How can developers use unsold residential inventory to their advantage?

Published: April 6, 2019 1:32:44 PM

To avoid bleeding on multiple fronts, it would be fairly wise for real estate developers to choose from multiple options available to them to let the cash flows rolling from unsold residential stock.

real estate, real estate in India, residential projects, unsold residential inventory, builders, Discounted SalesThe top 7 cities, including Delhi-NCR, Mumbai, Kolkata, Bengaluru, Pune, Chennai, and Hyderabad, had residential inventory overhang of 33 months in Q4 2018.

The real estate sector has been witnessing a slowdown for the past few years. While projects are in the completion stage, sales have been sluggish, which has led to unsold inventory available with the developers. The top 7 cities, including Delhi-NCR, Mumbai, Kolkata, Bengaluru, Pune, Chennai, and Hyderabad, had residential inventory overhang of 33 months in Q4 2018. An inventory overhang of 18-24 months signifies a fairly healthy market. This situation has been hurting developers in numerous ways:

# Lack of demand and excess supply have been putting downward pressure on price, thus eroding profit margins. Due to lack of appreciation in prices, buyers are not in a hurry to buy property.

# In case the developer had availed construction finance, typically at 12% to 14% to build the project, unsold inventory has a carrying cost. In simple terms, if this inventory gets sold out quickly, it will help to reduce debt burden in books. But if the inventory remains unsold, the developer will keep paying interest on the outstanding debt.

# Since working capital gets stuck in unsold inventory, developers are also unable to plan their cash flows for their future projects. The confidence in new project launches also takes a hit.

# There is a provision for income tax being applicable on notional rent from unsold inventory. As per the latest Union Budget 2019, the finance Minister has proposed extending the period of exemption from levy of tax on notional rent on unsold inventories from one year to two years, applicable from the end of the year in which the project is completed. This means in case inventory remains unsold for 2 years from the date of project completion, the developers will also need to pay income tax on notional rent.

# Apart from explicit costs as mentioned above, unsold inventory also has a maintenance cost, which the developer needs to bear. All fittings and fixtures need to be maintained on a regular basis in order to keep them in usable condition.

To avoid bleeding on multiple fronts, it would be fairly wise for real estate developers to choose from multiple options available to them to let the cash flows rolling from unsold residential stock:

1. Rental Model: Of late, there has been lot of thrust on coliving and student housing. There are various operators in the market who are looking for taking residential units in bulk on lease near the CBD areas, industrial locations, and educational hubs. Apart from earning, pre-tax yields of 3% – 4% p.a., developers can also charge maintenance cost on these units, which will not only keep the units in usable condition, but also earn some cash flows from them.

2. Inventory Funding: In case there is no existing loan outstanding on unsold units, the developers can avail inventory funding/Loan Against Property (LAP) from various financial institutions and utilize these funds for growth purposes. This is in a way cash flow discounting wherein sales proceeds from units are expected in future and given to the developer at certain discount rate. As these units get sold, loan taken against the units can be paid off.

3. Discounted Sales: There are some projects, which are so-called ‘dead units’ in a project, which are basically slow-moving units owing to various reasons such as extraordinarily large size compared to rest of the units in project or poor location. The developers should sell them at deep discounts rather than holding on to them. This will ensure that the cost of these units is recovered as holding on to them might be a loss-making proposition. Recently, few developers have started taking auction route to dispose off inventory and generate cash, which is unheard of until now. This is due to the realization that holding on to inventory, with the expectation of selling at a premium, is not a financially-wise option.

4. Barter: Developers can also negotiate to offer some ready units to vendors such as raw material suppliers, sales channel partners, architects, contractors, etc. in return for material purchased or services availed from them.

As long as residential real estate remains sluggish and prices do not firm up, the developers need to keep all their options open to preserve their slender margins. Until there is a way to keep cash registers ringing, the developers should embrace the option with both hands.

(By Sandeep Batra, Associate Director, Capital Markets & Investment Services at Colliers International India)

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