Real Estate: Addressing the risk-return anomaly

Deepesh Salgia

Tectonic changes in the real estate sector have increased the risk level for real estate business and simultaneously reduced its avenues for risk capital.


    • Increasing prices have now turned volatile, thus increasing business risk


    • Post RERA, landlords prefer upfront cash over Joint Development, requiring developers to take larger risk


    • Mandatory registration for home buyers after 10% of payment has dissuaded investors leading to shortage of risk capital for developers


    • GST too has disincentivised purchase of under-construction apartments, choking developers of risk capital



And most importantly, RERA demanding huge performance guarantees from developers has increased the business risk.

As a result, equity investment real estate projects have been pushed to a higher risk class but with returns that are much lower than before. It may be music to ears for those who have suffered from unscrupulous developers but a situation where returns do not justify the underlying risks would lead to a flight of capital from the sector. The target of Housing For All by 2022 will need huge equity capital infusion. Therefore, policymakers can ill-afford the current Risk-Return anomaly.

Critics of the above approach would argue that with mandatory escrow account mechanism, banks will be more comfortable funding real estate companies so funds will anyway flow into the sector. But debt alone cannot suffice, proportionate equity inflow is a must.

Also a rise in stock prices of real estate companies does not mean that the Capital Flight theory is incorrect. The rise in stock prices only means listed real estate stocks were beaten down significantly below their intrinsic value. It does not indicate fresh equity investment into real estate companies. The risk-return ratio for real estate business remains very skewed and needs corrective action for equity inflow into the sector.

Can policymakers address this Risk-Return anomaly, without sounding it as a favour to developers? Surprisingly, the answer is YES.


    1. Changes in rules for registration :



To protect the buyer, RERA mandates compulsory registration after 10% of payment. However, since registration requires full payment of stamp duty, it dissuades investors from under construction properties and also requires end users to have higher equity contribution.

What policymakers can do is to continue with registration on 10% payment but allow it with 0.1% stamp duty. The remaining stamp duty can be payable on possession.

Both end users and investors will find this an attractive proposition. Developers will have access to larger funds during the construction stage. And govt will lose no revenue.


    1. Addressing GST Disparity :



Currently, GST is payable only when a buyer purchases under-construction property. For ready property (after Completion Certificate), there is no GST. This disincentivises purchase of an under-construction property.

Govt needs to charge GST on ready properties (first transfer after Completion Certificate) and simultaneously subsume stamp duty with GST which means once GST is paid no stamp duty is required to be paid. Effectively, all buyers will be treated equally, govt will lose no revenues and developers will get larger funds under-construction.


    1. High share of Govt costs :



Out of the total money paid by the homebuyer, as much as 30% goes to govt in some form or the other (GST, stamp duty, stamp duty on land, municipal premiums, development charges etc.). Most industries pay 18%. And when govt charges about 5% to basic industries of roti and kapda, it is unfair if makaan has to pay 30%.

Even if govt does not want to reduce its share then it can at least defer it. Today most of the costs like municipal premiums, development charges and others are payable before approval of plans. Govt can make all its revenue payable on Occupation.

This will ensure that the interests of govt authorities, developers and buyers are all aligned towards timely completion of projects. Secondly, it will reduce the need for funds during the construction stage, ensuring larger supply of housing stock. Finally, RERA’s escrow account mechanism will ensure that govt’s revenues are safeguarded. For further safeguard, policymakers can insist on 5% additional money in escrow account.


    1. Allowing pre-launch investment for HNIs



With an intention to protect the investor, RERA does not allow developers to sell under-approval apartments.

To protect investors from the risk of structured products, SEBI did not ban such products but allowed them with larger ticket size. RERA could take a similar approach. This would open doors for a large amount of risk capital from HNIs coming to RE sector. 


    1. National Home Buyer Protection Fund :
      Sebi has an Investor Protection Fund for investments in stock market. On similar lines, a very small percentage (say 0.01%) of every property transaction could go to a National Home Buyer Protection Fund.


This fund can be used to support distressed projects. This safety net would increase the confidence level in the market and thus reduce business risk.

Lack of equity capital for real estate business would be an unwelcome situation not just for developers but also for the nation. Infrastructure sector has experienced the vagaries of excessive debt, let housing not follow that path.