Loopholes that hold back India’s real estate growth

Loopholes that hold back India’s real estate growth

 

By ANDY MUKHERJEE

 

PROPERTY developers in India, analysts agree, need to raise large sums of money to ease the shortage of everything from office towers, warehouses and shopping malls to apartments, multiplex cinemas and hotel rooms.

 

The financing itself shouldn’t prove very difficult. At US$400 billion a year, domestic savings in India now represent a significant source of funds for any profitable enterprise, including construction. There’s also ample interest globally, including from hedge funds and buyout specialists.

 

Lenders such as ICICI Bank Ltd are seeking billions of dollars from investors in North America, Europe, Japan and the Middle East to invest in property projects in India.

 

Yet, Indian real estate can absorb a lot more capital than is currently flowing into it – if only policymakers can fix a few basic loopholes in the laws governing property titles, taxation and creditor rights.

 

Failure by lawmakers and regulators to set clear rules on property rights and ownership will only widen the demand-supply gap that’s pushing rents to an intolerably high level.

 

Office rents in Nariman Point, Mumbai’s central business district, rose 14 per cent from the previous three months in the first quarter of 2008, Cushman & Wakefield Inc, a real estate services firm, said recently in a research report.

 

At 550 rupees (S$18) per square foot per month, Nariman Point is already as expensive as Singapore’s financial district.

 

And even then, there’s no shortage of demand: The average vacancy rate in Mumbai’s central business district was as low as one per cent last quarter.

 

The shortage isn’t limited to office space: Industrial property rents in Mumbai rose at the fastest pace in the world in 2007, New York-based Cushman said last month.

 

Among the bottlenecks affecting the flow of debt capital into Indian real estate is the absence of a good bankruptcy code.

 

A developer who takes a loan from a state-run bank would typically mortgage the property to the lender and agree to deposit part of the rents paid by tenants – or a share of the purchase price paid by the buyers – into a special account.

 

The money held in escrow is to be used only to service the debt.

 

Such an arrangement, foolproof as it may appear, doesn’t truly secure the interest of the lender. If the builder bungles an unrelated project and fails to meet its obligation to another creditor, the latter can get a court to appoint a liquidator who has the power to release the insolvent company from any onerous contracts. The liquidator may not exercise such a power to nullify an escrow, but the threat itself is a damper.

 

‘It’s conceivable that an escrow agreement may be set aside by the liquidator on the grounds that it is onerous,’ Moody’s Investors Service and its Indian affiliate ICRA Ltd noted in a joint study this month.

 

One way to give creditors greater comfort would be for the developer to sell the property that it wants financed to a special purpose vehicle, which the liquidator can’t touch even if the builder becomes insolvent. This presents another hurdle: very high stamp duties on property sales.

 

Stamp duties, a legacy of British rule, are a transaction tax. They vary from one Indian state to another and range from 3 per cent to 15 per cent of the property value.

 

Among other challenges, property titles in India aren’t guaranteed and lenders face difficulties enforcing mortgages.

 

Banks in India have gained from a 2002 law that allows them quick possession of the asset in case the borrower fails to repay its loan; however, this fast-track route to debt recovery isn’t open to mutual funds and insurance companies, which have to go through the normal, lengthy judicial process to get any of their capital back, the Moody’s/ICRA report said.

 

This narrows the potential investor base for mortgage-based debt securities.

 

Only a diversified group of investors can meet the financing requirement of the real estate industry.

 

After growing rapidly in the past few years, bank financing of property projects has hit a plateau, thanks to the monetary authority’s efforts to rein in credit growth.

 

Real estate loans by Indian banks amounted to 539 billion rupees on Feb 15, a 27 per cent increase from a year earlier.

 

This represents a marked slowdown from the 79 per cent annual pace at which bank loans to property companies grew in February 2007.

 

The property stock in India is too small and too dilapidated to serve the demands of a rapidly modernising economy.

 

Developers need access to stable, long-term financing from a variety of sources, including real estate investment trusts (Reits).

 

This will lead to judicious risk-sharing. Transparency in funding will eventually reduce the scope for bribery and corruption, which are endemic to the real estate industry. Fixing the legal loopholes will be the quickest way to reach both these goals. – Bloomberg

 

Source: Straits Times

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One Response

  1. Great post !
    Generally it is very intresting kind of investment, but I think that real estate is loosing it’s price too much.
    I own a site with prices for Moscow real estate listings and from the begining of this year it wasn’t grew….
    Anyway american real estate is more stabil in this case.

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