HYDERABAD: The Reserve Bank of India’s diktat to banks to link the disbursal of home loans to stages of construction, to protect the interests of buyers and contain the fallout of ‘innovative’ housing finance schemes, has yet again revived the debate over the right funding formula to sustain the real estate business. Developers have experimented with numerous funding options. Nevertheless, many of them are now being forced to seek other unregulated sources of funding, which come at a significantly higher cost.
While reputed developers are able to raise money at the interest rates of two to three per cent a month, smaller builders are paying close to four per cent a month with greater collaterals. The urgency varies from developer to developer, which is being seen as an opportunity by several high net-worth individuals (HNIs), exporters and even diamond merchants. Borrowing at rates as high as 48 per cent per annum, is not sustainable in any business. However, the realty sector has made use of such options in the past, if urgently required, for short-term periods.
Analysts point out that interest rates are higher for developers with whom the risk is high. When the lender is unsure of the track record of the developer, he obviously puts it in a high risk zone to extract higher interest rates. Developers with the ability to complete the project, are still raising money at around 20-25 per cent interest rate per annum. This scenario is likely to remain as long as there is serviceability of the interest cost. However, this looks unlikely in the near future. For example, as on March 2013, the top 20 listed companies held an inventory of Rs 67,096 crores. The ratio of inventory to sales on an average, based on FY13 sales, stood at more than 2:1.
Siddharth Rajpurohit, AVP of the The Market Financial Intelligence, explains that the real estate sector is facing a significant cash crunch, with the commercial segment under maximum pressure. As per the Confederation of Real Estate Developers’ Associations of India (CREDAI), the total housing target in the 12th five-year plan is 37 million, and developers are expected to face a funding gap of USD 70 billion for the same, over the next five years.
“Banks will be reluctant to provide additional funding in the present scenario, where major developers are unable to raise the required equity. With the RBI sucking out liquidity to control inflation, the cash crunch is projected to worsen. This may increase the cost of funds, which is already very high. As inventory piles up, we may witness a fall in the real estate prices, particularly in the commercial segment. Consequently, profit margins could shrink further, making projects unviable,” cautions Rajpurohit.
The construction-linked payment plan is one of the oldest plans. This plan not only puts pressure on developers to expedite the construction in order to receive the payments, but also safeguards the customer, as the outflow is linked to the completion of his/her house.
Gaurav Gupta, director, SG Estates, points out that the real problem lies in the cost of land, which can be as high as 40-60 per cent of the project’s total cost. It means that the developer has already incurred cost more than 50 per cent, to start with the project. Therefore, receiving payments in small trenches related to construction becomes totally unviable.
“The best solution to the problem is flexi-payment plans, where 40 per cent of the payment is released by the time the project reaches the stage of excavation and the balance amount is linked to the stage of construction. This addresses the concerns of both, buyers and developers. If new curbs are enforced on construction loans, then the real estate industry is bound to suffer. The market scenario at present, is not very encouraging, due to global factors and the slowdown in the domestic economy. In this situation of low sales and resultant liquidity issues, developers are relying heavily on construction loans, to ensure fast completion of projects and timely delivery,” points out Gupta.
Rahul Gaur, CMD of Brys Group, maintains that the RBI’s new guidelines have been seen as a setback by the developers, this year. “In any case, funding for real estate projects at every level has always been gap funding. Moreover, the business lacks a definite financial model. We have to secure funds in an eco-system where, instead of policies facilitating a seamless cash flow, all efforts are made to obstruct it, as if the shortage of housing is not a national issue but an issue of developers’ business alone,” Gaur complains.
CREDAI has criticised the Reserve Bank’s decision to link disbursal of home loans to stages of construction. The organisation insists that this move will harm developer sentiment and disturb business plans. “Housing finance institutions and banks normally safeguard their interest while devising various instruments,” points out Lalit Jain, chairman of CREDAI. “Abrupt circulars which advise banks against following established practices, will only harm sentiments and disrupt business plans. This will create setbacks for projects and affect the end consumers,” he cautions.
Some analysts feel that the RBI has done a wonderful job in protecting the interests of the customers. Nevertheless, they also add that the real estate sector could do with a little bit of assistance. The realty sector supports more than 100 ancillary industries. Consequently, if this sector grows, so does the economy. Hence, real estate should be treated at par with other industries and the working capital needs of the industry should be addressed like any other industry.
However, liberal funding has often meant that funds have been routed towards fresh land acquisitions, rather than completion of existing projects. Critics insist that developers have hurt their own cause. There seems to be no rational or acceptable funding formula that can pull the sector out of the current scenario. Developers, meanwhile, complain about the absence of a formal financial modelling of the business. The prime grouse is the absence of funding for buying land. At the same time, this absence also filters out the economically weak and insignificant developers.
Some independent financial analysts maintain that although real estate developers have hurt their own cause, a curb on construction funding would not be prudent. In the present scenario, the cost associated with the construction of a project has increased by around 25 per cent year-on-year. The sector will be unable to grow, if it relies only on equity funding. Hence, a curb on construction funding would definitely worsen the situation for the cash crunched sector.
On the other hand, construction-linked funding seems to be the most prudent method to maintain discipline in this opaque sector. Projects which have construction loans will do no harm to their cause if they follow an escrow account system to avoid diversion of funds. Moreover, banks and financial institutions have tightened their mechanisms to check on diversion of funds. Reputed players too, are focusing more on completing projects, rather than on new acquisitions. Ultimately, until a regulatory mechanism is evolved, funding will continue to be a debatable issue.