“Offload, offload, offload – get rid of your inventories” – This was the advice last year from Hardeep Singh Puri, the Housing and Urban Affairs Minister, for the Indian real estate developers. This recommendation came close on the heels of a similar statement made by Piyush Goyal, the Minister of Commerce and Industry, as the lockdowns had pushed the realty sector’s recovery from a multiyear slump back to the starting line.
The choices available to developers, according to Mr. Goyal, were simple: sell off their high-priced inventories at lower prevailing rates or default on loan repayments as there is lack of liquidity in the market. This Catch-22 situation forms the crux of the burden that inventory overhangs pose for the real estate sector in India – weighed down by Rs 3.7 lakh crore worth of unsold housing units in just the top 7 cities.
Stagnant market, stalled supply: the challenges posed by an inventory overhang
However, selling off unsold units will not be as quick a solution as these statements will have you believe. Property consultant Jones Lang LaSalle (JLL) has reported that the unsold inventory in India will take around 3.3 years to sell, especially with the demand shock that resulted from pandemic-related complications.
This brings us to one of the primary challenges faced by developers: the older their inventory gets, the longer it takes to liquidate. This creates a vicious cycle where, if developers choose to wait for a buyer who is willing to pay a property’s true worth, they face the risk of further depreciation in its value. At the same time, offering potential homebuyers high discounts to make the sale can result in massive losses for developers.
But inventory overhangs don’t just impact the developers’ profitability; they have other cascading effects as well. With the developer’s capital tied up in existing projects that won’t sell, any new project launch naturally gets impacted, forcing them to stall their construction pipelines. This impacts buyer sentiment negatively, as the fear of delay in projects deters new homebuyers from making a large investment.
This burgeoning liquidity crisis has an adverse impact on the real estate sector, which has remained hard-pressed for liquidity for several years due to a succession of crises and policy changes such as the 2016 banknote demonetization and the 2018 IL&FS crisis. The pandemic has further exacerbated this issue.
Taxation damage to developers
A simple reduction in prices to stimulate demand will not solve this conundrum, as it exposes developers to Income Tax penalties that result from the violation of the Ready Reckoner Rate (RRR). To address this, Finance Minister Nirmala Sitharaman allowed developers and homebuyers a 10% safe harbor limit below the stamp duty circle rate in Budget 2019-20, which was later increased to 20% in Budget 2021-22.
However, this is just a temporary fix valid only till 30 June, 2021. Furthermore, the safe harbor limit only extends to residential units worth a maximum of Rs 2 crore. The move leaves out the luxury housing segment that accounts for a significant chunk of this unsold inventory – an estimated 7,364 units priced at Rs 3 crore and above, launched as far back as December 2016, that are still unsold and depreciating.
Developers are also mandated to pay taxes on the unsold stock, based on their notional rental income, if the inventory is older than two years. This delivers a double whammy to real estate players, especially in markets that command high input and land acquisition costs. Take the case of Mumbai, the country’s most expensive property market, which also accounts for the greatest chunk of its unsold inventory. Developers in Maharashtra pay hefty premiums, levies, and other taxes that can account for a third of the overall project cost in the state. In some cases, premiums can exceed the cost of construction. For developers of such properties, taxation on unsold inventory and discounts for potential homebuyers can together prove to be too costly to bear.
Ultimately, unsold inventory has a deep-seated impact on every stakeholder in the real estate industry, creating cash-flow disruptions for developers and a stagnant market for investors and potential homeowners. Considering that real estate in India is set to account for a hefty 13% of the economy by 2025, inventory overhangs have the potential of having a cascading impact on the economy, if left unaddressed.
The way ahead
Despite these challenges, developers can take hope from improving homebuyer sentiment, evidenced by a sharp uptick in realty sales in the third and fourth quarters of 2020. Furthermore, in November 2020, HDFC Bank, the country’s largest home financier, reported its second-highest monthly disbursements in history. This growth in demand has been propelled by record-low home loan interest rates, the expanding affordable home market, government initiatives such as the reduction in stamp duty in Maharashtra, and the growing importance of owning a home in the wake of the pandemic. The offline to online transition of the realty sector, coupled with developers’ initiative to adopt fluid designing principles, is also likely to boost investor sentiment.
An accommodative fiscal policy, as maintained by the Reserve Bank of India, and resulting repo rate cuts are also giving a fillip to home loans in the country. The Central Bank’s decision to defer term loan and working capital loan payments has also helped to reduce the burden of home and construction loans on developers, easing their liquidity constraints. Newer investment avenues like Real Estate Investment Trusts are also helping to bring much-needed liquidity to developers.
The government has also taken several steps to boost homeownership like providing interest subsidies for middle- and lower-income groups under the Pradhan Mantri Awas Yojana (PMAY). In November 2019, the government even announced a Rs 25,000 crore Alternative Investments Fund to bring relief to 1,600 stalled projects, which were estimated to account for 4.58 lakh incomplete housing units. The move proved beneficial for many developers, and restricted possibilities of fraud due to a strict compliance outlay as it was open only to projects that were RERA-registered and net worth positive. The government can further consider granting the infrastructure status to real estate and introducing much-needed measures like single-window clearances and a rationalized GST to help lower developers’ cost of capital. Reintroducing the GST Input Tax Credit will also help by lowering the tax liability borne by developers. The Confederation of Real Estate Developers’ Associations of India (CREDAI) has also urged the government to mobilize additional institutional funding for developers through banks and NBFCs.
The onus of managing liquidity constraints, however, will ultimately fall on developers and their ability to change their methods. Over the past year, in the light of the government’s push to sell off existing inventory, developers have offered homebuyers attractive discounts, freebies, and flexible payment plans to drive sales. Smaller realty players, who are unable to provide such concessions, can consider tie-ups with larger developers to complete their projects. On the other hand, developers of both residential and commercial projects can also sell their commercial developments to domestic or overseas private equity funds to gain liquidity. Some developers even convert their residential projects to commercial ones to improve their prospects.
More than demand and sales, it is industry overhangs that reflect the actual health of the real estate market. See how the Delhi-NCR market witnessed a sharp slowdown in prices after 2013 due to waning investor interest and growing inventory overhang. However, circa 2018, as unsold inventory levels reduced by 15% on the back of demand revival of residential and commercial realty in Gurugram, Greater Noida, and Ghaziabad, the real estate market in the region witnessed a 35% increase in new launches. This not only bolstered real estate growth but also created employment and economic opportunity.
This, then, is the economic, business, and social impact that unsold inventory has on the real estate market. By addressing the pain points mentioned above, industry stakeholders can solve the ‘overhang’ issue and unlock its true potential. For a country looking at the real estate sector to lead its post-pandemic resurgence, not making an intervention is no longer an option.
(By Saurabh Garg, Co-Founder & CBO, NoBroker.com)