A Ghaziabad-based project has been stuck for almost 10 years now, as the developer exhausted all his internal accruals in outright land purchase and hoped to sell off and raise funds through construction-linked plans. With the kind of reputation that the developer had in the market, the plan sounded full-proof on paper. It started off well in terms of sales velocity and then, a slowdown hit the market. The developer could not continue construction and neither could he raise fresh funds. When banks refused to lend to the builder, he borrowed from private parties at an exorbitant rate of 3% per month. This higher cost of lending gave some initial push to the project but, with no fresh bookings, the developer suddenly found himself in a debt trap. However, this developer is not the only one to face such a predicament. Funding gap is the most critical issue in the business of real estate.
Also read: Unsold inventory: A symptom and not the cause of the housing market’s woes
How funding gap impacts project completion
Real estate, a capital-intensive business, is often stuck due to funding gap or the absence of operating cash flow. It may be easy to say that the developer has to factor in financial closure of the project at the time of launching the project but what comes in the way, is the biggest variable called market uncertainty.
Aditya Kushwaha, CEO and director, Axis Ecorp, points out that in real estate, developers have three primary ways of getting funds to complete projects. The first and the most common, is promoter’s capital; the second is from the revenue collection through the sale of upcoming units; and the third may be through gap funding.
“Yes, the real estate industry is prone to gap funding and it can come in handy in commercial real estate projects. Commercial real estate developers manage multiple projects together and gap funding via bank loan or equity funds, can help mitigate risk and maintain adequate liquidity,” says Kushwaha.
See also: Is cost escalation forcing builders to compromise on quality?
Operating cash flow availability unequal among realty segments
Rishi Sreedharan, co-founder and CEO, Hyphen, and governing body member, CREDAI, points out that real estate comprises various asset classes, typologies, and products. One would be remiss not to mention the excess funding available in a few of these and the stark deficiency of institutionalised capital in others, he says. Take infrastructure projects run by the government or residential apartment projects by large, listed developers, for example. They have greater access to institutional funding through corporate bonds, construction funding, structured debt, and other avenues at a low cost of capital, he adds.
“Despite being drivers of predictable cash flow, newer real estate classes, such as co-living, co-working and industrial housing, do not currently enjoy equal access to funds – either through LTVs >80% or low-cost LRDs. Hence, there is much to be desired in these new-age asset classes, for India’s real estate landscape to rise to the level of more mature markets such as Europe and the US,” says Sreedharan.
How to bridge the funding gap?
To bridge the gap, real estate industry stakeholders have been asking policy-makers to award it an industry status. This would enable developers to explore more funding options. Retail participation through collective strata or crowdfunding in rent-yielding, Grade-A assets run by companies, property share, etc., are some of the suggested measures.
The government can provide necessary tailwinds to the sector by subsidising or cushioning the tax implications of exits from selling such assets or instruments. This retail participation could also make way for a great deal of innovative financial products and innovative collective schemes on the institution-side, which, when brought under the ambit of SEBI, will also bring much-needed transparency and accountability in a sector affected by significant trust deficits.
See also: Indian realty suffers from low consumer satisfaction, shows Track2Realty’s C-SAT score
Institutional mechanism of credit-based lending
Real estate businesses generating predictable cash flows could be allowed to avail of existing avenues like capital asset financing, newer avenues of debt capital like OBS financing, revenue-based financing and more. Under its Housing for All initiative, the government could consider providing relief through continued GST exemptions, to the organised rental real estate sector. Credit, or in other words performance-linked lending, could be explored to bridge the funding gap.
Can PE funds bridge the funding gap?
Industry insiders point out that PE funds’ inflow into the sector, which sounds good on paper, is not a one-size-fits-all solution for the business. First of all, PE deals are mostly in the commercial real estate segment, which are income-producing assets. Secondly, most of the PE deals are actually not ‘private equity’ funding but ‘debt’ funding as the funds need to have some sort of minimum returns guarantee.
More importantly, most of the institutional funds in the Indian real estate are close ended, with roughly 3-5 years’ tenure this may not be not conducive for a business like real estate, where project timelines are subject to various variables. These funds have to exit, because they have to close the fund and when they do, it may or may not be the right time to exit. Currency devaluation is another risk that the PE funds are nowadays wary of.
More importantly, most of the PE and other institutional funding, are mostly available to the listed Grade-A developers. Others have to look for private sources of funding, often at rates as high as 3%-4% monthly.
Are buy-back guarantees harming, rather than helping real estate?
Many housing projects across India are also stuck, because desperate developers have been aggressive in raising money, by offering sales with a guarantee that if the price falls, they will buy it back.
Some of the buyers in such projects are end-users, while others are investors. The margin for initiating the buy-back is often 20% or more, because about 10% is the expense in buyback, brokerages, paperwork, etc. So, if you begin to suffer beyond 20%, then, they are willing to buy back at the price you bought it.
With multiple issues fueling the funding gap in the Indian housing market, there doesn’t seem to be any immediate solution in sight, at least till the sector is awarded industry status and regulations are made more fool-proof.
(The writer is CEO, Track2Realty)
Ravi Sinha is a journalist with nearly two decades of cross-discipline media exposure. He is the CEO of real estate think-tank group Track2Realty. He has been writing extensively on the real estate sector for nearly a decade. Evaluation of real estate brand performance is his expertise and he has immense insight into consumers’ psychograph in the property market.
Twitter: https://twitter.com/ravitrack2media
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