Real estate: Soft launches can lead to a hard landing

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Home buyers are flocking towards 'pre-launch' schemes, unaware that the risks are greater than the discounts dangled before them. Home buyers are flocking towards 'pre-launch' schemes, unaware that the risks are greater than the discounts dangled before them.
SummaryCash-strapped developers are resorting to pre-launch sales to lure buyers with discounted prices.

With the festival season turning lacklustre and with the RBI clampdown on 80:20 payment schemes and its variants, a good number of developers are increasingly opting for ‘pre-launch’ to lure buyers and to get their cash flows going. There is even a fancy name to this called ‘soft launch’. Home buyers are flocking towards such schemes, unaware that the risks are greater than the discounts dangled before them. Legal experts term this ‘illegal’ while property consultants advise buyers to stay away from them.

The Carrot

Under this scheme, the developer discounts the price by as much as 10-20 per cent of the prevailing rate in the locality. This is usually communicated, before work begins, through a network of brokers and old clients for a limited number of units and for a limited period.

Buyers who book by giving a token sum of around 10-20 per cent of the total cost are given a receipt, and not an agreement for sale. At most it can take the form of ‘Expression of Interest’. Buyers are given the impression that it is a special discount, and a price rise is imminent once the official launch takes place. End-users feel they have landed a good deal, while investors believe they can plan their exit at a handsome profit.

“Pre-launch offers are illegal. There is no provision in law that the developer can launch the project before obtaining approvals. However, developers both small and big across the country are using this method,” says Vinod Sampat, a Mumbai-based advocate and a real estate expert.

The Reality

The ‘scheme’ is just a fund-raising tactic for the developer. There are cases where developers do not even own the land but go ahead with pre-launch. There are some developers who have made a down-payment for the land, and will pay off the balance through collections from these buyers.

“Lending to the real estate sector is currently in a low-sentiment phase. Interest rates are high for funding that is still available, and some developers do not meet the required eligibility norms for funding at all. In such circumstances, they may seek to raise interest-free capital from the market by pre-launching their project,” says Om Ahuja, CEO-Residential Services, Jones Lang LaSalle India.

Then there are others who own land, but have no approvals. Such developers open the pre-launch window to pile up as much capital as possible. They then close the offer and raise prices to make good the discount they had to give.

During pre-launch, developers do not disclose much details about the project. Buyers, however, do not raise many questions and are taken in by advertisements such as “limited period offer”, “first come, first served”, “prices to rise from next week” and so on.

“People are lured to investing in such properties and it needs to be stopped. This is deception,” says Pankaj Kapoor, MD, Liases Foras, a real estate consulting firm.

“The main reason for such schemes is that without approvals and clear title, no lender will finance the project. But legal position is clear. One cannot sell something that does not exist,” says Naresh Mehta, a Mumbai-based property consultant.

The Risks

Such schemes carry substantial risks, and it would be foolhardy to ignore them.

If the land is not owned by the developer, and in future if some legal or technical issues crop up, then the project could be a non-starter. If permissions do not come through, or some prohibitions are applicable to the plot or the project such as coastal zone regulations, then again the project will run into trouble. In such a case, the project may have to be down-sized, which means it may not remain viable anymore. The developer may abandon the project leaving the buyers to face the consequences.

If the developer begins the project with alterations and a down-sized plan, he may not keep his commitment of the pre-launch rate as it would be unviable since he has lost on his profits with the amended plan.

If the developer diverts the funds gathered from the pre-launch to another project, then be prepared for delays, and the financial consequences given the interest burden.

If due to non-compliance of any law or regulation, the properties of the developer gets attached, or auctioned off by a law enforcement agency, the pre-launch project is left in the lurch.

Factoring in these risks, the odds are loaded heavily against the buyer. Further, there is no legal document such as an agreement of sale, but only a receipt, which has no legal strength. In case the project does not take off, the buyer may get back the token amount, but after a while, but investors should factor in the opportunity cost of this deal.

There is another aspect, often overlooked. Once the project attracts significant interest at the market price, developers do try and offload the pre-launch buyer through some inducement so as to resell the flat to a new buyer at a higher price.

This can take several forms: giving a smaller unit than that promised, inferior placement (floor, wing or view), lower quality of amenities, extra charges for additional facilities or demand for market price for committed quality, simply terminating the agreement on a lame technicality by refunding the token sum or even without it, or entering into a legal battle with the buyer to make him give up to the developer’s terms. There are several cases of developers who have trapped buyers through such methods.

“Investing in pre-launches is, generally speaking, not a route that end users are advised to take, unless there is a high degree of certainty implied in the builder’s brand and track record,” says Ahuja.

The Remedy

The Real Estate Regulatory Bill is currently with a Standing Committee of the Parliament, and there are expectations it could become an Act sometime next year. Once enacted, most of these ills would be taken care of under its provisions, as it will ban pre-launch offers, restrict diversion of funds, and mandate a model agreement between the developer and the buyer.

Although the Maharashtra Ownership Flats Act, 1963 has specific provisions prohibiting pre-launch and there is a clause that a developer has to execute the agreement before accepting any advance from the flat buyer, it has become an open trend. This indicates the lack of adequate checks from the authorities.

Haryana government has already cautioned buyers against this trend, and has advised buyers to contact the Department of Town and Country Planning to verify the licence given to the developer.

Buyers should insist on entering into an agreement for sale on the payment of the token sum. The agreement should contain all the details of the project. If the developer refuses or evades, it would be better to walk away.

Another route is to take the help of a lawyer to generate a search report of the project that includes the legal status of the property and detail of the owners and legality of its ownership along with any loans or obligations on it. Buyers can form a group and engage a lawyer to save on legal fees.

“Investing in pre-launched projects is a high-risk undertaking which can pay off as long as one has factored in all possible variables. It makes most sense to investors who have a high risk appetite and the ability to weather an eventual setback,” says Ahuja.

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