1. HDFC’s Deepak Parekh wrong on land purchases? Here’s why

HDFC’s Deepak Parekh wrong on land purchases? Here’s why

Allowing banks to fund purchases of land is simply too risky, will leave builders with no skin in the game

By: | Updated: June 28, 2016 8:11 AM
That may be so, and Deepak Parekh is absolutely right when he says that merely reducing interest rates is not enough, homes must be priced reasonably for people to be able to afford them.  (PTI)

That may be so, and Deepak Parekh is absolutely right when he says that merely reducing interest rates is not enough, homes must be priced reasonably for people to be able to afford them. (PTI)

No less an authority on real estate than Deepak Parekh feels banks and housing finance companies should be permitted to fund land transactions. Parekh, chairman of housing mortgage player HDFC, argues the high rates of interest charged by non-banking financial companies (NBFCs) and foreign private equity (PE) firms are driving up the price of land and, consequently, the price of houses, too.

That may be so, and Deepak Parekh is absolutely right when he says that merely reducing interest rates is not enough, homes must be priced reasonably for people to be able to afford them. But asking banks to fund land purchases is too risky and will leave the promoter with little or no skin in the game. Land purchases must be funded almost entirely by the developer; that must be his equity contribution to the project.

The reason property hasn’t become more affordable in India is because builders want to earn big margins and, consequently, do not want to reduce prices even if sales are slackening. To be sure, there is a shortage of land in the bigger cities and that keeps costs for the developer elevated. That is an issue state governments need to address—land being a state subject—and that should not be difficult to do.

That apart , builders are unwilling to lower prices because it would upset investors—as distinct from owners—who buy into properties expecting a certain return. Many of these investors are politicians—the builder-politician nexus is what has helped many a developer hold prices even during the biggest slump.

Builders are also reluctant to offer newer customers, in a project, a lower rate because the early buyers will be miffed. The net result of developers having constructed hundreds of buildings without being able to sell the flats is a huge pile-up in inventory, currently estimated at around 7 lakh units across the country. Industry experts say that given the limited appetite for homes, it could take some four or five years before this inventory is cleared. Among the worst-hit areas are Gurgaon and Noida not to mention the 50,000 or so luxury apartments—each costing at least R8 crore—that remain unsold in central and south Mumbai.

Despite this, prices have not come off! The core of the problem today is that most developers are over-leveraged, but it is the banks and other lenders that are in trouble. The government bailed out real estate companies after the financial crisis in late-2008 by allowing banks to restucture their loans. That was a big mistake because, even today, some of these firms have large amounts of debt on their balance-sheets. Outstanding loans to commercial real estate stood at Rs 1.77 lakh crore on April 16, 2016, up 6.7% over April 2015. That may be less than 3% of outstanding loans, but some of it may never be returned to the lenders.

Many builders borrowed to fund a specific property but have instead diverted the funds to buy land parcels. As a consequence, projects remain incomplete with buyers not just waiting for years to get possession but also bearing a cost. Where the buildings have been completed, the apartments are priced so high that there are few takers—and that has crimped the cash-flows of builders. The only way to resolve the issue, as has been suggested ad nauseum, is by increasing the supply of land. That alone will bring down prices. Also, developers need to be penalised if they divert funds or if they do not complete projects on time. Much of this is being addressed in the Real Estate Act; for instance, 70% of the collections from home-buyers will be set aside in an escrow account. Ideally, this should have been 100% because funds earmarked for a project should not be utilised elsewhere, but 70% is a good start. Developers will also need to pay customers interest at the same rate at which the latter will pay if payments are delayed. Not surprisingly, builders are complaining the new rules will increase the paperwork, especially if the government delays clearances. Without doubt, the government must be accountable for giving the necessary clearances on time so that construction isn’t delayed. But few would disagree that it is the builders, who scarcely believe in accountability, that need to be disciplined. Some of these are listed companies claiming to be professionally-managed.

The Act will make it difficult for unorganised developers and brokers to operate as they have been doing and perhaps it is time they were weeded out to make way for organised players who are willing to give customers what is rightfully theirs. Perhaps, after some years, when it is proven that the Real Estate Regulator is able to discipline builders, bank loans for land could be considered. At this point, it is simply too risky.


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