted suitably with this monetary policy,” he said.

rishikumar.vundi@thehindu.co.in

Real Estate Regulation Bill to draw fair industry practices, accountability

The Real Estate Regulation and Development Bill is set to encourage fair practices in real estate dealings and will fix accountability with the developer at every stage of development, according to real estate experts.

The Real Estate (Regulation and Development) Bill 2013 seeks to establish the Real Estate Regulatory Authority to protect the interest of consumers in the real estate sector. The Bill is for regulation and promotion of the real estate sector and to ensure sale of plot, apartment of building, as the case may be, in an efficient and transparent manner.

The Land Acquisition and Rehabilitation & Resettlement Bill is expected to reduce litigations and delays in projects by providing defined guidelines for land compensation. Furthermore, the changes to the Special Economic Zone with respect to relaxation to the minimum built up area criteria are a step in the right direction, providing an impetus to real estate developers, according to latest report on real estate by the Federation of Indian Chambers of Commerce and Industry (FICCI) and Ernst & Young (EY).

Said Venu Gopal, executive director, EY: "Revisions in SEZ guidelines helps unlock value from investments and assists in faster completion of the project, thereby easing liquidity pressure. The focus of funding has moved from plain vanilla equity deals to debt and structured products. Valuation presents a significant challenge to equity deals. Mezzanine debt and structured funding helps bridge the gap between the expectation of promoters and investors."

Developers are shedding non-core activities to de-leverage their balance sheets and reduce the outgo on account of interest. Several developers are exploring asset-light models such as joint development agreement (JDA) to reduce the impact of funding land purchase. "In tight liquidity conditions, JDAs help developers make optimum use of capital by simultaneously entering multiple projects. Better realisation on account of an upside from future cash flows helps land owners as well," added Venu Gopal.

According to the report, the Indian real estate sector is going through a paradigm shift, driven by regulatory developments and new trends in the industry, which will facilitate increasing efficiency and transparency. The country's demographic advantage, rising urbanisation and income levels, growing middle class and planned infrastructure investment of Rs 55 lakh crore in the twelfth Five-Year Plan (FYP) indicate a robust long-term prospects for the sector.

FICCI - EY's white paper on "Building New Dimensions For Real Estate Growth", addresses issues in the sector including IT-enabled business transformation, fraud vulnerability and mitigation, and effective workforce management. It also highlights several policy interventions in the sector, new emerging asset classes and developments in the South Indian real estate market.

Developers have started focusing on new asset classes such as affordable housing, senior living, education and healthcare real estate which provide promising investment opportunities. The medical city concept is gaining visibility on the back of extensive budgetary focus on health and family welfare by the Indian government. Medical tourism is also set to grow in future due to India's cost advantage and is likely to be the primary driver of health cities. Entertainment-related real estate, such as sports cities and amusement parks are unique emerging asset classes in India.The report added that 'transit-oriented real estate' (TORE) involves development of industrial hubs, townships, retail and office space around major airports, industrial corridors, dedicated freight corridors and metro rail.

The modernisation of major international airports, development of dedicated freight corridor and national manufacturing zones (NMZs), existing and upcoming metro rail projects in key cities have driven the growth of TORE in the country, as per the whitepaper.

Said J C Sharma, chairman, FICCI sub-committee on South India Real Estate and VC & MD, Sobha Developers Ltd, "Traditional methodologies in the industry have been put to test, providing an exciting phase for developers to evaluate new growth channels. Development of these emerging asset classes is gaining momentum in almost all urban centers of the country. The need is to harness the potential in an efficient manner."

http://www.business-standard.com/article/economy-policy/real-estate-regulation-bill-to-draw-fair-industry-practices-accountability-113091901135_1.html