From the perspective of policy reforms in the personal finance domain, the last one year has been truly gratifying. Mutual funds, which were already customer-friendly products to begin with, have become more so with the ban on entry load. In the insurance domain, the new Ulip norms are expected to tilt the balance more in favour of buyers. Now it is time the spotlight of reforms was focused on that one sector where the customer still gets a raw deal -real estate.
The boom and bust cycle in real estate over the last one decade showcased all that is wrong with this sector. Owing to the flood of liquidity from abroad and low interest rates in the country (which boosted demand), real estate prices started moving up in India from around 2002. Developers raised foreign money (via external commercial borrowings, FDI and private-equity investments) and within the country (from IPOs, banks and buyers) to buy land. But then they did not go on to build and deliver projects. Instead they bought more land, launched more projects, and collected more money. Amid the speculative frenzy that had gripped the markets it was easy to sell projects. Many developers over-extended themselves. They took on more debt and launched more projects than they could deliver on schedule.
Then came the crisis of October 2008 and the accompanying liquidity crunch. Nearly all sources of funding dried up. Sales volumes dropped precipitously. Prices stopped rising and then corrected by at least 30-50 per cent. The aftermath wasn't pretty. Strapped for funds, many projects, even by leading developers, got delayed. Buyers filed cases in consumer courts, staged dharna in front of developers' offices, and formed online groups to apply collective pressure on developers to deliver projects. A few developers would surely have defaulted on their loans had the Reserve Bank not allowed banks to restructure real estate loans.
The shabby manner in which buyers were treated in the entire cycle underscores the need for reforms. Here is my short wish list of reforms that I believe should take priority so that purchasing a house becomes less of an ordeal in our country.
First and foremost, a sector as important as real estate needs a regulator. The Ministry of Housing had issued a draft model Real Estate (Regulation of Development) Act in September 2009. Regulatory reforms in the real estate sector get complicated by the fact that it is a state subject. So this model bill will first have to be passed by Parliament, and then adopted by the state of Delhi. Each state will then have to adopt it individually by having it passed thorough its own legislature. Thus the legislative agenda is rather tall. So far not even the first step - introducing the bill in Parliament - has been taken. Since it is common knowledge that real estate sector plays host to a lot of black money, even informed commentators and not just conspiracy theorists, wonder if there are vested interests at work trying to prevent this draft bill from becoming law.
But if and when this major legislative hurdle is crossed, the benefits would be many. The regulator could begin by insisting on licensing of developers. That would prevent scams such as 'pre-launches'. These are a regular feature of the Indian property market every time it perks up. Fly-by-night operators collect money from buyers even before they have bought the land or received regulatory approval for their project and then flee with the money.
Another reform that a regulator would bring about is making the penalties for delays in delivery of projects harsher. In the last boom, developers launched more projects than they could handle because the penalties aren't stringent enough at present (and developers include clauses in the sales agreement that allow them to escape payment).
The regulator could also insist that all projects are advertised and sold on the basis of carpet area. Today buyers often find that the flats delivered to them are much smaller than what was advertised. (Developers take the plea that what was advertised was the super built-up area, which includes common areas).
Today, on an average, developers require 52 clearances to launch a project. Getting them all takes about two years. This is a major reason for cost escalation and delays. Once a state appoints a regulator, it could move towards the concept of single-window clearance managed by the regulator.
Apart from the discipline that a regulator would impose on an unruly sector, many other reforms need to be implemented at the earliest. Stamp duty rates in states range from 5-15 per cent. Reducing these rates towards the lower end of this range would increase compliance and state governments' revenues, while reducing customers' burden.
Large parcels of prime land remain locked up (under Court orders) on account of the disputes that the Urban Land Ceiling Regulation Act (ULCRA) gave rise to. Further, it is a legacy of the Rent Control Act (RCA) that prime real estate in many cities lies in dilapidated condition. Since rentals don't get revised, landlords don't have an incentive for renovating their properties. The Centre has already abolished these laws. Many states, however, have yet to abolish them even though doing so is a pre-condition for receiving JNNURM funds. In many states, even though these laws have been repealed, the cases filed under them have not yet been withdrawn.
Finally, worldwide floor space index (FSI) within cities ranges from as high as 15 in the central business district to 0.2 in the suburbs. But in India most cities have low FSI and it is uniform throughout the city. It does not vary depending on factors like business potential, density of population, and availability of infrastructure. With land becoming so expensive, clearly FSIs need to be revised upward.
In Singapore, the government wants to tap the scope for developing underground real estate. So it is working on a master plan, a framework for property rights, and a valuation model for underground real estate. While it would be too much to ask for that kind of visionary approach in India yet, isn't it time at least the basics fell in place?
Bad debt fears still exist
This time round the fear stems from unlisted realty players. Once conditions in the stock markets
improved from around March 2009, a number of listed real estate players went for Qualified Institutional Placements (QIPs). Through fresh injection of equity, they managed to bring down their debt to more reasonable levels. Thereafter, the consensus in the equity markets has been that debt-related worries within the real estate sector are a thing of the past.
That may not entirely be true. Debt overhang very much exists; only the players burdened by it have changed. According to a recent study by HDFC Securities, the total debt exposure of the banking sector to the real estate sector at the end of May 2010 stood at `95,700 crore. What is particularly worrisome about this exposure is that only 22 per cent of the loans have been made to listed players; the balance has been made to smaller, unlisted players. Some of these players (around nine) plan to enter the markets via IPOs in the near future.
Loans to smaller players is a cause for worry. Unlike the bigger players who have access to multiple sources of funding, the smaller players depend only on bank funding and internal accruals. Moreover, since the beginning of the recovery, property prices in the major metros have risen by 25-40 per cent and are at or near their pre-crisis peak. With prices surging, transaction volumes have dipped. And with interest rates also moving up, it is unlikely that volumes will revive anytime soon. It is also unlikely that the Reserve Bank will once again permit banks to restructure their loans to real estate players, as it had during the 2008-09 crisis.
The banks that have a high exposure to the real estate sector include PNB (8.2 per cent of total loans), ICICI Bank (7.5 per cent), OBC (7.4 per cent) and Axis Bank (5.2 per cent). The saga of high indebtedness of real estate players thus continues. Those investing in bank stocks must keep a hawk eye on their loans to real estate companies. And those investing in IPOs of real estate companies must also look closely at the debt levels of these players.