Real Estate

Here’s Why the Biggest Crib of Real Estate Companies is a Big Lie

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Earlier this month, Raghuram Rajan, the governor of the Reserve Bank of India(RBI) presented the second monetary policy statement for 2016-2017. Rajan decided to keep the repo rate at 6.5%.  Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.

The real estate lobby Confederation of Real Estate Developers’ Associations of India (CREDAI) wasn’t happy with this. As C Shekar Reddy, ex-president and national executive member of CREDAI told The New Indian Express: “Banks are charging 9.50 pc or more interest on home loans. People will be motivated to buy homes if the loan interest rates are lowered. All our representations to banks to cut the interests rates to give a fillip to the struggling housing sector have gone in vain. Whenever we approached the banks earlier, they said they would think of reducing interest rates if RBI did so with its policy rates.”

Similar statements were made by other CREDAI officials as well. As Geetambar Anand, the president of CREDAI told the Press Trust of India: “It was on expected lines. Now, banks should be advised to reduce interest on home loans by another 50 basis points.” One basis point is one hundredth of a percentage.

The basic point being made is that the RBI has kept the repo rate too high. As the repo rate is high, the interest rate charged by banks on home loans are high. As interest on home loans is high, people are not buying homes. As people are not buying homes, real estate companies are suffering. Or as SARE Homes MD Vineet Relia told PTI: “Since demand in real estate and allied industries remains sluggish, a rate cut could have improved liquidity and created renewed interest in property purchase.”

While all this sounds quite logical, it isn’t correct. Every month, the Reserve Bank of India releases the sectoral deployment of credit data. This data essentially gives out the total amount of lending carried out by banks to different sectors. And this includes home loans given out for the purchase of homes.

In the last one year (actually it’s a period slightly greater than a year, between April 17, 2015 and April 29, 2016), the overall lending of banks (i.e. non-food credit) has grown by just 8.4%. As I explained in yesterday’s column, this has happened primarily because banks have more or less stopped making fresh loans to industry.

Nevertheless, the retail loans of banks have grown at a very good pace, over the last one year. The retail loans include home loans, vehicle loans, education loans, credit card outstanding, loans against fixed deposits, loans against shares/bonds, and personal loans.

The overall growth of retail loans in the last one year stood at 19.7%. This had stood at 15.7% between April 2014 and April 2015. The home loans given out by banks have also seen a fairly robust growth. Home loans grew by 18.1% to Rs 7,58,203 crore, over the last one year. They had grown by 17.1% between April 2014 and April 2015.

Things become a little more interesting if we look at this data in a little more detail. The RBI gives also gives data on priority sector home loans. As per the Master Circular issued by the RBI in July 2014, priority sector home loans are essentially loans to individuals up to Rs 25 lakh in metropolitan centres with population above ten lakh and Rs 15 lakh in other centres.

The home loans given under the priority sector lending that banks need to carry out, grew by 7.6%, over the last one year. They had grown by 4.4% between April 2014 and April 2015.

As far as the non-priority sector home loans (home loans greater than Rs 25 lakh in centres with a population of above 10 lakh and greater than Rs 15 lakh in other centres), are concerned, they grew by a whopping 28.6%, in the last one year. The loans had grown by 33% between April 2014 and April 2015.

What does this tell us? The priority sector home loans are not growing because there are very few real estate markets in the country which banks service, where homes of up to Rs 15 lakh or Rs 25 lakh are available. The growth in priority sector home loan lending has been even slower than the overall bank lending growth.

In fact, in April 2014, priority sector home loans, made up for 56% of total home loans. By April 2015, this was down to 50%. And in April 2016, this stood at 45%. This is definitive evidence of the high real estate prices that continue to prevail in this country, despite what real estate builders keep telling us.

As far as non-priority sector home loans are concerned, they have grown by close to 29% over the last one year, after growing by 33% between April 2014 and April 2015. And that is a pretty good rate of growth, when overall lending growth is 8.4%, and retail lending growth is 19.7%. So what are the builders really complaining about?

I think what seems to be happening is that the home buyers are no longer buying under-construction homes. I have no way of verifying this through data. But that is what the data along with the builders cribbing all the time about the RBI, seems to suggest.

Over the last few years, many builders haven’t delivered homes on time. This has led to a situation where many individuals have had to pay the pre EMI along with the rent as well. Some people I know are even paying their EMIs along with their rents. (I don’t know how EMIs have started without possession of the home being taken).

Some builders have disappeared as well, after taking money from home buyers. Hence, homebuyers are staying away from under-construction property is what my analysis seems to suggest. It seems the buyers are now buying completed homes, which is where the home loans taken are basically going. This can mean that investors who had bought homes in the past are now selling out. It could also mean that builders who had completed inventory are selling it now.

This has hit the entire business model of the real estate developers, who raise money from prospective buyers, when they start building, without putting much of their own capital at risk. But then, for this, they have no one but themselves to blame.

The column originally appeared in the Vivek Kaul Diary on June 16, 2016

Rajasthan’s Land Bill Unlocks Dead Capital And It Should Be Replicated In Other States

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On April 4, 2016, the Rajasthan assembly passed the Rajasthan Urban Land (Certification of Titles) Bill. This legislation will give a statutory backing to land records. In the process Rajasthan became the first Indian state to enact a law on property titles.

Indeed, this is a big move. What we have in India up until now is what urban planner Swati Ramanathan calls presumed ownership. In a recent column in Mint she explains this: “What we have in India today is a system of “presumed ownership”. The notion that a “sale deed” is proof of ownership is misplaced. The registration of property at the stamps and registration department merely acknowledges that a transaction has taken place between two parties. It does not verify or guarantee that the seller is indeed the indisputable owner, nor that the buyer is now indisputably the new owner.” This explains why so many property cases end up in court. With clear property titles, this is less likely to happen.

With the Bill being passed, the Rajasthan government will have to get around to setting up the Urban Land Title Certification Authority.

Anyone who wants a land title will have to apply to this authority. The act of applying for a title to this authority is voluntary. As the Section 23 of the Bill points out: “As soon as may be, after the receipt of application…the Certification Authority shall scrutinize the information and the documents furnished by the applicant and seek their verification from the relevant record maintained by the State Government or any other authority to satisfy himself about the veracity of the information and authenticity of such documents.”

If the Land Title Certification Authority is satisfied “about the veracity of the information and authenticity of such documents” it will certify the “status of applicant as lawful holder of title of the urban land specified in the application.” This initial provisional certificate will be valid for a period of two years.

If during the period of two years no counter claim or objection is received by the Land Certification Authority, it will after the two years are over, issue a permanent certificate of title for the land. The state government shall stand as a “guarantor for the genuineness and authenticity of the title”.

This data will be maintained on the Computerized Land Evaluation and Administration of Records (CLEAR), a central system of electronic data storage. If the entire system works as it is envisaged to, then the number of property disputes are likely to come down, given that people will have a clear title to the land that they own. This will be guaranteed by the state government.

Clear titles will also lead to the unlocking of what the Peruvian economist Hernando de Soto calls dead capital.  De Soto essentially points out that in the Western countries, land and buildings are also used as capital because land titles are clear. This is not in the case in developing countries like India. He calls these assets in developing countries “dead capital”.

As he writes in The Mystery of Capital—Why Capitalism Triumphs in the West and Fails Everywhere Else: “Why can’t buildings and land elsewhere in the world also lead this parallel life?…My reply is: Dead capital exists because we have forgotten that converting a physical asset to borrow money to finance an enterprise for example – requires a very complex process.”

The presence of clear land titles essentially simplifies the entire idea of being able to borrow against what Soto calls dead capital. As he writes: “Any asset whose economic and social aspects are not fixed in a formal property system is extremely hard to move in the market. How can the huge amounts of assets changing hands in a modern market economy be controlled if not through a formal property process?”

The lack of a formal property process hurts. As de Soto writes: “Without such a system, any trade of an asset, say a piece of real estate, requires an enormous effort just to determine the basics of the transaction: does the seller own the real estate and have the right to transfer it? Can he pledge it? Will the new owner be accepted as such by those who enforce property rights?”

In this scenario, it becomes difficult to sell land/building as well as raise capital by borrowing against it. Once the titles become clear and the government guarantees it, the problem gets solved.

Akhilesh Tilotia makes a similar point in his book The Making of India. As he writes: “Hernando de Soto…points out that many small entrepreneurs lack legal ownership of their property, making it difficult for them to (1) obtain credit to expand or (2) sell their business when either they or their businesses have run the course. The existence of such massive exclusion generates two parallel economies: legal and extra-legal. An elite minority enjoys the economic benefits of law and globalization, while a majority of the entrepreneurs are stuck in poverty, where their assets languish as dead capital.”

This can be corrected with a proper system of land titles. As Tilotia writes: “India, with its 120 million small and marginal cultivators and 8.5 million retail(mom-and-pop) outlets requires strong land title records to help these entrepreneurs to prosper and gain benefits of economic growth.”

If what has started in Rajasthan spreads to other parts of the country including rural India, there are other benefits as well. The average size of agricultural land-holding has been falling over the decades. As per Agriculture Census of 2010-11: “The average size of holdings for all operational classes (small & marginal, medium and large) have declined over the years and for all classes put together it has come down to 1.16 hectare in 2010-11 from 2.82 hectare in 1970-71.”

As the same land is divided between more and more family members over the generations the average holding has fallen dramatically. Further, as per Agriculture Census 2010-11, small and marginal holdings of less than 2 hectare account for 85 per cent of the total operational holdings and 44 per cent of the total operated area. This could have only gotten worse since 2010-11.

Clear land titles can play a part here. As de Soto writes: “In a developed country, the farmer’s son who wishes to follow in his father’s footsteps can keep the farm by buying out his more commercially minded siblings. Farmers in many developing countries have no such option and must continually subdivide their farms for each generation until the parcels are too small to farm profitably.”

Clear land titles can clearly help India’s 120 million small and marginal cultivators.

To conclude, it is important that what has started in Rajasthan starts to spread in other parts of the country as well and other states get around to passing a similar law.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on Swarajya Mag on April 14, 2016

Why Do Builders Overbuild

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Conversations with friends who live in Delhi and the National Capital Region(NCR) inevitably turn towards the topic of real estate. Over the last two weeks, I met two friends and we ended up talking about the perils of the idea of owning real estate, among other things.

In case of one friend the builder has taken the money and is postponing building the apartments. Meanwhile, the housing finance company has turned a blind eye to this. At the same time, my friend is paying the EMI, though the promised home is nowhere in sight. He continues to pay rent as well. Not a happy situation to be in.

In case of the second friend, the builder ended up building more floors than he had initially promised. My friend was lucky to get possession and move in. But with more floors he is now sharing the infrastructure with more people than was initially planned and this has its own share of problems.

Other than sharing the infrastructure there is a bigger problem which most people don’t even realise. As Sushil Kumar Sayal writes in Inside Unreal Estate—A Journey Through India’s Most Controversial Sector: “When the builder builds a ten-floor block he digs the foundation to a certain depth; when the additional floors are added, does he ensure the foundation is deeper? He doesn’t. The authorities not only turn a blind eye to this safety hazard but are often hand in glove with errant builders.”

The question is why do builders overbuild? The builder-broker nexus essentially leads to overbuilding. As Sayal writes: “There is a close relationship between builders and brokers. Thus, very few builders in and around Delhi put their money into a project upfront. As soon as he wins land in an auction, he collects his band of brokers and sells the project to them. With that money, he pays for the land. The brokers, in return, are assured of space at a discount.”

What this clearly tells us is that the builder has very little of his own money (i.e. equity/capital) riding on the project at any point of time. Also, since he is giving a discount to the broker, he overbuilds. As Sayal writes: “Since he has given a discount to the brokers, the builder overbuilds in order to make money. The extra construction is frequently regularized. Even if it isn’t, nothing stops the builder and brokers from selling it. Often, the builder doesn’t even bother to get a completion certificate.”

The regularisation of the illegal floors happens in the days to come and is easy business for the builder. As Swati Ramanthan wrote in the Mint in June 2014: “State regularization initiatives unfortunately, have become tainted as tools for corruption, or political populism, or as a means to generate revenue for the state. Consider the following: in Kolkata, a meagre ex-parte penalty of Rs.500 per square foot allows regularization of illegal floors.”

In this scenario it is not surprising that the builder builds extra floors and gets away with it. Also, what explains the fact that the builders goes around selling a project which he hasn’t got a total clearance for? The simple answer is greed. But there is a more complicated answer as well. The economic incentive is at work.

As Sayal writes: “Under the law, a builder cannot sell his project unless he has secured all the clearances. These clearances can take up to two years to obtain. Given the high land prices all over the country, no builder can afford to let the investment sit idle for two years. He has no choice but to violate the law and pre-sell the project.”

In fact, this will be the single biggest impediment to the success of the Real Estate (Regulation and Development) Bill, 2013, which was recently passed. I had made this point on December 14, last year. Nevertheless, it is worth repeating here.

The Real Estate Act wants the real estate regulator (to be set up in every state) in order to facilitate the growth and promotion of a healthy, transparent, efficient and competitive real estate sector, to make recommendations to the appropriate state government on creation of a single window system ensuring time bound project approvals and clearances for timely completion of real estate projects.

I guess there is nothing beyond this the central government can really do. So it ultimately boils down to the state governments whether they are in the mood to give a single window clearance for real estate projects.

How good are the chances of something like that happening? The entire process of clearing a real estate project through the various stages is a good money making exercise for both state level politicians as well as bureaucrats.

So the economic incentive is clearly against a single window clearance. Also, much of the money thus raised is used to fight elections at the state level. The builder-political nexus is a huge source of finance to fight elections at the state level for politicians. Will this nexus break down?

You know what I think of it. Nevertheless, let’s wait and watch.

The column originally appeared on Vivek Kaul’s Diary on March 28, 2016

India Is Still Facing The Ill-Effects Of The Congress Era Inflation

India's PM Singh speaks during India Economic Summit in New Delhi
The devil, like beauty, always lies in the detail.

Sometime last week the Central Statistics Office(CSO) put out data which clearly shows that India is still facing the ill-effects of the inflationary era unleashed by the Congress led United Progressive Alliance (UPA) government.

Between 2008-2009 and 2013-2014, the average consumer price inflation was higher than 10%. Food inflation was higher than 11%. High inflation essentially forced people to spend more and in the process they had lesser money to save.

Take a look at the following table. The household savings fell from 23.39% of the nominal Gross Domestic Product (GDP) to 19.06%. Nominal GDP does not take inflation into account.

In Rs crore2011-20122012-20132013-20142014-2015
Household Savings2065453223395023609362380488
As a % of total savings68.20%66.40%63.40%57.20%
As a % of nominal GDP23.39%22.36%20.94%19.06%
Net Financial Savings (Gross financial savings minus financial liabilities)642609733616862873961307
As a % of nominal GDP7.28%7.34%7.65%7.70%
Saving in physical assets1389209146368414608441379411
As a % of nominal GDP15.73%14.65%12.96%11.05%

The household savings primarily comprise of financial savings as well as savings in physical assets and savings in the form of gold and silver ornaments. The overall household savings have fallen from 23.39% of the GDP in 2011-2012 to 19.06% in 2014-2015.

The household financial savings (i.e. investments made in fixed deposits, provident funds, shares and debentures and life insurance) rose marginally from 7.28% to 7.70% of the GDP.

What the table does not tell you is that in 2007-2008, before the Congress led UPA government initiated an era of high-inflation, the household financial savings had stood at 11.45% of the GDP. Between 2007-2008 and 2011-2012, household financial savings fell dramatically. They haven’t really recovered since then despite lower inflation numbers.

In 2014-2015, the consumer price inflation was at an average of 5.83% during the course of the year. Food inflation was at 6.26%. The after-effects of the era of high inflation are still being felt. The low growth in household financial savings also explains why despite a massive fall in inflation, interest rates haven’t fallen at the same pace. If savings had risen at a much faster rate, the interest rates would have fallen more.

Savings in physical assets (homes, land, flats etc.) have fallen dramatically between 2011-2012 and 2014-2015 from 15.73% of the GDP to around 11.05%. This is again a reflection of the fact that people are not saving enough despite low inflation. One possible explanation for this is that incomes are not going up at a fast pace.

The other point that needs to be made here is that the real estate prices have gone way beyond what most people can afford. And that explains to some extent why household financial savings have risen between 2011-2012 and 2014-2015, but physical assets have not.

Now take a look at the following table. Companies (non-financial corporations) have been saving more over the years. Their savings have gone up from 9.59% of the GDP in 2011-2012 to 12.27% of the GDP in 2014-2015. What does this tell us?

 

In Rs crore2011-20122012-20132013-20142014-2015
Savings of non-financial corporations84713499032212180201532262
As a % of total savings28.00%29.40%32.70%37.20%
As a % of nominal GDP9.59%9.91%10.80%12.27%
Savings of financial corporations272371300599294180335679
As a % of total savings9.00%8.90%7.90%8.20%
As a % of nominal GDP3.08%3.01%2.61%2.69%
Savings of general government-158234-160048-148089-131729
As a % of total savings-5.20%-4.80%-4.00%3.20%
As a % of nominal GDP-1.79%-1.60%-1.31%-1.05%

 

It tells us that there are not enough investment opportunities going around and hence the profits that these companies are making are not being invested to expand but being saved. This is again a good indicator of the overall slow trend of the economy.

For sustainable economic growth to happen a country needs to produce things. As the Say’s Law states “A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value.”

The law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. Production of goods also creates new jobs.

A pithier version of this law is, “Supply creates its own demand.” And that is why industrial expansion is important for economic growth to happen. But currently that doesn’t seem to be happening.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on Swarajya on February 3, 2016

All you wanted to know about the Real Estate Bill but were afraid to ask

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On December 9, 2015, the union cabinet led by Prime Minister Narendra Modi approved the Real Estate (Regulation and Development) Bill, 2015, as reported by the Select Committee of Rajya Sabha.

In May earlier this year, the bill had been sent to a Select Committee of the Rajya Sabha. The union cabinet has accepted all the suggestions made by the Select Committee. The Bill will now be put up before both the houses of Parliament.

So what does the Bill have to offer? The real estate market in India is an excellent example of information asymmetry where one side has much more information than the other. In this case, the real estate promoters and the real estate agents have much more information than the home-buyers. Even getting something as basic as the going price of an apartment in a given area is very difficult.

The Rajya Sabha Select Committee on the Bill met real estate consumers and this is what it had to say in its report: “These consumers were unanimous in their submission that they have no means to know about the real status of the project for example whether all the approvals have been obtained, who is holding the title of the land, what is the financing pattern of the project and what has been the past record of the builder etc.? As a result, they invested their money without having any information about the project. In many cases, they were not given what was promised to them and in almost all cases the project was delayed.”

The Bill seeks to tackle this information asymmetry and the fact that the real estate sector does not have any single regulator regulating it. The Bill talks about setting up of a real estate regulator (Real Estate Regulatory Authority to be very precise) in every state and union territory. A real estate promoter needs to register a project with the real estate regulator before he starts selling or advertising it.

Projects with the area of land proposed to be developed exceeding five hundred square metres or where more than eight apartments are to be developed, need to be registered with the real estate regulator of the state they are based in.

The application to the regulator needs to be accompanied with details like the real estate projects already launched by the real estate promoter in the past five years. It also needs to be mentioned whether these projects have been completed or are still under development. If the projects has been delayed, the reasons for the delay need to be mentioned.

Over and above this an authenticated copy of the approvals and commencement certificate from the competent authority also needs to be submitted. Other important details like land title, the layout plan for the proposed project, the location details of the project, also need to be submitted to the regulator.

After an approval is granted by the real estate regulator, the real estate promoter will have  to upload all these details on to the website of the real estate regulator. Any advertisement of the project should have the precise link to the project details as well.

At the time of booking and issuing an allotment letter to the buyer, the promoter needs to make available to the buyer, the time schedule of completion of the project, including the provisions for civic infrastructure like water, sanitation and electricity.

Many real estate companies over the years have sold homes without the basic amenities in place. In some cases, housing societies have even lacked a water connection and have needed to get water delivered through water tankers almost on a daily basis for years. The Real Estate Bill hopes to correct this. It also hopes to correct the information asymmetry that prevails in the sector up until now.

The Bill also allows any real estate buyer to file a complaint against the real estate promoter or real estate agent with the real estate regulator in case any violation of the provisions of the Bill as and when it becomes an Act.

A major problem with the sector has been a delay in the delivery of homes. One of the major reasons this happens is because real estate companies announce a new project, raise money and then use that money either to complete an earlier project or pay off debt.

This has led to a situation where many projects have been delayed endlessly given that the trick of starting a new project and raising money doesn’t seem to be working anymore. The Bill seeks to correct this situation. The real estate promoter needs to maintain 50% or “such higher percent, as notified by the appropriate government” of the amount raised from the buyers of homes, in a separate bank account.

This money can be only used for the cost of construction and can be withdrawn by the real estate promoter in proportion to the percentage of completion of the project. This is one of the major clauses in the Bill and if implemented correctly can bring huge relief for the buyers.

This clause has been diluted. In the original version of the Bill, the promoter needed to maintain 70% of the amount raised in a separate bank account. The reason offered for this dilution is that in many cases land prices form a major part of the project and maintaining 70% of the money raised in a separate bank account isn’t the best way forward.

Further, up until now the buyer while buying a home had no clue about what exactly was the area that he was paying for. The Bill defines the term carpet area exactly as: ““carpet area” means the net usable floor area of an apartment, excluding the area covered by the external walls, areas under services shafts, exclusive balcony or verandah area and exclusive open terrace area, but includes the area covered by the internal partition walls of the apartment.” Again, if implemented well this clause can bring huge relief to home buyers.

Real estate agents will also need to register with the regulator. This is another good move where not anyone and everyone will jump into become a real estate agent or a broker, as is the case currently.

Also, currently the real estate promoters keep changing the plans as they keep building the project. Once the Bill becomes an Act, this may no longer be possible. Any alterations to sanctioned plans, layout plans and specifications of the buildings or the common areas within the project will need written consent of at least two-thirds of the buyers other than the promoter, who have bought apartments in the building.

This is another buyer friendly measure. On a jovial note what this means is that real estate promoters will have to stop advertising all those swimming pools which are planned at the time a project is launched but never get built.

Up until now buyers have had to pay a huge rate of interest every time they miss a payment to the real estate promoter. But the promoters never pay or at least don’t pay the same high rate of interest, if there is any delay on their part. The Bill essentially calls for the same rate of interest to be paid by the real estate promoter as well as the buyer in the eventuality of a default on either side.

Further, if the promoter violates any one of the provisions under section 3 of the Bill he shall be punishable with imprisonment for a term which may extend up to three years or a fine which may extend up to a further 10% of the estimated cost of the project, or with both. Section 3 of the Bill basically deals with the real estate promoter having to register with the real estate regulator before launching a project and then following a series of buyer-friendly steps.

On paper, the Bill seems to be well thought out and takes care of the all the issues that buyers have had with real estate promoters in the years gone by.

Nevertheless, the implementation of the Bill as and when it becomes and Act, will be carried out at the state government level. And whether state governments carry out the implementation in true letter and spirit remains to be seen. I have a few reservations regarding the implementation of the Bill when it becomes an Act, which I shall discuss in a column next week.

Postscript: The Rajya Sabha website has uploaded the Select Committee’s recommendations as well as the Real Estate Bill in a scanned format instead of uploading the proper report.
If Digital India is the way forward this is clearly not done. Information needs to be made available to everyone in the most accessible way. Hope the concerned authorities are listening.

The column originally appeared on The Daily Reckoning on December 11, 2015