Real Estate Crisis: COVID-19 Effect or Weak Fundamentals
This article has been written by Akhil Dudreja for Arthashastra Intelligence Foundation
Introduction
Real Estate industry is a prime driver of India’s GDP. It contributes around 6.5–7% to the GDP and generates millions of jobs. It comprises of 4 sub-sectors — housing, retail, hospitality, and commercial. These sub-sectors directly or indirectly generate millions of jobs in other core labour-intensive industries. With Real Estate being in doldrums, it will further add to the stress in the economy and delay the recovery. A lot of people would blame Covid-19 for Real Estate’s downfall, but the problems started way before that due to years of mismanagement by all the stakeholders involved.
Current Scenario
Before we delve into what could be done to revive Real Estate, let’s first understand what went wrong. Real Estate prices have been kept artificially high for way too long now- Booming stock market created an illusion of robust home sales in major metros. That led to the flow of larger investments, significant price increases and led people to believe that there would be good returns for all kinds of investors. To take advantage of this, developers started constructing bigger and more lavish units priced at an average of Rs 3–4 crore. Can you imagine such prices in a country where the average household income is not even Rs 50,000?
Like every bubble, this also had to burst. Prices of flats have started to come down, sales have declined and there is a stoppage of cash flow, which in turn has slowed down the construction activity. Forget about Private Equity, even the domestic investors are not willing to put their money into the projects because they haven’t received returns on their previous investments.
Shocks of Demonetization & GST
Demonetisation and its consequences- Demonetisation also broke the back of the industry as a large percentage of Real Estate deals were done in cash and that cash would be utilized in the projects. Since our government decided to do away with such transactions and no money coming in from the investors, developers have had to depend on financing from banks and NBFCs. Since banks don’t prefer to lend much to the Real Estate sector, NBFCs had to take the mantle of financing projects. NBFC money is essentially high-interest money and in case of a slowdown in sales, it becomes difficult to service the dues. Since the IL&FS and DHFL crisis, liquidity at NBFC level has also dried up. With houses not selling, and NBFCs unwilling to lend more, developers have no cash flow and have been left in a soup, unable to complete their projects.
Confusion regarding GST rates — GST rules state that the buyer needs to pay GST while buying a house if the project hasn’t received Occupation Certificate. If the project has received the same, then the buyer isn’t liable to pay the GST. This has an inherent flaw in it — buyers are either willing to buy units during the launch of a project or when the project is ready. It’s hard to find buyers who are willing to buy during the middle stages of the project. This again causes cash flow issues. The government has toyed with the idea of reducing GST to 5% with no input credit, but this hasn’t changed the buyer’s attitude much. While GST is a good idea, but it has failed to provide the required impetus to the real estate sector.
Developers unable to discount prices — Quite a few developers are willing to reduce prices to improve the cash flow and repay their debts, but lenders are not allowing them to sell below Minimum Selling Price that was decided at the time of sanction. While bankers are right in their own regard as selling units at lower prices would reduce their security cover, but they need to understand that this is the only way left to generate enough cash flow in the project. If lenders had overvalued the projects at the time of sanction, then they also need to bear the brunt of this slowdown.
Another reason why developers have been unable to cut prices is that local administrative bodies have kept increasing the ready reckoner rate by 3–5% each year whereas housing prices have remained stable. Developers are not allowed to sell a unit below the ready reckoner price and since the gap has closed down between the ready reckoner and market price, developers are not left with much room to cut the prices. Apart from the above-mentioned reasons, buyer’s general mistrust in developers has further increased the slowdown in the industry, though RERA has tried to rectify this issue.
What can be done?
Let’s look at what can be done to salvage the industry. Lenders will have to work closely with developers in ensuring the projects get completed, even if lenders have to take a certain hit on their loans. Restricting developers and not allowing them to reduce prices would only aggravate the situation and lead to bigger write-offs.
Local administrative bodies need to stop treating Real Estate as a cash cow. It isn’t the money-making machine it used to be. These bodies really need to reduce approval prices and streamline the approval process by introducing a single-window clearance mechanism. Currently, obtaining all the approvals is a time taking process that delays the project. Also, these bodies can reduce the stamp duty that needs to be paid on the purchase of the unit.
RBI should allow lenders one-time restructuring of all loans without any terms and conditions. This will greatly improve the position of developers as well as the lenders. GST regulation needs to be modified so that people are encouraged to buy more houses during the middle stages of the projects.
Recently, SEBI has finalized the regulations governing Real Estate Investment Trusts (REITs) and India’s first REIT had been listed on the stock market. This trust will help developers access funds and create new investment avenue for institutions and investors. REITs have the potential to act as a war chest fund to real estate, just like mutual funds are to equities.
Our final take is that all the stakeholders involved should endeavour to complete the stuck projects, sell off the existing inventory before making further investments in new projects.
Conclusion
Although COVID-19 was blamed entirely for the downfall of the Real Estate industry in the initial stages it is now proved to be partially true. Real estate sector has been facing downfall due to the mismanagement of all stakeholders. Most importantly, it looks wise to sell off the existing inventory before making further investments in new projects by the developers minding the REIT benefits. The downfall of the real-estate sector can be controlled by the combining efforts of the regulatory bodies like RBI, SEBI and GST council by adopting a robust framework and clear guidelines.