“What we call real estate – the solid ground to build a house on – is the broad foundation on which nearly all the guilt of the world rests,” said Nathaniel Hawthorne, American classic novelist. While this may have been said in a different context, it does seem appropriate now, whether seen in the background of the sub-prime crisis or domestic woes of the realty sector.
Indian real estate developers have been reeling under the pressure of formidable forces – steep borrowing costs now further worsened by a funds crunch and slackening demand for property. While real estate sector has traditionally been subject to market cycles, the deteriorating funding scenario appears to have caught the players off-guard this time round.
The pain appears to have reached such an advanced stage that the National Real Estate Development Council (Naredco) and the Confederation of Real Estate Developers’ Association of India (CREDAI) have petitioned the Government to ease FDI investment and External Commercial Borrowing (ECB) norms and also formulate a policy for rescheduling of loans to facilitate the rollover of players’ existing debt.
While most industries have been hurt by higher borrowing cost, the problem of availability of funds faced by the realty sector is a fairly recent development.
“Barring the last 45 days when the banking system faced liquidity issues, banks have always been funding the sector,” says Ram Yadav, Head Finance and Strategy of Mumbai-based real estate redevelopment player Orbit Corporation.
Sushil Mantri, Chairman, Mantri Developers, also suggests that it could only be natural for banks to turn cautious under the current financial market circumstances not only in case of real estate but across various fields of businesses.
While larger players or players with sufficient private equity backing (early on) have managed to get money to fund their projects, albeit some at higher costs, the CREDAI’s appeal is clearly suggestive of troubles in raising loans by the small- and medium-sized players.
Real estate sector seeks ‘stimulus package’
Root of the problems
While it is quite usual nowadays to attribute every problem in every sector to the “global credit crisis”, the genesis of the problems for the Indian realty sector can actually be traced a little way back, to 2007.
Anurag Mathur, Joint Managing Director, India, Cushman & Wakefield, summarises the issues thus: “Debt has always been a restricted commodity to the sector; the Government’s move to tighten the screws in the sector to control inflation increased the cost of funds. At the same time, the crisis that began in the West resulted in drying of funds from sources such as private equity and other foreign funds; IPO market for the real estate too was the first to take a beating on the back of global market events”.
‘Realty market to see mismatch in demand-supply’
A rare occurrence
If external debt funding had been the only issue, then property developers could nevertheless have generated some internal cash flows from completed projects to plough into the business? Property prices could also have been slashed to generate faster cash flows.
Vinayak Chatterjee, Chairman of infrastructure consulting company Feedback Ventures, traces the current crisis to a series of events, whose probability of occurrence, all at once, is rare and was therefore unexpected.
According to him the pull back of consumer demand as a result of higher interest cost, reduced the demand for ongoing projects; this was the earliest sign of trouble. He opines that this phenomenon was also observed in the dip in consumer loans – be it vehicles, durables or homes.
Following this was the sharp rally in commodity prices resulting in an almost 30 per cent increase in input costs for developers in late 2007 and early 2008. Inflation too was simultaneously doing its bit to push up project costs.
Even as developers were grappling with slackening demand and rising costs, developer finance took sudden flight, on the back of the global credit crisis, thus precipitating the crisis.
“Balance sheets, leveraged to risky levels, combined with land grab, made the situation worse for some” says Chatterjee.
Hoarding land bank
Yadav of Orbit Corporation elaborates on the land aspect to point out another possible reason for the current woes. He feels that ‘hoarding’ of land bank resorted to by developers to woo funds or get listed and command high market capitalisations, could also have precipitated the current troubles. Traditionally, developers funded their land purchases through profits generated by their projects, additional capital brought in by promoters and sometimes also bridge-financing for short periods of 2-3 months.
But in recent times Yadav says that “short-term debt” was used for adding to the land bank rather than executing projects on time. He feels that the trouble arose as the focus of developers shifted from the customer to creating a sizeable land bank, obtaining valuations for it and then using this to raise further funds. The risks of delayed execution of the projects had meanwhile increased. With lenders redeeming their short-term borrowings, the land banks remained, while the developers were left without any cash flows from “completed projects” to keep the business running smoothly.
“Very few had given a thought to the high execution risks. How could a developer who has been sitting on 30-40 years’ worth of land bank, with little track record on execution, deliver all the land into constructed properties in 3-4 years’ time?” he asks. Not having proven their cash flows over a short period, the developer may not be well placed to receive further finance from the same source, either.
Sachin Sandhir, MD, Country Head, RICS (The Royal Institution of Chartered Surveyors) India, an organisation that helps maintain standards in the realty industry, also agrees that the quest to become pan-India players and pricing of land at values that were fairly high were reasons, other than souring market sentiment, that had led to a clamp down on the industry, thus tightening the funding.
The near-term solution
Further shortage of funds could spell disaster for small- and medium-sized players as projects will be completely stalled, feels Sandhir. According to him, a relaxation in External Commercial Borrowings may provide much needed relief now. This source of funding is however not easy at this point in time; FDI-complaint projects or those promoted by Government agencies may stand a better chance of tapping this channel.
Chatterjee recommends a structured intervention into the sector to infuse liquidity. This done, the onus would lie on property developers to quickly get back their cash cycles by executing projects and resorting to price cuts. Even then, the property market revival may be a painfully slow process, taking a good 9-18 months in his view.
