Budget 2019 is going to be unveiled in a few days. And market is abuzz with opinion of stakeholders. Demanding incentives and relaxations, developers are vying to tide over the crisis looming over the real estate sector.
The suggestions on offer range from setting up a special window to bail out troubled non-banking finance companies (NBFCs), tax rationalisation, subsuming stamp duty, extending input credit tax particularly for commercial real estate, reducing corporate tax, abolishing Minimum Alternate Tax in order to provide thrust to Special Economic Zones; and some demanding infrastructure status for the industry.
Besides the above cited direct measures, industrial bodies have asked government to consider offering exemption of Rs 3 lakh on taxable income from the current Rs 2 lakh against home loans on self-occupied properties under section 24 of Income Tax Act. Some have also appealed government to let property be dealt under section 71 and 71 of Income Tax Act which allows people to claim tax exemption by showing losses. Framing uniform definition of affordable housing for all government agencies is another demand.
An industrial body of developers wants banks to start funding land transactions for affordable housing. The federation says since land cost constitutes about 40% of the entire project cost, property prices cannot be brought down without rationalised finance cost.
Reserve Bank of India (RBI) had directed banks to stop funding land purchases in 2009. Bankers started exercising caution while lending to real estate sector owing to the rising asset quality mismatch. However private equities, institutional investors and venture capitalists based out of developed economies started fuelling Indian markets thereafter.
NBFCs and private equity players took active interest in the realty sector and provided funds to the developers. But the rates they charged were exorbitant. In the current scenario broadly there are two ways to give thrust to the ailing industry:
- Rationalising finance cost so that stakeholders can create capacity
- Opening land banks to enable more participation of stakeholders
But before we go for another round of quick-fix solutions, let us analyse what happened in the past
Table 1.1 – Real estate price movement (Rs psf) across key cities shows continuous growth between 2009 and 2014
|City||CY 2009||CY 2010||CY 2011||CY 2012||CY 2013||CY 2014||CY 2015||CY 2016||CY 2017||CY 2018|
(Source – Liases Foras)
Graph 1.1 – Sales and inventory trend over the years reveal supply outpace demand by a huge margin
(Source – Liases Foras)
During the credit boom, property prices kept increasing. In some cities prices doubled within four to five years. As flats turned too expensive, sales started stagnating while inventory kept climbing up year after year. The graph above shows monumental increase in inventory compared to sales. It was only after RERA was imposed that construction activity slowed down.
Besides RERA, government had also rolled out several other policy measures onwards 2016 such as demonetisation, GST and bankruptcy code. We have also noticed buying activity has gone up in the recent years from the time prices have remained under check.
Buyers entered the market since prices remained muted but preferred near-complete or complete properties over under-construction apartments. While GST was imposed on under-construction apartment, no taxes were levied on transactions in ready apartments. Also buyer confidence in under-construction property market started weaning over time due to inordinate delays and default.
Table 1.2 below shows how buyer preference shifted towards ready/completed properties over under-construction ones in the past few years. Sales in the ready property grew from 11% to 27% in the past five years. Going forward some improvement in traction of under-construction residential properties can be noticed since GST rate was brought down in the interim union budget announced in February 2019.
Table 1.2 — Proportion of demand of ready units in total sales
|CITY||CY 2014||CY 2015||CY 2016||CY 2017||CY 2018|
(Source – Liases Foras)
Nobody but buyers were complaining in good times
Among large economies across the globe India has the highest NPA ratio at present, according to Bloomberg. Most of them started originating onwards 2006-07. Driven by the growth story, banks opened their gates for real estate players as well as for other sectors.
Developers were able to secure funds for their projects without having to involve their own stakes or skin in the game. Developers kept increasing the prices quarter after quarter and buyers remained at bay (graph 1.1).
Land valuation skyrocketed and nobody except end-user was complaining back then. Prices kept increasing irrespective of demand and housing affordability index kept worsening. Uncertainty hit the market rally in September 2008, soon after Lehman Brothers collapsed pushing the western world into recession.
As a measure to offset ripples induced by global economic crisis, in 2008 Reserve Bank of India (RBI) allowed banks to restructure loans to developers. It also opened a special window to help banks, mutual funds, non-banking finance companies (NB FCs) and housing finance companies (HFCs) tide over liquidity crisis.
It should be noted that all the four financial sectors are interconnected and stress in any one of them manifests stress in the overall financial industry. The idea was to insulate the domestic economy from post-meltdown shocks and turbulence in 2009. And things seemingly were back on track.
Five years later RBI intervened again in July 2013, in order to support the economy and opened up a special lending window, this time to provide clutches to mutual funds. Sudden panic erupted in the domestic market when foreign institutional investors exited Indian stock market in hordes soon after US Federal Reserve announced it would be tapering in bond purchase programme (taper tantrum). The two direct interventions infused much-needed capital amidst highly sluggish market conditions. But when purse was loosened, land valuation was also jacked up.
As banks were highly regulated, foreign players opted for NBFCs and other financial segment players instead and the policy to allow 100% foreign direct investments into NBFC also acted in their favour. NBFCs doling out bullion loans, vehicle loans and property loans attracted a lot of foreign investors. Humongous amounts of foreign investments got routed to Indian markets in 2007, 2008 and 2009.
Share of NBFC sector, which accounted for 8.4% of Indian economy till 2006 soared to 14% by March 2015. Credit boom that spanned onwards 2007 up to 2011 led into anomalies in the market. Buyers were left in the lurch since houses remained unaffordable.
As land prices kept soaring, developers remained focused on building high-end or luxury products in order to increase their profit margin. With funds available freely, share of promoter equity in a project kept reducing over the years.
Globally several academicians in their research project and studies have shown impact of foreign direct investment on property prices. In fact in January 2010 then RBI governor D Subbarao commented that high levels of global liquidity were contributing to rising asset prices in India.
Hurt both by prices and policy paralysis
After a free run that lasted for more than a decade the first regulatory reform in the highly speculative property market came in the form of Real Estate Regulation and Development Act. Originally moved in the parliament in 2013 under UPA government RERA was enforced in 2017.
It was the first time government created a regulatory body to protect the buyers from malpractises of developers. While established developers tried to meet commitment, the fly-by-night operators managed to dupe a lot of buyers by then. In fact delays in construction of real estate projects became commonplace all across the country with NCR topping the list of fraudulent builders.
Though it was evident that speculators were flipping properties and ballooning property prices (particularly in the pre-launch phases) it took 10 years for authorities to enact a law. Much before RERA came into force, while releasing its guidelines and master circular on housing finance RBI kept asking banks/lenders to ensure that funds given to developers/builders are not used for speculation of land. RBI also stressed on giving loans to developers who had necessary permissions and asked banks to go ahead with disbursement only after borrowers obtain requisite clearances from the concerned authorities.
RBI policy measures
- In this context, we advise that while appraising loan proposals involving real estate, banks should ensure that the borrowers should have obtained prior permission from government /local governments/other statutory authorities for the project, wherever required. In order that the loan approval process is not hampered on account of this, while the proposals could be sanctioned in normal course, the disbursements should be made only after the borrower has obtained requisite clearances from the government authorities – RBI March 1, 2006
- Care should also be taken to see that prices charged from the ultimate beneficiaries do not include any speculative element, that is, prices should be based only on the documented price of land, the actual cost of construction and a reasonable profit margin – June 2006 master circular on housing finance.
- The deterioration in asset quality of Indian banks, especially PSBs, can be traced to the credit boom of 2006-2011 when bank lending grew at an average rate of over 20 per cent. Other factors that contributed to the deterioration in asset quality were lax credit appraisal and post-sanction monitoring standards; project delays and cost overruns; and absence of a strong bankruptcy regime until May 2016 – December 2018.
To put a check on the speculative market conditions RBI tried to take some measures in the past but by that time damage had been done. Besides RERA the other law framed by the government Insolvency and Bankruptcy Code has given more teeth to both buyers as well as financial institutions. Earlier developers were able to get off the hook easily since banks rarely declared stalled projects as non-performing asset.
Government too shoulders the blame
While it is easy to pin blame on developers, speculators, regulators and investors for the current scheme of things in the housing sector, lawmakers in the Parliament cannot be let off the hook either. Strong policy measures were brought about in the last three years and schemes under Pradhan Mantri Awas Yojana are gaining pace only now. Another positive step taken was to revise the tax rules on home loans and limiting exemption on interest component to Rs 2 lakh only.
We have multiple agencies at central and state level to provide for housing, but somehow gap only continues to widen. Plus interest of buyers was never kept paramount resulting into large scale malpractises in the industry.
As per estimates of working group for 12th Five Year Plan (2012-17), shortage of urban housing is about 18.80 million units (1.88 crore units). And housing scenario is worse off in rural India. Estimated shortage in rural parts is pegged at 43.67 million (4.36 crore units) in the same plan.
Under PMAY Urban programme 26 lakh houses have been completed from 2014 onwards. A total of about 84 lakh houses have been sanctioned in urban areas under the scheme.
While government is busy plugging the gap, our data shows that 10 lakh units are lying unsold in metro cities (Mumbai Metropolitan Region, National Capital Region, Bengaluru, Pune, Kolkata, Hyderabad, Chennai and Ahmedabad) and additional 5 lakh in other cities.
So why is buyer refraining from entering into the market? Well our data shows that national average psf rate (on carpet area in apartment units) stands close to Rs 7,000.
Such high prices are haunting the buyers because there is dearth of affordable units in the market. Also government made minimal intervention to regulate the highly speculative sector for almost a decade. Let us look at the list of loopholes which have led to the inefficiency in real estate sector just as they have hit other sectors all this while and what has been done to resolve them –
- Regulators/bankers without teeth: RBI has limited power to improve governance of PSU banks. PJ Nayak Committee in 2014 recommended that Bank Nationalisation Act as well as SBI Act be repealed and PSU banks be registered under the Companies Act, 2013 to ensure better board governance. Having much higher ratio of NPAs compared to private banks, PSU banks remain under the influence of government and political parties.
- Banks had to think twice before declaring accounts of defaulting developers as NPAs earlier. To maintain profits on their books, banks used to avoid dubbing a bad loan into an NPA till the time disputes between two parties were settled with mediation of Debts Recovery Tribunals. Also the recovery rate was dismally low (13%) to encourage builders from initiating action against developers. Though the mandate was to settle complaints within six months, DRTs took an average of four years to dispose cases. The problem can be gauged from the fact that by March 2018 one-fourth of loans given to large business groups turned into NPAs in the country. Implementation of Insolvency and Bankruptcy Code since December 2016 has addressed the problem to a large extent but cases are rarely being disposed within the due timeline.
- While Central Repository of Information on Large Credits (CRILC) was set introduced in May 2014 so that bankers are able to monitor and report bad loans valuing Rs 5 crore or more information on borrowings from banks, NBFCs, market, external commercial borrowings, foreign currency convertible bonds, rupee denominated bonds (masala bonds) or inter-corporate borrowings are not available in a single repository. Government should expedite and support RBI’s move to set up Public Credit Registry.
- Similarly government needs to create a repository to monitor debt snapshot of trusts, societies, association of persons, general partnership firms, proprietorships among others. At the moment Ministry of Corporate Affairs only monitor data of companies and limited liability partnerships. With increased financialisation happening we need to know how much an entity owes to each other since NBFC, mutual funds, foreign portfolio investors, alternative investment funds, private equity players among others are participating in the economy.
Aiming for a healthy recovery
It seems that our growth story has ended abruptly. From rags to riches to losing it all again. But that is what people with myopic vision would believe. Between growth and clean-up what is more important? We say clean up.
For all sectors, including real estate, it is time to start with a clean slate. Once the rubble around NPAs settle down, our resilient financial industry and institutions would spring back with renewed vigour and so would the real estate sector.
But to hit the road to recovery some preparation is required. We have seen merely reducing interest rate is not enough to boost real estate industry. Exorbitant rates charged by NBFCs and private equities coupled with greed of developers have driven the property prices up irrespective of demand. Going back to the original concept in this union budget and policy measures ahead government needs to:
- Rationalise finance cost so that stakeholders can create capacity
- Open land banks to enable more participation to create capacity
- We have seen in the past that developers kept holding on to prices even when sales were not happening in that proportion. It appears that developers did not want their margins to come down. Since money of financial institutions/investors is also involved, reducing prices would force all stakeholders to rejig their financial models. The bailouts given to real estate companies by allowing restructuring in the past have failed in tackling inefficiencies of the industry. Before allowing banks to fund land purchase at reasonable rates, government will have to discipline developers. Ensuring provisions under RERA are followed in letter and spirit shall be the first step and binding for all stakeholders.
- SEBI has already opened up real estate investment trusts (REIT) and investment trust to retail investors (InVIT) for commercial real estate with certain limitations recently. Accordingly similar options can be done to explore residential real estate to open up more avenues of funding for industry players.
- Once developers are disciplined, granting infrastructure status to the industry on the lines of affordable housing will help them avail external commercial borrowing, foreign portfolio investments and delve into similar funding routes. In a possible sign of emerging shoots of recovery, it is seen that after a brief lull, foreign fund flow into the sector has increased in the first half of 2019 after regulatory steps have been enforced.
- Providing single window clearance to building construction related plans/proposals is equally important. At the moment just to get environment clearance for a project, a developer requires an average of nine months. Investors may lose interest in the realty sector if government only keeps regulating the stakeholders further without fixing responsibility of its own officials.
- Leaving the industry unregulated has created a huge inventory of unproductive projects across the country and particularly in northern states. Savings of lakhs of buyers are at stake in such stalled projects. A special project vehicle or public-private partnership project needs to be created under the supervision of expert committee to resolve such issues. After evaluating feasibility of stuck projects reputed builders or government agencies with proven track record needs to be roped in to finish the stalled projects in a time-bound manner. Such private developers need to be incentivised in some form to generate their interest in stuck projects.
Opening land bank
- Convincing developers to create capacity will not work unless government facilitates seamless land acquisition in order to bring down land cost. A state subject, land acquisition laws vary across different states. On an average it takes about four and a half years to complete acquisition process (according to study done by Centre for Science and Environment) In the absence of efficient policies to acquire land, developers enter into an agreement with the seller directly. Besides paying direct cost to the seller, developers also have to consider the cost to manage bureaucracy and cost of elapsed time before he is able to sell anything on the said chunk of land. The model growing popular in some states is the land pooling method in which farmers are bartering bigger chunk of land in exchange of fully developed commercial or residential plots. But a lot of ground needs to be covered on this front.
- It has been seen world over that creation of more land bank does not necessarily mean more housing for medium or lower income group families. But if done with proper planning opening land bank can mitigate housing problem. Since migrants continuously flow in developed urban centers and need accommodation immediately creation of affordable rental housing by opening land bank is the way forward. Rental housing schemes are going to be rewarding for all stakeholders. Unutilised government land can be opened and tie-ups with developers can be done to promote affordable rental homes for urban youth.
- A lot of construction activity has taken place in peripheries of a city under the guise of affordable housing schemes. Most of these units attracted investors when government offered tax exemptions to people under section 71 of Income Tax and remain unused. It is time infrastructure and enough social fabric is created in such locations in order to attract people. Such schemes can also be considered for affordable rental scheme.
- Revising building byelaws to meet contemporary housing needs is another field where we lack. Revising floor space index norms, segregating urban agglomerations into zones to decongest commercial business districts is another need.