Realty development firms addressing real estate financing bottlenecks

Realty development firms addressing real estate financing bottlenecks
Environment ministry had issued a notification last year that exempted construction projects from prior environment clearance. Photo by Reuters.
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The development of the real estate sector, due to its capital-intensive nature, is largely dependent on funding. In 2005, India’s real estate and construction sector was opened up for foreign investment. This led to the evolution of the sector from being largely dependent on domestic, unorganised capital to attracting an increasing number of global investors. They ranged from real estate funds to private equity funds, sovereign wealth funds, hedge funds and also strategic investors or foreign developers.

While institutional activity in real estate peaked around 2006-08, with a mix of project-level and entity-level investments, trends changed radically following the global financial crisis in 2008 and 2009. The period immediately following the crisis saw the banks become increasingly wary of lending to the sector and high-risk weightages were placed on lending to the sector by the Reserve Bank of India (RBI). This led to issues for the sector as funding by banks reduced considerably and alternative sources of funds are limited and expensive. Funds are also unable to cover the lifecycle of a project, thus leading to shortage of long-term funding. These issues are compounded by time-consuming approval processes and high input costs, leaving the developer facing high costs and low sales.

A significant challenge faced by real estate development firms is that national banks in India consider real estate investments a high-risk asset. Moreover, various restrictions imposed by the central bank have limited the exposure of banks to the sector. Another key challenge is that no single source of finance is able to cover the entire lifecycle of a project. Alternative sources of finance are limited and expensive, leading to higher costs of properties. This is typically passed on to consumers, who usually take the double hit of high home loan rates and increasing capital values, resulting in subdued demand in the sector.

The Indian government has taken various initiatives for easing the funding concerns faced by the industry. While steps such as setting up a real estate regulatory authority, easing up of foreign direct investment (FDI) norms, opening up the sector for real estate investment trusts, or REITs, are in the right direction, ensuring fund availability cannot be left to the government alone. As the government takes the necessary steps to ease up funding, the real estate sector also need to be aware that the responsibility of the sector’s credibility lies with them. Here are a few key steps they can adopt to help with the funding crunch faced by the sector.

Initiate tie-ups with banks to promote confidence: Real estate entities can consider tie-ups with banks for long-term funding requirements if they have concrete project plans. Banks largely remain sceptical of the sector because of the ambiguity of financial soundness, project execution processes and timelines. If promoters involve banks from the conceptualisation stage, rather than approaching them for financing alone, they might be able to instill more confidence. The establishment of a real estate regulatory authority will also help banks regain confidence in the sector.

Develop quality assets: Real estate entities should look at improving the quality of their assets and also at redevelopment of inferior-grade properties. This will not only help them achieve better returns on their investments, but will also allow a larger proportion of their portfolio to be REIT-compliant.

Ensure transparency of operations: Lack of confidence in the sector’s capability to deliver is one of the biggest reasons why end users are shying away from the market, especially from under-construction projects.

Invest in due diligence to avoid defaults: Real estate entities should be extra cautious while purchasing land or acquiring any property to avoid legal hurdles at a later stage. There have been instances where litigations related to purchased land surface much after the developer has launched the project. If real estate entities are more cautious while acquiring land, a multitude of problems can be avoided during a project’s execution.

Timely execution of projects and building a portfolio of quality assets will be instrumental in attracting investors to the sector and bringing down lending costs. Also, banks need to ensure that the realty sector does not bear the brunt of being a high-risk one. Developer and project viability can be assessed at a project level to allow for fair play for real estate developers. Lending institutions and development firms need to work in conjunction with the government to ensure that the industry is not devoid of its most basic need to grow—finance.

 

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Anshuman Magazine Anshuman Magazine is chairman-India and south east Asia, CBRE.