Month: September 2017

It’s Time Enforcement Directorate(ED) Investigated “Errant” Real Estate Companies for Money Laundering

India-Real-Estate-Market

Many real estate companies around the National Capital Region have taken money from homebuyers over the years, and failed to deliver homes. Some of these companies have also defaulted on bank loans.

Take the case of Jaypee Infratech, one such company, which has been in the news lately. The company has collected anywhere from 70 to 100 per cent of the price of the homes that they were selling, from around 27,000 buyers. These buyers have paid anywhere between Rs 40 lakh each to Rs 1 crore each, to the company.

On the other hand, the company has defaulted on a loan of Rs 526 crore.

Or let’s take the case of Amrapali Group. One of the group companies (Amrapali Silicon City Private Ltd.)  has defaulted on a loan amount of Rs 59.38 crore. Over and above this defaulted amount, overdue interest and penal interest adds to another Rs 11.77 crore.

This takes the total amount to a little over Rs 71 crore. On the other hand, a newsreport in The Times of India suggests that there are nearly 45,000 homebuyers to whom the Amrapali group hasn’t delivered the promised homes.

A report in the Business Today suggests that the group “owes over Rs 1,000 crore to about 10 banks”.

When a debtor defaults, the banks can file an application under the Insolvency and Bankruptcy Code, 2016, with the National Company Law Tribunal, to trigger the Corporate Insolvency Resolution Process and appoint an insolvency resolution professional.

Under this, the existing board of the company is suspended. The professional has 180 days to come up with a workable solution for the company to be able to repay the loans it has defaulted on. This can be extended by another 90 days. At the end of 270 days if no solution is in sight, then a liquidator is appointed.

The trouble is that currently the homebuyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated. Some suggestions have been made that the homebuyers can be compensated under Section 53(1)(f) of the Insolvency and Bankruptcy Code. This is after workmen, secured creditors, employees other than workmen, unsecured creditors, amounts owed to the central and the state government, etc., have been compensated and before preference shareholders and equity shareholders, are compensated.

In fact, Section 53(1)(f) lists “any remaining debts and dues,” under it. The question is can the money handed over by the homebuyers to these real estate companies be treated as debt? From the legal point of view this does not make sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. Even with this point, the homebuyers come to low in the hierarchy to hope to be compensated at the end of the liquidation process.

In the case of Jaypee Infratech, where the buyers went to the Supreme Court, in order to stall the insolvency resolution process, the Court has directed the insolvency resolution professional to come up with an interim resolution plan within 45 days. This plan is expected to take into account the interests of homebuyers i.e. those people who paid Jaypee Infratech for homes that were never delivered.

The Supreme Court needs to basically decide whether homebuyers can be categorised as financial creditors or not.

But does not answer the basic question: Where did the money that the homebuyers handed over to the real estate companies, actually go? This is an important question to ask because the bank loans that the developers have defaulted on are really very small, in comparison to the total amount of money they have raised from homebuyers and siphoned off.

Take the case of Jaypee Infratech. The company has defaulted on a Rs 526 crore loan from IDBI Bank. In comparison, various media reports and suffering homebuyers suggest, that the company has taken on more than Rs 20,000 crore from homebuyers. Where did this money go?

Given this, the bank defaults and the non-delivery of homes are two separate issues, and they need to be treated separately.

Of course, Jaypee Infratech is not the only company here. There are many other companies. A newsreport in The Hindustan Times suggests that 13 FIRs were filed against six such companies, Amrapali, Supertech, Alpine Realtech Private Limited, BRUY Limited, Today Home Builders and JNC developers, in early September 2017.

The question is where did the money all these companies and others, raised from homebuyers disappear? Did the promoters pad up the expenses and tunnel this money out to buy land? Or did they simply siphon this money off? Or did they use it to complete other projects? And if that was the case, where did the money that was raised for these other projects go? It clearly seems that money has been laundered by promoters of these companies.

Unless, these questions are answered and the homebuyers’ money recovered from the errant real estate companies, there is no way that this issue can be solved.

Hence, the questions listed above need to be investigated. Given that FIRs have already been filed against many real estate companies which have not delivered on homes, under the required sections of the Indian Penal Code, the Enforcement Directorate can register cases against these companies and carry out detailed investigations under the Prevention of Money Laundering Act (PMLA).

Of course, this would mean investigating many companies, but the modus operandi of laundering money in many cases would be similar. At the same time, this can set the record straight for the future. If housing for all is to be achieved by 2022 (or even 2032 for that matter), the private real estate companies need to play an important role in it. And given that, it is important that the errant real estate companies not be allowed to get-away with the crime that they have committed against the homebuyers.

A precedent needs to be set, so that in the future, things like these do not happen all over again. It is also an excellent opportunity for prime minister Narendra Modi to revive his fight against black money and show some concrete action on this front. The hard-earned money of most homebuyers has been laundered and converted into black money and that needs to be tackled.

The column originally appeared on Equitymaster on September 18, 2017.

Modinomics, meet the industrial slowdown!

narendra modi
The Prime Minister, Shri Narendra Modi addressing the Nation on the occasion of 71st Independence Day from the ramparts of Red Fort, in Delhi on August 15, 2017.

The index of industrial production (IIP) figures declared earlier this week, portray a worrying picture of the overall Indian economy. The IIP is a measure of industrial activity in the country.

For the month of July 2017, the IIP grew by 1.2 per cent in comparison to July 2016. In June 2017, it had contracted by 0.2 per cent. While, there has been some improvement month on month, the overall trend of the IIP growth has been down for a while. Take a look at Figure 1, which basically plots the IIP growth (or contraction for that matter) over the last four years.

Figure 1:


As is clear from Figure 1, for more than a year now, the overall trend of IIP growth in the country has been downward. This is a clear indication of a slowdown in the growth of industrial activity.

One of the ways through which IIP is measured is referred as economic activity based classification. As per this method, manufacturing accounts for 77.6 per cent of the IIP. And if things for overall IIP have been bad, they have been worse for manufacturing. Take a look at Figure 2, which basically plots the growth (and contraction) in manufacturing over the last four years.

Figure 2:

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Source:  Ministry of Statistics and Programme Implementation.

What does Figure 2 tell us? The manufacturing scene in the country doesn’t look great. In July 2017, manufacturing grew by just 0.1 per cent, after having contracted by 0.5 per cent in June 2017. This is a trend that was also visible in the gross domestic product (GDP) data released in late August 2017. Let’s take a look at Figure 3, which plots the growth rates of industry and manufacturing using GDP data, over the last four years.

Figure 3:

Figure 3 clearly tells us that the growth in industry and manufacturing as per the GDP data is at a four-year low. For the period April to June 2017, industry and manufacturing grew at 1.6 per cent and 1.2 per respectively, in comparison to the same period last year.

What does this mean for the overall economy? Industry has formed around 29-31 per cent of the GDP over the years. The fact nearly one-third of the economy is barely growing should be a big reason for worry. This will impact economic growth in both direct and indirect ways. If one-third of the economy barely grows, overall economic growth is bound to slowdown. That is the direct impact.

What about the indirect impact? In order to understand this, we need to figure out how many people actually work for industry. In 2009-2010, the industry as a whole employed around 9.9 crore individuals. Analysts, Nikhil Gupta and Madhurima Chowdhury, who work for stock brokerage Motillal Oswal, in a recent research note using data from the 2014-2015 Annual Survey of Industries, state: “Over the past 35 years, employment in Indian industrial sector has grown at an average of ~2%.” The actual figure is 1.9 per cent per year.

Hence, employment in the industrial sector tends to rise at the rate of 1.9 per year on an average. Using this, we can conclude that by March 2017, the total number of people working in industry would stand at around 11.3 crore. Further, the average Indian family has 5 people. Given this, around 55 crore individuals in a population of 130 crore or around 42 per cent of the population depend on income from industry, in one way or another. An if the industry is barely growing, these people will go slow on their consumption and other expenditure, and in the process slowdown overall economic growth. This is the indirect impact.

Why is this happening? The economic slowdown initiated by demonetisation is basically continuing. It is worth remembering that first and foremost is a medium of exchange. It is a token to carry out economic transactions. When you take 86.4 per cent of the currency in circulation out of an economy, where 80 to 98 per cent of the consumer transactions (in volume, and depending on which data source you take) is carried out in cash, economic transactions are bound to slowdown. And ultimately this is reflecting in the manufacturing data.

If there is slowdown in consumption, there is a bound to be a slowdown in manufacturing. If people are not buying stuff at the same pace as they were in the past, there is no point in companies increasing production like they were in the past.

The irony is that this crisis the Modi government brought upon us. Indeed, this is very worrying in a country where one million individuals are entering the workforce every month. That makes it 1.2 crore, a year. If the growth in industrial sector slows down to the level that it currently has, how will any jobs be created for these youth.

And that is a question worth asking.

The column originally appeared in Newslaundry on September 14, 2017.

 

The Mathematical Logic Behind Soap Operas

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In response to the last week’s piece (If you are smart, why aren’t you rich?), a couple of readers wrote in wanting to know why do large families in general and large business families in particular, split. Interestingly, this question has been an area of academic research. The British evolutionary psychologist Robin Dunbar has done some interesting work in this area.

The average individual has his or her strongest relationships with five people at any point of time, suggests Dunbar. As Geoffrey West writes in Scale—The Universal Laws of Growth, Innovation and Sustainability, in Organisms, Economies, Cities and Companies: “These are the people we are closest to and care most deeply about.” These typically tend to include our parents, spouses or children. They also include close friends or partners (if not spouses).

At the next level, there are around 15 people. These typically tend to be close friends but not the closest ones. At the next level, there around 50 people. As West writes: “[These are] people you might still call friends though you would only rarely invite them to dinner but would like to invite them to a party or gathering. This might consist of coworkers, neighbours down the street, or relatives you don’t see very often.”

The final level has around 150 people with whom we have social contact with. This number (i.e. 150) is also referred to as the Dunbar number (in the name of Robin Dunbar). The question is why is the Dunbar number limited to 150? As West writes: “We simply do not have the computational capacity to manage social relationships effectively beyond this size”. Hence, “increasing the group size beyond this number will result in significantly less social stability, coherence, and connectivity, ultimately lead to its disintegration.”

Dear Reader, you must be wondering by now, what has all this got to do with large families splitting? Allow me to explain.

If you look at Dunbar’s logic explained earlier, at any point of time, an individual can have close and strong relationships with five people. This basically means that an individual can at best be close to two or three siblings and not all of them.

West gives the example of his grandparents’ family and then compares it with that of his family. His grandparents had eight children. This basically meant that there were 10 people in the family. Ten people in the family meant there were 45 different relationships at play at any point of time. (You can do the maths for this, it is fairly simple. If there are two people in a family, there is one relationship. If there are three people in a family, there are three relationships at play. If there are four people in the family, there are six relationships at play and so on).

When there are 45 different relationships at play, obviously everyone cannot possibly get along with everyone else. As West writes: “If these loosely followed a Dunbar pattern where each child was strongly connected to two or three of their siblings in addition to parents, not everyone could love everyone else equally.” There is also the question of time that one needs to invest in maintaining any relationship.

In comparison to West’s grandparents’ family, his family has four members (he, his wife and their two children). This basically means that there were six different relationships at play at any point of time. And chances of managing six relationships are better than manging 45 relationships.

This is precisely why large families split. Even if they don’t split, everyone doesn’t get along with everyone and there are fights and disagreements happening and conspiracies being hatched. TV  serials all over the world make use of this dynamic, brilliantly. And which is why you rarely see a soap opera around a nuclear family. How many disagreements can happen among four people? And how many conspiracies can they hatch up? The audience also relate to these soap operas in their own weird ways and tend to watch them.

The column originally appeared in the Bangalore Mirror  on September 13, 2017.

How Do You Solve a Super-Mess Like Jaypee Infratech

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The real estate company Jaypee Infratech will go through insolvency proceedings. Earlier, this week, the Supreme Court asked the insolvency resolution professional to take over the management of the company. The insolvency resolution professional has also been asked to submit an interim resolution plan within 45 days. This plan is expected to take into account the interests of homebuyers i.e. those people who paid Jaypee Infratech for homes that were never delivered. In doing this, the Supreme Court modified an earlier order.

Here is an excellent example of messy situation which has probably got messier.
Jaypee Infratech has defaulted on a loan of Rs 526.11 crore from IDBI Bank. At the same time, the company took money from 32,000 prospective homebuyers with a promise of delivering homes. How much money was raised from these homebuyers? The numbers in the media vary from Rs 17,000 crore to Rs 25,000 crore.

This basically means that an average buyer paid Jaypee Infratech anywhere between Rs 53 lakh to Rs 78 lakh. That is clearly a lot of money. The Bankruptcy and Insolvency Code in its current form does not leave anything for the buyers. The homebuyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated.

From the legal point of view this makes sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. But then given that thousands of families are involved, should only the legal view prevail is a question even though tricky, worth asking. The Supreme Court now needs to decide whether the buyers are financial creditors or not.

Of course, the bureaucrats who wrote the bankruptcy code did not take the real estate sector and the way it operates, into account.

Let’s consider the situation with Jaypee Infratech. It has defaulted on a loan worth Rs 526 crore. The company would have offered an asset(s) as a collateral or a security against this loan. This asset can be sold and IDBI Bank can get the money, back. Of course, it may or may not get the entire defaulted loan amount back. This would depend on the current market value of the asset(s) offered as a collateral.

Of course, in the current scheme of things, the homebuyers are nowhere in the picture. The insolvency resolution professional has to come up with a plan that can correct for this scenario. One of the things that could possibly be looked at is to handover the project to another builder who can complete the project. But this builder would need more money for it. Where will this money come from? Will the buyers who have already paid anywhere between Rs 53 lakh to Rs 78 lakh on an average, be in the mood, to handover more money? More than the mood, will they have more money to handover? We aren’t talking exactly about small amounts here.

Further, if there is talk of compensation from selling the collateral, what sort of compensation can the buyers look at? The asset that Jaypee Infratech must have offered as a collateral was for a loan worth Rs 526 crore. How would that be enough to compensate 32,000 homebuyers who had invested anywhere between Rs 17,000 crore to Rs 25,000 crore in total, with Jaypee Infratech.

Another option is sell the half-built apartments (or in whatever shape they are in) to a new builder and then use that money to compensate the buyers. Of course, in this case, the buyers will have to take a haircut (i.e. they will not get their full money back). Also, will other builders be ready to buy in this environment where the real estate sector isn’t exactly going anywhere.

Jaypee Infratech defaulted on the loan it took from IDBI Bank. It also took a lot of money from homebuyers and did not deliver apartments. Where has all this money gone? Has it been siphoned off? Has it been used to build a landbank? Has it been used to complete previous projects? If it has been used to complete previous projects, then where did the money collected for those projects, go? Or has it been diverted to other group companies?

The bankruptcy and insolvency code in its current form does not allow for a forensic audit of companies which have defaulted on bank loans. But that is precisely what is required in case of Jaypee Infratech to figure out where did such a huge amount of money disappear. The amount that has been siphoned off from buyers is so huge that it cannot be repaid using the assets that may have been offered as a collateral against the bank loan which has been defaulted on.

Of course, any forensic audit will take time. But there is hardly any other market based solution that can be arrived at. Further, a situation as messy as this one is, cannot be set right in a short period of time. Also, it will set the tone for other similar cases, which are bound to come up in the days to come.

In the days to come, there will be great pressure on the government to bailout the homebuyers and if not that, at least compensate them to some extent. The government needs to resist this because if it doesn’t, it will send up setting a bad precedent.

The larger point here is that in this case the bank default is hardly an issue. The bigger issue is the fact that such a huge amount of money has been siphoned off from the homebuyers. The learning here is that the cases of bank defaults and homes not being delivered, are two separate cases and need to be considered separately as well. The central government now needs to work actively towards a market based solution.

Meanwhile many homebuyers will continue paying an EMI on the home loans they took to buy their dream homes. They would be paying money towards an asset which they won’t be getting their hands on, anytime soon. They will also have to continue paying a rent for the homes that they currently live in. Of course, this is not a great situation to be in.

But then that’s how big the mess in India’s real estate sector is. And that is not going to change anytime soon.

The column originally appeared on Firstpost on September 13, 2017.

India’s Big and Messy Real Estate Ponzi Scheme, Just Got Messier

 

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Over the last few years, many real estate companies across the country, particularly in Delhi and the National Capital Region (NCR), have taken money from home buyers and not been able to deliver promised homes on time.

Some of these companies have also taken loans from banks and defaulted on those loans as well. Basically, these companies have taken money from home buyers, they have also taken loans from banks, and still been unable to deliver the promised homes. In some cases, real estate companies have already booked sales on homes they are yet to deliver.

The question is where has this money gone?
I think there are two answers to the question. 1) Promoters of real estate companies have siphoned off a part of the loans they took on from banks and the money they took from buyers. 2) This money has been diverted for other uses, like completing previous projects and buying more land (or to put it in real estate parlance for building a formidable land bank).

Banks are now looking to recover their bad loans from real estate companies. And at the same time, the buyers are also hopeful that someday their dream homes will be delivered to them.

There are several interesting issues that crop up here:

a) It is now more or less clear that the real estate companies had been happily running a Ponzi scheme. A Ponzi scheme is basically a financial scam in which investors are promised very high returns. The money being invested by the second set of investors is used to pay off the first set. The money invested by the third set of investors is used to pay off the second set and so on. A Ponzi scheme runs until the money being invested in the scheme is greater than the money that is going to redeem the investment of the early investors. The moment this reverses, the scheme collapses.

The real estate companies essentially followed this model. They announced a new real estate project and then raised money against it. This money was then used to buy more land or simply siphoned off. Then a new project was announced. The money raised against the new project was used to complete the earlier project. Of course, I am simplifying things a bit here, but that was the basic modus operandi.

The key in this method of selling homes was the ability to keep launching new projects. Over the years, as real estate returns fell, the ability of real estate companies to launch new projects came own drastically. Once this happened, they couldn’t raise enough money to complete their existing projects. And this led to many buyers being left stranded in a rented home.

b) The inability to deliver on promised homes along with low returns has put off people from investing in real estate. The falling interest in owning real estate becomes clear from the savings figures as well. As per the recently released annual report of the Reserve Bank of India, in 2012-2013, savings in physical assets made up for 14.4 per cent of the gross national disposable income (GNDI). By 2015-2016 this had fallen to 10.7 per cent of the GNDI. GNDI is a concept similar to GDP which also takes remittances from abroad and food aid into account. India’s GNDI is around 1.03 times its gross domestic product.

c) A bulk of the buyers had bought homes by taking on home loans from banks. They are currently paying EMIs against these loans. They are also paying a rent to live in the homes that they currently do. Given this, they are monetarily stretched. Further, they are paying an EMI for an asset which they haven’t got as yet and will probably never get in the form they had originally envisaged.

d) When prospective buyers take a home loan from a bank, the home they are buying is the collateral or the security against the loan that is taken. In many cases, the real estate companies have offered these homes against which home loans had already been taken, as a collateral to the banks, and taken on more loans. So, the buyers have been taken for a ride here. Also, the question is how have banks allowed dual financing on the same asset?

It is worth remembering here that many real estate companies which have defaulted on banks loans and delivering homes, worked on a pay as you build model. This basically meant that these companies got paid in instalments from the buyers at every stage of construction.

Hence, the homes were technically owned by the buyer (or to put it more specifically the bank from which the buyer had taken on a home loan) and could not have been offered as a collateral, without the consent of the buyer. Nevertheless, that seems to have happened. This is something that the banks need to explain. (In case you want to understand dual financing in even more detail click here and here).

e) So, where does that leave the buyer? Recently, bankruptcy proceedings have been started against Jaypee Infratech which took money from more than 30,000 buyers and did not deliver on the promised homes. At the same time, it has defaulted on bank loans. The Supreme Court has stayed these proceedings.

The Bankruptcy and Insolvency Code in its current form does not leave anything for the buyers. The buyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated. From the legal point of view this makes sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. But then given that thousands of families are involved, should only the legal view prevail is a question even though tricky, worth asking.

Of course, the bureaucrats who wrote the bankruptcy code did not take the real estate sector and the way it operates, into account. This is something that the government should hopefully correct for in the days to come.

f) Suggestions are now being made that like the banks, the buyers should also be ready for a haircut (i.e. be ready to accept a part of the money they had invested with a real estate company to buy a flat and not the entire amount). The trouble with this argument is that for the banks, the bad loans of real estate companies are just a part of their overall bad loans. For the buyers, the money they invested with real estate companies was probably the biggest investment they ever made and if they have to take a haircut on it, they will probably never recover financially from it.

The Supreme Court now needs to decide whether the buyers are financial creditors or not. This is a tricky question, which I shall elaborate on later in the days to come.

g) In all this, the real estate promoters seem to be having the last laugh. A part of the money they borrowed from banks and took from real estate buyers, has been tunnelled out. It is hardly likely that the bankers will be able to go after their other assets (i.e. the land bank they built by tunnelling out money) in order to recover their loans. Hence, they have clearly managed to limit their losses.

In fact, in a fair world, the balance sheets of these real estate companies would have been subjected to forensic accounting in order to figure out where did the money go. But the bankruptcy code has no such provision. If it did that would inevitably delay the resolution process.

And this brings me back to the point that I keep making for all my readers who forever seem to want solutions to all problems; everything in India does not have a clear solution.

Of course, now the central government will have to get involved if this issue has to be sorted at any level. I only hope that they try and arrive at a private sector solution and the taxpayer money is not used in any form. Already, a section of the real estate sector is talking about a government bailout. If the builders in India don’t have money, who does?

To conclude, the mess in the real estate sector in India is an excellent example of what follows when a Ponzi scheme goes bust. And as they like to say in Hollywood films, you ain’t seen nothin’ yet. Keep watching.

The column originally appeared on Equitymaster.com on September 11, 2017.