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Wednesday, August 31, 2016

Indian Real Estate Market: Some Thoughts
Photo: Don R. Campbell
The Indian real estate market has seen a huge boom in the past decade thanks to a growing urban middle class population. Major real estate companies are targeting developable areas and turning them into construction marvels.

Real estate in India has been severely impacted by the global economic meltdown, leading to stressed assets that have affected buyers as well as developers. Incomplete or delayed projects, depleted financial resources and unutilised land parcels point towards the urgent need for innovative solutions to break the logjam. The solution lies in tackling the ‘stressed assets’ and reviving the real estate sector.

India’s real estate sector witnessed a boom in 2004-08 leading to a proliferation of commercial office space and retail mall space when companies and investors were lapping up every announcement/launch.

Faced with a long time-gap cycle between purchase of land and delivery of product, companies entered in frenzied land parcel purchases to cope up with the rush. But this crashed with the economic slowdown.

Anyway, the Indian Real Estate sector is not only the biggest contributor to Gross Domestic Product (GDP) of the country but is also one of the largest sectors in terms of Foreign Direct Investment (FDI) inflows in the country. 

The two main reasons responsible for an upcoming boom in the real estate industry in India include liberalization of Government policies, which has decreased the need for permissions and licenses before taking up mega construction projects and the expanding industrial sector. Urbanization and increasing household income are some of the major factors that influence demand for residential /commercial property which results in India's economic growth.

India is expected to gain back its growth momentum in the medium term owing to higher savings and easing inflationary pressures which would lead to capital formation and fresh investments.

The NDA government has taken several initiatives to encourage the development in the sector, the key ones being:
  • Relaxation in the norms to allow foreign direct investment (FDI) in the construction development sector. This move is expected to boost affordable housing projects and smart cities across the country.
  • Clearance of model real estate bill by the Union Cabinet.
The Securities and Exchange Board of India (SEBI) has notified final regulations that will govern real estate investment trusts (REITs) and infrastructure investment trusts (InvITs). This move will enable easier access to funds for developers and create a new investment avenue for institutions and high net worth individuals and eventually ordinary investors. 

Tax efficiency can be critical to the success of REITs. While the basic framework for one-level taxation has been laid down by the Finance (No. 2) Act, 2014 and supplemented by the Finance Bill, 2015, certain challenges persist in structuring a REIT.

Demand for residential/commercial property is being driven by India's economic growth. One of the core sub-sectors of residential, commercial, retail and housing, the first category offers maximum promise, while the balance three sectors are also growing well and have a bright future. Residential segments are nowadays hero of the moment due to continues demand.










 In the light of positive sentiment, the sector could heave a sigh of relief. But questions still remain over the unfinished and undelivered projects. Recently, states have begun cracking the whip on errant developers. In Maharashtra home buyers can now file an FIR with the police and have the errant developers arrested. With such harsh measures being introduced, developers will think twice before delaying possession.

Real estate dealers are banking on festive season for a surge in property market. Property purchases are expected to rise during Ganesh Chaturthi and Navratri as the period is considered auspicious for locking new deals.

Property sales are likely to jump by 10-15 per cent this season as compared to last year due to prospects of better crop production on bountiful rains and conducive weather, according to industry experts.

Property prices are unlikely to drop from the current levels despite huge unsold properties due to squeezing margins and anticipation of demand from upcoming companies.Property dealers said September to November is the peak period for sales and purchase of properties.

The landscape changes:
Consequently, malls began closing and commercial office space faced excessive ‘over-supply’. Sales halted and lease rentals went down drastically. To continue business, real estate companies shifted to residential projects, hoping that the shortage of homes in India would fuel adequate demand.

However, those expectations were belied and today, even the completed residential projects have suffered from delays, fall in prices and unsold inventories.

These stressful conditions have precipitated judicial and buyer activism, burgeoning complaints by buyers and investors and a surfeit of stressed assets with real estate companies.

In this backdrop there are a series of measures that can be adopted. First, land parcels are the first of the stressed assets which can be salvaged by the Government and urban development authorities/public sector corporations.

These were auctioned or leased and here, projects were unable to mushroom. The issue is that they cannot be launched in the near future as the existing excess supplies still have to be absorbed.

So the solution lies in returning the land and money/funds paid by the developers. Not only would the Government benefit from increased land prices but the developers would also get ready-made cash to pump into viable projects.

Building them up:
The second set of stressed assets comprise delayed projects where cash outflow is less than the expected inflows. These are the projects where a substantial part of the structure is ready, but they need ‘top-up’ funds for completion and delivery.

So where would these funds be sourced from? Obviously, they can be taken from funds received by surrender of leased/auctioned land parcels by the Government/public sector corporations.

Even a construction-linked commitment from buyers, with a marginal funding from financial institutions to kick-start the largely-completed structure, can be another source.

This is again a win-win situation because the developer would revive stalled projects and buyers would benefit from assets purchased at old prices.

The third set of stressed assets are those projects that have not begun construction but have hugely over-leveraged, either through excess collections from buyers or due to huge debts to financial institutions. These are projects and companies in distress.

The first option would be to look for internal funds from the companies itself. It could be funds returned by the Government or authorities for land parcels returned to the agency concerned, but to be kept in Escrow Accounts to be used for completing distressed projects primarily.

The second option could be to permit Rules of Escrow accounts for existing projects to allow funded projects to pay for over-leveraged projects and projects which can be completed.

To begin with, banks and State authorities can draw up lists and examine the magnitude of the problem. These can be used by the new real estate regulatory authorities to be set up in each State.

Also, the authorities could act as a bridge between companies in distress and banking institutions to give finance at reasonable rates and for short-term duration to complete distressed projects.

The quantum of funds required can be worked out by the figures collected by banks and State authorities. While dealing with the situation, we must factor in the reality that many are in trouble only because of economic realities they cannot control.

So, in a situation where it is critical to restore the faith of buyers, the Government, banks and the real estate industry should collaborate for innovative solutions.

Good initiatives:
Some such steps have been taken by the surface transport ministry. They include:

To give 10 per cent of the project cost as advance to private developers, which could be deducted along with interest from the pre-scheduled payments due to the Real Estate companies.

Raw materials can be collectively bargained at discounted rates, due to large requirements of the sector.

The Government and public sector undertakings could plan to buy housing in bulk, fulfiling the requirements of housing among government/PSU employees and at the same time get the same in prized locations. They could be provided on an immediate availability basis. Also, the prices will be lower than the Government/PSU costs, specially if interest rates will be added, to the cost of money being deployed if the same were to be constructed by the Government/PSUs.

In sum, the real estate logjam can be tackled with the right approach, ideas and implementation.

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