2019 was a strong year for real estate investment trusts, or REITs. The real estate sector delivered a 28% total return for the year, thanks to the REIT-friendly

Are the steps announced by Nirmala Seetharaman enough to revive the real estate sector? If not, why?

A small story is in place here. There was farmer who had a special hen. A hen that laid golden eggs. But there was a constraint, as with everything. The hen laid only one egg a day. The farmer got greedy & thought why to wait for the eggs every day. He decides to have ALL of the eggs the same day.

You know the rest…..

The sorry of Indian real estate sector is quite similar. We’ll see how this happened & why it is so complex to revive this now. Finally, how we can we review it, if at all.

How did the golden hen got killed?

There was an interesting business model that the real estate sector enjoyed in India. The norm is that every business needs capital to start with. Else everyone can start the business. Initial investment & working capital is what creates an entry barrier for any business.

Not in real estate. This was the only industry where you could actually have a negative working capital. Developers could launch the projects & collect money without commensurate investments. The construction linked plans were designed to collect 95% payment from customers at the completion of the structure itself. At this point, the builder has not spent more than 60% of the project cost. With 95% money collected & no penalty on delayed possession, the builder is sitting on clean 35% profit. He stops the work as there is no incentive to complete the project just to get the balance 5% of payment. The result is what you see all across India, more specifically the Delhi NCR region – Incomplete & abandoned buildings. The golden eggs were getting laid every day.

Now where did the 35% profit go ? It went to buying new land banks & financing the new projects to further create this money printing machine without any penalty what-so-ever. Because the money machine was going well, it attracted many “new entrants” in the market. After all, you just need some political connections to get approvals (with speed money of course) & you could launch a project, collect money & take profits.

Now this could not have continued forever. It is like riding a tiger. One can’t get down & the people got going. The golden hen was close to getting killed soon. The first signals came when the new sales dropped.

There is only so much that customers can buy. After all, they also need to sell the flats bought earlier & then invest in the new ones. But the old ones are not ready. They are still standing tall but abandoned as the builder has left those to launch newer projects. After all, the business was to collect money as fast as possible, by launching & abandoning projects. The new customers vanished as they were already stuck in old abandoned projects. As the fresh sales slowed down & so did the new launches. Look at the steep fall in the new project launches.

The new money collected was not enough to cover the construction cost. The pipeline went dry. There was no money to complete the old projects. The builders had bit more than they could chew. The golden hen was killed.

So what is the challenge now?

The challenge is this.

A huge unsold inventory of homes across 8 major cities of India. We have nearly 7 lac unsold homes at a conservative estimates. Some estimates put this number at 12 lac units if we include the smaller builders. At the rate of sales that we have currently, it will take 3 years to finish the inventory of existing homes, assuming still that we anyways need one year inventory as the gestation period is high for projects. So effectively we don’t need any new launches for next 3 years & we’ll still not be short of homes to sell. That is some problem the industry is sitting on.

But there is an even bigger problem. And that is related to this very unsold inventory. There is NO CASH FLOW with builder to complete the projects. Since new launches were feeding the old projects, when fresh sales stop, the existing projects also come to a halt. Since the builder took out more money in advance & spent it outside of the project, there is no money today. Don’t ask me where the money was siphoned off, take your guess – new launches, politics, election financing, other business, safe heavens abroad, etc. But all that is immaterial now. The fact is the payment plans were front-loaded & there was no penalty for delayed possession. The result is a Ponzi scheme which has gone bust.

How is the real estate financing itself now?

See the contrast in the funding of real estate projects in India from 2018 to 2019. You’ll be surprised to know that banks don’t do real estate financing. They just finance your home loans but real estate builders are too risky for them. Most of this financing happens from private equity players , NBFCs & people like you & me who take home loans. Cheapest funding is customers as they don’t demand any interest payments for delays (of the law is lax in this case). Private equity is tough & demands 20% plus returns at the least. NBFCs demand atleast 14% to 18% returns when they lend to real estate. Even that lending has now dried up sharply in 2019 after IL&FS crisis. The below chart is sufficient to explain ths story of funding drop for Indian real estate.

So the solution to the whole issue is only this:

We need fresh money to complete the existing abandoned projects so that those become valuable & the fresh cycle of renting & buying can start. Where will the fresh money come from ? Well we’ll answer that in a bit. Consider the solutions on the table so far.

Supreme court & bankruptcy board has recommended that the existing projects be handed over to new reliable builder like NBCC & manage the funds in a water tight manner to avoid any pilferage. But that is not a solution. Whoever comes in will have to start by investing money into projects. And a project where 50% of costs are due & only 5% to 10% collection is pending from customers, there clearly is a shortfall of 40%. Who will pay this 40% gap funding ?

The government ? Well why should the government pay for private investors? In any case this is not possible. There are talks of privatization of Air India, BSNL, other PSU banks to save funds for other govt services. This makes it impossible for tax payers money to be routed for such projects only to benefit some handful of “rich investors”.

The banks ? Ha ha….. Try asking even for a rate of interest waiver from them. They have a business to run. There is no way any bank can afford to bear such losses. In any case, most are struggling to avoid bad debts due to loans given to builders thru NBFCs. Banks don’t lend to real estate developers as a practice. Are you surprised ?

The customers? Yes of course. Doesn’t matter how long it takes for them to realize. The fact is that this is the only viable solution. The sooner the buyers realize this, the better for them. And most of them do know this. The issue however becomes more complex as many of the buyers are actually “investors or property flippers”. They just bought the apartment to sell it before is becomes due for possession. They never had the money to buy it, they just wanted to play the price rise game. They don’t have the money even now. They want others to solve the problem so they can liquidate their investment.

Whichever way it works, this is very difficult puzzle. The buyers will have to get going on the viable solution asap & stop the day dreaming about the bankers or government taking a share of the loss. The bank funded the buyer on his credit report. They will not budge until the customer defaults on his payment. Rest they don’t care much. After all to buy the property was your call. And only you benefited had the investment done well. Think of this – Have you shared the fruits of your profit with the bank when one of your past properties appreciated well ? Trust you get the point. Your risk, your profit (& also your loss, when that comes).

What can government do ?

There is very limited the government can do with the legal system of the country. That will take its own time & they don’t care much about the consumers as such. The homes will not get build by passing orders for NBCC to build. I have seen some of such ridiculous orders. The issue is lack of funds. Passing order will not do anything here. This is not a criminal justice system to punish someone. The money is lost

What government can do is to improve the infrastructure fast wherever the key projects are so that would improve capital values at those places. This may pull new buyers into the market at higher rates & that money can then move the logjam created in the industry. It can make the loans cheaper & create an environment where new buyers feel confident of buying their homes. No buyer wants to see their home value go down. Ironically, buyers will come at higher prices when they see the home appreciation. They will take bigger loans which can bail out the builders & the old buyers. Funny as it may sound, this is how the industry works. After all, everyone got into the frenzy in the anticipation that home values will appreciate forever.

We need another frenzy now. Take loans folks, you may actually be saving your own homes. No sellers can save the industry. Only buyers can.

Feel free to mail or write to me on twitter

Honest – Unbiased – Simplified, as always.

Edit: Finance minister just announced a real estate package to complete the stuck projects. Rs 10,000 crore will be provided by the government & additional Rs 15,000 crores by LIC & SBI. The details of how this will work our are not clear(as is with most of the headline moving announcements). Meanwhile, have a look at city-wise numbers of UNSOLD inventory in India. Keep this in mind while you ruch to buy your dream home. Surprising that builders are still able to sell their projects creating a hype around scarcity of their flats. Typical sales trick from the oldest sales book used across the world. But is still works with us.


Anarock Property Research

Funds dry up for real estate sector; IL&FS, NBFC crises drag down sector

Booster plan for real estate may have a multiplier effect; top 26 stocks that may benefit the most