Debt, Debt, Debt……Everywhere !!

Debt, Debt, Debt……Everywhere !!

The four letter word that everyone loathes today is DEBT. Whether it is retail borrowings, industrial credit or loan to developers, debt has occupied the top of the mind discussions as demonetisation had done in November 2016. It is commonly believed that the biggest concern comes from real estate sector. And while identifying the reasons for high indebtedness in real estate, oversupply, economic slowdown and developer’s greed are believed to be the key factors. Unfortunately they only happen to be the more obvious reasons. Oversupply and economic slowdown lead to mismatch between Demand and Supply - for which most developers have contingency plans. And as far as developer’s greed is concerned, when were developers not greedy ? So even these are insufficient explanations to the quantum of debt within the sector.

What has actually caused this humongous debt in the structural shift in the core pillar of the real estate business. The business model that has served real estate sector for over 50 years is now being challenged. The single biggest factor that had, in the past, made this business exciting, was the large availability of funds from the Purchaser Under Construction ( PUC ). This dependable funding was like a lifeline that ensured developers could undertake large projects even with small promoter’s equity. And it is through the power of money from PUCs that the country has seen so much development across decades.

Earlier, PUC offered a unique value proposition to developers :

a)    Non-recourse Capital :

Pre-RERA, when a PUC  would buy an apartment under-construction, he had no mechanism to recover money from developer ( in case of delays etc). Moreover, many PUCs themselves would not demand money since they would risk losing money that was paid by them in cash (without receipt). Effectively, PUCs was a source of non-recourse (non-returnable) capital for many developers.

b)    Quasi Equity : Being non-recourse money, bankers would earlier treat PUC money as quasi-equity. And therefore the effective Debt-Equity ratio of developers always remained in a very comfortable zone.

c)     Risk Capital : In pre-RERA times, PUCs were allowed to buy homes in projects with part-approvals and pending title clearance. These PUCs would take high risk for an equivalent gain. Such source of risk capital significantly reduced the actual requirement of developer’s own capital.

Today, post-demonetisation and post-RERA, most funds from PUCs come through cheque and with full recourse clause. Delay could now mean full repayment of PUC funds with interest. So, PUC money remains no more quasi equity but gets morphed into quasi- debt. At one stroke, this morphing takes the developers’ debt:equity ratio into a suffocating zone ( as promoter’s equity remains minuscule).

Moreover, the PUCs earlier were largely private financers, investors etc. who would put their ‘own’ money to invest in under-construction projects. Now salaried class forms the chunk of PUCs, whose biggest source of their funds is money ‘borrowed’ from banks/HFCs. When one adds these loans,  the sector-level Debt-Equity ratio reaches dangerous levels.  

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With all the advantages of PUC now vanishing, real estate has become a completely new game. A game that cannot be played with old arms and ammunitions. New tools are required to be  developed – something that is not in developers’ realm alone. Bankers, Regulators and Approving  Authorities will have to join developers to innovate levers that would work in the new framework of things.

This innovation exercise could possibly involve devising mechanism that would allow developers to sell apartments in projects with semi-approved plans to HNIs (the way SEBI permits sale of riskier financial products only to HNIs),

OR possibly structuring call options where qualified investors can take call on future price by paying a premium to developer ; this premium would provide developers with much wanted risk capital. And for investors, it would allow portfolio-betting on real estate prices across India using minimal resources.

OR  may be reforming the anomaly within GST structure where tax on input services is more than that on output

OR perhaps the regulator realizes that the benefits of input credit should be available to the sector offering largest employment in the country.

OR possibly the regulator enacts law that defers all govt taxes to project completion, thus reducing working capital  and also reducing transaction costs ( stamp duty/GST etc) for PUCs which has of late been a big hurdle for PUCs.

Which one will actually happen, only time will tell but only such disruptive ideas can catalyse

 infusion of  large Risk Capital into the sector and ensure  a comfortable sector-level Debt-Equity ratio. Thus making banks, regulator and developers stop worrying about debt and focus on their core product….Home…Sweet Home, incidentally another four letter word, however, the most revered one.