6 reasons why underwriting is bad for real estate sector in India

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

What is underwriting in real estate and why do real estate developers go for it?

Sumit was looking to purchase a property in Noida and he missed out on the opportunity to book a flat with reputed developer last time because within 2 days of the launch, the project was sold out. He had made up his mind not to miss such opportunities next time. However, even after keeping an eye on new project launches, he missed out again and now the only option left was to book the apartment with channel partners, underwriters, or brokers.

Why does this happen? He questioned…and even wondered…”I read an article last time, and it said…real estate demand is dropping”. How come, these new projects are sold out within a day or two of their launch??

The reason behind the selling of these new real estate projects in a day or two is not the actual demand but artificial demand. Real estate developers use the services of their nexus of brokers and financiers who underwrite these projects.

Real Estate project underwriting in its broader term means sharing the risk of the developer. Brokers or financing houses underwrite the real estate project, which means they have taken on the risk of distributing/selling the project. Should they not be able to find enough investors or customers, they will have to hold some stock themselves. Underwriters make their income from the price difference between the price they pay to the real estate developer and what they collect from investors or from broker-dealers who buy portions of the offering.

With the help of this nexus, developers start making claims that their projects are sold out. With underwriting, developers are able to create a situation wherein they let prospective buyer believe that there is demand for the project and that they should buy the property now or else the prices will go up shortly. And this normally creates a herd mentality among end-users and they have no other option but to buy the property.


Why underwriting is not good for real estate sector in India

• Artificial demand

The demand thus created by the nexus of builders and underwriters clearly sends the signals to the market that “All is well” with realty sector and demand is robust. However, for a given city the actual demand supply equilibrium can be understood by studying and analyzing the capital value appreciation and rental yields. If demand is robust, it should reflect in the rental yields as well. However, what we see in most Indian cities is the fact that rentals have not kept pace with the capital value appreciation. The artificial demand created by the builder-underwriter nexus keeps the capital value of housing stock unjustifiably high.

• Prices keep on moving up despite the sluggish market economy and demand

We keep reading from various leading research agencies about the amount of unsold stock lying with the developers and how it has increased over the last quarter or year. There is hope that prices might come down to reasonable level. And all of us sit on the fence hoping that prices are going to come down, but what happens is actually opposite. Prices are always going up. Demand or no demand, prices in real estate sector in India move only in one direction and that is up. There is never a correction. Why? Well, coupled with the limited launch of new supply, holding up of existing inventory keep the prices firm. Finally, the buyer gives in and the cycle continues as usual.

• Seller’s market

Housing is a basic need where one dreams of having a house with certain features and specifications. In reality, buyers are forced to buy whatever is available at prevailing market prices. There seems to be no choice whatsoever for buyer to buy a piece of land and construct his own property due to high prices.

• Non preferential allotment

There might be people who might have contacted the developer early and would have thought of booking an apartment at their desired floor with best available view. However, this wishful thought may not come true due to underwriting of the project as it may be blocked by underwriters in bulk bookings.

• Housing is treated as an investment class rather than a basic need

People or businesses with deep pocket and unaccounted income invest in some of these projects to park their money. There are instances when one individual or business house owns multiple residential properties. Whereas the land allotted by civic authority to builders should have served the purpose of creating housing supply for the needy at justifiable price, what we see is the mad rush by people to own multiple properties. And this builder-underwriter nexus serves this well by allowing cash component in property dealings.

• Black money

A builder offloads its stock to underwriters and then an underwriter sells the stock to end-users or investors. Based on the artificial demand created, builder keeps on increasing the prices periodically (monthly or quarterly). The underwriter then sells the property at lower value than the current builder price. The premium charged by the underwriter is usually paid in cash by the investors. And this leads to a circle wherein an investor with unaccounted income invests in property and the cash amount received by the underwriter is again pushed back into buying of another housing stock.


Are there any solutions to this builder-underwriter problem?

Yes, there is a solution. Whenever a real estate developer sells, it should be made mandatory by law that the buyer information will be made public. By having the buyer information, not only will this lead to actual demand but may also put a curb on entering of black money into real estate sector. But, will the authorities pay any attention to this? We don’t know and this is where the Real estate regulatory bill has also failed. Read more on real estate regulatory bill in the next column.

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6 steps that can make real estate efficient and corruption free in India

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

We have been writing a lot about the inefficiencies and mal practices in real estate sector in India. A lot of focus of our writing has been on highlighting the issues that plague the industry and how those issues can be tackled. While other ideas such as RTI; Aadhar; and recently Jan Lokpal bill has seen the light of the day, issues in real estate sector still remains unresolved. There is no denying that implementation of RTI, Aadhar, and Jan Lokpal bill will help in eliminating corruption from the government-public interface. But, what about real estate, where most of the cash finds its way? Why is the government not bringing in policy measures to cure the sector? We list some of the measures that can help in eliminating corruption from the real estate sector. In no way, these are the only measures, but, we are confident that implementation of the following measures will certainly help the sector.

• Equalize market rate and circle rates

As the name suggests, market rates are determined by the economics of demand and supply equilibrium. Buyers and sellers participate in the market and transactions take place fairly & without any stimulus. Circle rates are the minimum rates fixed by the state government and a buyer of the property is entitled to pay stamp duty charges on these rates whenever a transaction takes place. For example, in Gurgaon, the market rate of an apartment in a multistory building is 7000 Rs/sqft, while the circle rate for the same apartment as fixed by the state government is 4000 Rs/sqft. For a 1000 sqft apartment, the stamp duty charges as per the circle rate would be Rs. 320000. While the stamp duty charges as per the market rates would be Rs. 560000. Therefore, it presents an opportunity for the buyer to under report the apartment value on papers in order to save on stamp duty charges. Equalizing market rates and circle rates would eliminate the practice of under-reporting of the property value. However, this may affect the growth of real estate sector because of fewer transactions between buyer and seller. And this can lead to an adverse impact on GDP of the state as well as the country. Well, the move to equalize market rates with circle rates should also be complemented with reduction in stamp duty charges.

• Reduce stamp duty charges:

Stamp duty charges are exorbitant in most states across India. Stamp duty charges are least in Madhya Pradesh at 0.5%, while they are about 8% in states like Haryana, Punjab, Rajasthan, UP. Now, let’s say stamp duty charges are brought down in all states to a uniform level of 1%. Therefore, one would now pay Rs. 70000 as stamp duty charges on a flat of 1000 sqft with a market price of Rs 7000 per sqft. This move will not only encourage buyers to report market value of the property but will also lead to more and more transactions. Research based on past transactions can result in the optimum value of stamp duty charges which incentivizes true reporting as well as increased velocity of transactions across states in India.

• Cap on property transfer on government sponsored schemes

On government sponsored schemes such as the recent DDA flats scheme, there should be a tenure cap. In other words, people who applied for the scheme and got allocation should not be able to sell the allocated apartment in secondary market for a fixed time period (say, 5 years). This happens in many countries in EU. The tenure cap will drive away speculators and only the real needy people will participate in the whole process. Can you imagine for 15000 DDA flats, some 15 Lacs application came. But this one looks impractical because banks, government bodies, and agencies all made money by issuing a lottery system. And then, they would say, we are pro-poor and these schemes help poor of the country. We came across a property dealer in Delhi who filled 8 forms for the DDA scheme. He called in various relatives and friends from his native Bihar and he made sure that at-least 8-9 forms were filled. He paid for the whole process and in return if a flat was allotted to any of those 8-9 members, he would share 50% of the proceeds. Everyone knows what a big lottery this whole flat allocation system is, yet government is not changing the policy. And who is benefitting? Government bodies by charging a fee for every form sold; banks for providing upfront money to the customer at an interest; and the rich who already owns multiple properties.

• Cap on home ownership in certain cities

Certain cities such as Mumbai, Delhi, and other major metros have become unaffordable for the masses. A basic 2BHK is virtually out of the reach for a salaried person and he/she has to go to the outskirts of the city to fulfill his/her dream of home ownership. People with deep pockets own multiple properties in these cities. Housing is considered an investment vehicle first and then the basic need. In China, the government has moved in recent years to quell home price amid worry that surging costs could lead to social unrest and has set Home-Ownership Curbs in Shanghai and Beijing. Can it be done in India?

• Computerization of property titles across the country

E-governance is the need of the hour. When there is no dearth of talent in the country when it comes to software development and technology, why don’t we see the computerization of property records? In many instances, a single property is registered under 2 or 3 names and this leads to disputes. Computerization of property titles will not only eliminate property disputes but it will also help in land acquisition processes for mass urbanization.

• Make it easy as far as capital gains tax are concerned

An individual is liable to pay capital gains tax whenever there is significant gain over the buying price. Applicability of long term and short term Capital gains taxes should be made simple. In order to reduce or avoid being liable to pay capital gains tax, an assessee can either purchase a house within a period of one year before or two years after the date on which the transfer took place, or construct a house within a period of three years after the date of transfer. Why can’t we have a common wealth tax instead of so many complicated tax structures?

Is it desirable as far as real estate is concerned or are we just getting too ahead of ourselves?

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Why is Property market still in doldrums??

Why is real estate market still in doldrums?? Many say, it’s because of BJP Government. But is this good or bad?? Let’s find out.

As we all know, property market in India thrives on cash (or unreported income). As long as cash is being pumped into the realty market, it thrives and investors make merry. However, the Narendra Modi government's efforts to uncover black money have reduced the generation of black money in the system. The impact of this change will become more pronounced in the coming months.

"With the new Black Money Bill (which was passed by the Parliament on May 26) and with the Cabinet approving the Benami Transactions Bill in May this year, the crackdown on Black Money will continue further.

All these steps by the Narendra Modi government have impacted the realty market in short term; however, it's a step in right direction (if we look at the long term prospects).

For too many years, people avoided taxes and pumped that cash into realty market. Consequences of such theft (avoidance of tax) meant property prices were shooting (almost doubling in 2 years). People parked their unreported income into real estate. Some bought 8 flats, some bought 15 plots. It was crazy. Real estate became the best asset class to make money in short period of time.

However, working class (or salaried class) was suffering because of high values of real estate. They could not buy their dream home. Their dreams of owning a home was fading, slowly but surely. Congress party did nothing to stop this mad rush to own the real estate.

Even though, Black Money from abroad can take time (years) to come to India. But, we have GOOD news that generation of Black Money within the country may slow down (or stop) and Property prices can become affordable for the working class and their dreams of owning a home can become a reality.

Investors can cry and they will cry, but it’s a step in right direction by Modi government. Few (maybe 1 or 2 %) investors shall not be able to decide the fate of 90% of public.

Amen :)

Will increasing property circle rates in Delhi stop black money transactions? We believe….No

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

Delhi Government has increased the property circle rates across all categories of colonies. The change in circle rates has been effected from 23rd September 2014. The increase in circle rates has been a whopping 20%. What are circle rates? Circle rate is the minimum property price set up by the local government to calculate stamp duty and registration charges for any property transaction within the city.

Here are the new circle rates for Delhi:

	New Circle Rate for Land (in  Rs/Sq.Mt.)	Stamp Duty @5% for Joint Holding (in Rs)	Old Circle Rate for Land (in Rs/Sq.Mt.)	Stamp Duty @5% for Joint Holding (in Rs)	Differential (in Rs)	Increase in stamp duty 100 Sq Mt  plot (in Rs)	Increase in stamp duty 300 Sq Mt plot (in Rs)	Increase in stamp duty 500 Sq Mt plot (in Rs)	Increase in stamp duty 1000 Sq Mt plot (in Rs)
Category A	774000	38700	645000	32250	6450	645000	1935000	3225000	6450000
Category B	245520	12276	204600	10230	2046	204600	613800	1023000	2046000
Category C	159840	7992	133224	6661.2	1330.8	133080	399240	665400	1330800
Category D	127680	6384	106384	5319.2	1064.8	106480	319440	532400	1064800
Category E	70080	3504	58365	2918.25	585.75	58575	175725	292875	585750
Category F	56640	2832	47140	2357	475	47500	142500	237500	475000
Category G	46200	2310	38442	1922.1	387.9	38790	116370	193950	387900
Category H	23280	1164	19361	968.05	195.95	19595	58785	97975	195950

The stamp duty charges in Delhi are as follows:
Male - 6%, Female - 4%, Joint - 5%, Senior Citizen - 6%, Company - 6%

The idea behind increasing the circle rates in Delhi is to curb black money component which is rampant in property transactions across the country. Really, will increasing the circle rates curb black money transactions? We are doubtful; on the contrary, it may further push up the property prices and slow down the already subdued demand.

In our opinion, it is a lazy way of looking at the issue of black money in property transactions. So, what could the government do to curb black money component in property transactions?

• Equalize circle rates and prevailing market rates, i.e. there is no circle rate, in fact, stamp duty and registration charges should be calculated on the prevailing market rates. But this will increase the stamp duty burden on buyers. And hence, property transactions will slow down considerably and therefore loss of revenue for the government and adverse impact on the economy. To overcome this issue, government must reduce the stamp duty charges.

• Reduce stamp duty charges to 1% of property value.

• Reducing stamp duty charges and equalizing circle rates with market rates will encourage the buyer and seller to report the correct property value. And hence, it will help in curbing the black money transactions.

• At the same time, people will transact more frequently which will have a positive impact on revenue generation for the government.

• Therefore, need of the hour is to reduce stamp duty charges and equalize market rates with circle rates. Increasing circle rates at the current stamp duty levels will in fact encourage more cash transactions.

Is the revenue generation department of local government listening??

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Don’t blame the ‘Babus’ of town planning departments and city development authorities

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

Another one bites the dust! Well, we are talking about the latest scam or scandal or irregularity or blunder or whatever you may call it in real estate sector in India. This time, it’s the Supertech’s Emerald Court project in Sector 93-A Noida on Noida – Greater Noida expressway.

What happened? The project was started in 2006 and permission for 15 towers of 11 storeys each was given. However, in 2009, 2 towers namely ‘Apex Tower’ and ‘Ceyane Tower’ of 40 storeys each were added to the project. That means addition of 857 new apartments.

So what? It all looks fine, where is the irregularity? Well, these two new towers violate the UP government’s 2010 apartment act. The 2010 apartment act which was being designed by ‘Babus’ says that builder should take permission from existing buyers before construction, and should also follow the maximum density norm (maximum number of people in one acre), FSI norm, minimum distance between two towers, etc.

So, were these guidelines of the ‘Apartment Act’ flouted? Yes, that seems to be the case and therefore Allahabad High Court has ordered to demolish these 2 towers of 40 storeys each.

So, whose fault is it primarily? Builder says, we will appeal in the Supreme Court against the judgment because project is legal and has all the necessary approvals from the Noida Authority? Whose fault is it then? Is it the fault of ‘Babus’ of Noida Authority? Nah….it can’t be, they work hard to make sure that whatever they design (2010 Apartment Act) is implemented by hook or crook. Then whose fault is it? It’s the customer’s fault you stupid…why did they buy these apartments? They should have done their due-diligence….isn't it? Hmm…..

Well, on a serious note, time has come for Courts to look at the role of the ‘Babus’, and if necessary spank them at their back side severely for allowing illegal construction.

Customers can not be taken for a ride by colluding builders and authorities. The babus who are supposed to protect the interests of home buyers are busy amassing tens or hundreds of crores of illegal property for themselves by taking advantage of their positions.

Since, 2011, these scams have been a common phenomenon:

In 2011, DLF’s Belaire project in Gurgaon met the same fate wherein charges of project delay, illegal construction of additional floors were raised by the Resident welfare association of the project.

In 2012, Noida Extension fiasco came to limelight wherein farmers agitated against the authorities for acquiring land at throw away prices and also changing the land use from industrial to residential. The matter was resolved after courts intervened in and farmers were compensated adequately.

In 2013, we had Campa Cola fiasco in Mumbai wherein illegal floors were built in late 1980s and were ordered to be demolished in 2013.

And now in 2014, we have the Supertech Emerald Court matter in Noida wherein again the court has ordered demolition of illegal towers.

So, will this continue in coming years? Will the ‘Babus’ pay attention to the sufferings of home buyers? Will the ‘Babus’ stand up and implement the laws and acts in all fairness? We will see….But, thankfully for the common man; all is not lost as long as Courts discharge their duties.

Greed on the part of the property developer is ubiquitous, but what explains greed of these Babus who in reality are supposed to keep a check on the greed of developers???

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What impact will RBI move of changing currency notes printed before 2005 and coming Loksabha Elections have on Real Estate sector in India?

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

• Land purchase may slow down due to RBI move to change currency notes printed before 2005

We all are aware of the fact that virtually all land deals whether large or small takes place with huge amount of money paid in cash to avoid stamp duty charges. Now, Let’s assume, there is a land transaction that is going to take place between party A and party B and the market price of the land is rupees 5 crores. As per the circle rates, the land price comes out to be rupees 2 crores. The remaining 3 crores will be paid in cash by party A to party B. Given that, RBI has announced that currency notes before 2005 needs to be exchanged. In this situation, Party B is not going to accept cash amount with currency notes printed before 2005. Therefore, it puts pressure on party A to exchange his/her currency notes with the banks. And in certain instances, party A may not be in a position to go to banks for the exchange of currency notes due to the fear of income tax authorities taking note of such huge levels of unreported income. However, it is yet to be seen what impact will there be on realty sector, but there is all the likelihood of fewer land transactions due to the RBI’s latest move to change the currency notes printed before 2005.

• Elections and real estate

Elections are a democratic phenomenon, which happens every 5 years in India. There are two kinds of election namely assembly elections for respective states and general elections for parliamentary system in India. All political parties whether small or large, regional or national strive hard to win elections and form the new government. It is commonly known that to win elections, political parties use all kinds of methods from announcing distribution of laptops, offering cycles, to free subsidies. The idea is to target the voters with such schemes in order to swing the pendulum in their favor.

And to win these elections, large amount of money is spent on advertising, organizing rallies, pamphlets, banners, press, traveling to various constituencies. About Rs 10,000 crore was spent in Lok Sabha campaign in 2009. And according to some estimates, this time that figure will be between Rs 15,000 crore and Rs 20,000 crore. There is no hidden fact that, the huge amount of money required is spent in form of cash. So, where does this money come from? Well, political parties will claim that this money is raised from their followers, supporters. Who are these followers? To put it bluntly, there is no free lunch here. All these so called followers who provide cash to political parties will like to claim their spending if the party they support comes in power. These claims may vary from allocation of natural resources, tax benefits, subsidies, dissolved cases, etc.

Now, how are all these followers able to provide such large amount of cash to these parties? We all know that in India even though most businesses claim to do business by the rule of law, but in reality they do under report their income and it is that income that is ploughed in real estate, gold, or elections. All these sectors have the unending capacity to absorb unaccounted cash. Therefore it is fair to say that when elections are round the corner, the investment in gold or real estate may dip and funds may be diverted towards elections.

• Impact of elections on property sector in India?

As observed earlier that during the time of elections, the funds are diverted towards political parties’ election campaign. And the sectors that suffer the most are real estate and gold. Large amount of unaccounted cash is provided to these political parties which until now would have been parked primarily in real estate. In fact, during election times one can notice the increase in distress sale activity in real estate. Since, huge amount of money is required for elections; properties worth millions are sold at below market rates to generate sufficient cash for elections. It is also highly likely that real estate developers will cut down on new launches of housing units or commercial real estate and will solely focus on selling the existing inventory.

• Should I buy the property during election times?

From the end-uses point of view, it is possibly the best time to buy. One can focus on buying from secondary market or resale market. As suggested earlier, there is strong likelihood that distress sales will increase and it presents end-users with an opportunity to buy at lower rates. However, buying in secondary market means, one has to pay huge amount of property value in cash. It is also the good time to negotiate hard with the developer if one is buying directly from the developer.  Since developers are only focusing on clearing the existing inventory, it presents end-user with an opportunity to bargain hard and get substantial discounts on the property.

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How does black money hurt the country where it originated and how does it travel to foreign countries?

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

Black money hurts the country a lot. The tax revenues if reportedly accurately by individuals and businesses would have gone to the country’s exchequer. The government with right intentions could have used these revenues judiciously by building infrastructure (ports, roads, educational, healthcare, communication, power, etc) and that would have resulted in higher GDP growth, more jobs, and poverty reduction. Instead these revenues now lie with individuals & businesses and some of them invest these amounts in domestic assets such as real estate and gold. Why only real estate and gold? Primarily because of the ability of these assets class to absorb cash and this is turn distorts the property and gold market. Housing becomes unaffordable in a country where there is shortage of about 18.78 million houses as per the 2012 estimates. There are various other disadvantages of black money as we have covered in many of our other posts.

However, in this post, we are focusing our energies on black money that travels abroad. This is the worst form of corruption because money which could have been used for nation building is now building other nations. We pondered a lot and thought of ways in which this black money can travel outside. In recent times, stashing of black money in foreign banks (read, tax havens) has been the topic of debate between the political parties, media, and the public at large. There have been theories that Indians are the largest depositors of black money in foreign banks. There have been murmurs that the amount of black money stashed abroad could be as high as India’s GDP, which is close to 1.84 trillion US$.

In a press conference few months back CBI director (central bureau of investigation) put that number to be 500 billion US$, almost 35% of India’s current GDP. By any stretch of imagination, this is huge amount for a country, whose fiscal deficit is at record high level, whose infrastructure needs investment at a scale which has been unprecedented in human history.

There are various discussions, round tables with tax havens countries to bring back the money deposited to India. But so far, only a pittance of the total amount has been declared. It will take time, says government sources.

Now, the whole scene of stashing black money to foreign banks got us thinking…how the hell this black money would travel to those foreign banks? How? And in this article, we encourage readers to answer this very question.

Explored a bit and two possible scenarios came to our mind

Formal Routes:

1. Wire transfer: Wire transfer or credit transfer is a method of electronic funds transfer from one person or institution (entity) to another. This one looks formal and we are sure it can be traced with proper tools and training.
2. Buying foreign assets such as real estate, companies, etc: But this is all in white and traceable.
3. People traveling abroad: People traveling abroad carry the allowable cash with them and deposit it in foreign accounts. But that is going to take years to reach 500 billion US$.

Informal (or should we say black) routes:

1. Gold Transfer: Gold is bought by these tax evaders in the parent country and then the same is transferred to foreign shores in ships or chartered planes.
2. Money transfer: Rupee or parent country currency is converted to internationally accepted currency (usually US$) with central bank knowing all the details and then that converted money is flown to foreign shores in chartered planes. Now, this amount in internationally accepted currency is used by the foreign country for their own investment purposes which ultimately lead to growth in those countries at the cost of growth in parent countries where the money actually originated.

In all these informal (black) routes, we fail to understand, why central bank or country’s top political leadership is clueless in tracing the black money? As far as we understand, money just cannot move out of the country without their approval.

Our imagination took us to these ideas…but we are sure, there are talents out there who could help us in deciphering all this. Waiting to hear from all you guys out there about the possible routes of black money traveling to foreign shores.

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It’s all about perception…isn’t it? And how is real estate sector in India perceived? Can the perception be changed? Let’s make it a New Year resolution :)

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

Good bye 2013 and welcome 2014, Happy New Year to each and everyone out there. Last year was tough for realty sector in India with GDP slowing down, high inflation and interest rates, and lack of demand from end-users. Will 2014 be different? Yes, it can be. However, the perception towards real estate sector needs to change and all the participants have to do their tiny bit in bringing out the positive image for the sector.

Current perception towards real estate sector in India:
Well, what is perception? It’s nothing but how people from outside view the sector. And how do they view it? Just talk to any common man and one would get the answer. The sector is perceived to be entrenched in corruption, black money, political maneuvering, builder – politicians nexus, etc. If one were to draw a sketch of the real estate sector on people’s perception, this is how it will appear:

The perception is that builders, politicians, and bureaucrats are working for each other when it comes to realty sector. This nexus is so strong that, policies are made, tweaked to favor the rich and powerful builders. Look at what happened at Campa Cola compound in Mumbai. The project was approved in 1980s by the BMC. Builder not only constructed the towers as per the approved plan but also illegally constructed some additional floors. Now, who would believe that these illegal floors were constructed without the knowledge of BMC or some local politicians? And now citizens are facing the heat. Doesn’t the picture above clearly highlight the situation in Campa Cola Compound of Mumbai?

Let’s examine the role of each stakeholder in the real estate sector closely:

• Town planning department or the authorized government agencies:

The department is armed with civil services officials with foresight to develop the city and plan for increased urbanization. New areas are demarcated for future residential, industrial, and recreational growth within the city. The process of demarcating land, allocation it to developers, tax collection, etc. is perceived to be inefficient and corrupt. We as citizens have no idea on what basis or methodology these areas are demarcated. Real estate project approval process is so cumbersome and opaque that there is no way out but to bribe the officials to obtain project approvals on time. And therefore, what we get is increased cost of property and unorganized real estate development.

Our team members have been visiting the new upcoming areas in Delhi NCR region. Real estate development in these areas has been taking place for almost 8-9 years and all we found is ghost cities. The infrastructure including electricity, water, sewage, roads, waste management is nowhere to be seen and yet we find plethora of high-rise development of brick and mortar. Some of these developments are self-sustainable. One can imagine the cost of living in these self-sustainable townships. More importantly, what will happen to unauthorized slums in the region? How those living in slums will be rehabilitated? Or will urban class who has tasted global standards live in conjunction with slum dwellers? There seems to be no answer.

To our question of who will live in those new buildings? Many builders, brokers, and investors would respond by saying that there is such a dearth of housing in the country that customers would lap up whatever is offered to them.

• Real estate developers:

With the planning and foresight of government officials, builders would enter the fray and acquire land for residential, industrial, or recreational purposes. There is strong perception that if builders are loaded with sufficient funds, there is no way in this world that they can be stopped from developing those ghost towns. Market research, planning, and concrete data are all fancy words for builders with deep pockets. To say that there is an utmost disrespect for planning & research would again be an understatement. Promoted as world-class real estate, there is perception that quality of construction is compromised in most of the final product delivered to the customer. The builder's focus on maximizing the profit often results in squeezing of the room-sizes and cut down on the open areas.

The question to be asked is how it is sustainable for builders to develop these ghost towns. Well, when party is on, the credit is available on cheap rates and there is always this heavy component of black money entering into real estate sector. However, when credit availability becomes tight and there is supervision on black money component, things start to change. This is what seems to be happening today and there seems to be no respite for builders from huge debt levels, customers’ lack of interest, and high rate of credit availability.

Will the bubble burst? Well, as long as entering of black money into the sector is not prohibited or controlled, this can continue although at slower pace than what we witnessed during 2003-2007.

• Media:

No one can deny the positive role of media in today’s times. However, there are occasions when media is perceived to be doing the services for politicians – builder’s nexus. As soon as the builders announce their 'world-class' projects with fancy western names, the media related to real estate development will go gung-ho about new development in the city and how it will shape the future of the city. Glorifying articles with questionable data related to infrastructure development will be published which forces customers/investors in believing about the merits of investing in these new ghost towns. Articles about roads, connectivity, metro projects, and industrial development will be published on a daily basis to lure people to invest in these new cities where no one lives for years before people actually start to move in. That movement of people however can take upward of 10 years is another matter. Maybe that’s the foresight of government officials or builders who don’t mind delaying the project since everything is in their favor and customers are at their mercy.

Case in point is the Noida extension fiasco in 2011-12, and promotion of upcoming airport on Yamuna expressway which was eventually canceled, etc.

• Investors:

Investors with unreported cash or income are the first ones to invest in these ghost towns. Where else can they park this hard earned money of theirs but for the real estate sector? What happens is the money which should have gone to the government in form of taxes would now sit in these ghost towns. The government with right intentions could have developed the necessary infrastructure with tax revenues which could have led to an organized economic growth in the region. But those are fairy tale stories and happen only in utopian societies.

• End users:

End users with modest income who have been sitting on the fence for all those years finally give in. They start buying for homes from investors in secondary market involving white and black transaction. Why white and black transaction? Well, to save on ridiculously high stamp duty and registration charges. And they just hope that situations like Campa Cola do not happen to them.

So, this is all about the existing perception. Can the perception be changed?

Yes, after all, we are all part of one common society and there is contribution from each one of us.


What can the Town Planning department or government agencies do to change the current perception?

1. There is already an effort being made by the government in bringing the real estate regulatory act. Although a small step, but this is a welcome step.
2. Land allocation process should be made transparent by auction mechanism or whatever the best possible alternative is.
3. Upcoming infrastructure in the city should be presented in the public domain credibly so that everyone has the information about the city development and therefore can participate in the process of real estate investment. The idea is to curb insider information practices wherein some investors connected to the policy makers make windfall profits and rest languish.
4. Project approval processes should be streamlined and made transparent. There is a wider belief among experts that by doing so, real estate costs can come down by whopping 20%.
5. Construction laws should be looked and analyzed on regular basis to improve the city development and curb illegal construction practices.

What can builders to change the current perception?

• Sell projects only when all the approvals have been obtained
• Clear distinction between carpet area and saleable area
• Clear deadline for project completion
• Third party supervision of construction quality

What can media do to change the current perception?

• Continue to report facts accurately about city development and upcoming infrastructure.
• Highlight the wrong practices by any of the participants in realty sector.

What can end-users do to change the current perception?

• Be an extrovert buyer. Ask questions before buying in a particular project
• Make payments in cheque and pay the taxes accurately.
• Thorough due-diligence
• Coming together with other buyers and forming a group

There is no denying that perception reflects reality. Even a single step of correction can go a long way in changing the reality of realty sector and change the current perception.

Cheers

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What lessons can real estate sector in India learn from Aam Aadmi Party?

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

Well, it’s been an incredible journey for Aam Aadmi Party. Although still in its nascent stage, the party has chosen the path less traveled by political parties so far in India. The party was the product of anti-corruption movement in India with Anna Hazare at its helm. However, due to internal differences among the anti-corruption movement members and a burning desire of the leaders of Aam Aadmi Party (AAP) to make a substantial change to the Indian political system led its entry into formal politics. If the anti-corruption movement was all about putting pressure from outside on the political system in India, the members of Aam Aadmi Party has vowed to make a difference by getting inside the political system. The party is led by Arvind Kejriwal, who has a substantial track record in Indian Revenue Services, RTI activism, other NGOs, and joining Anna Hazare for bringing in Lokpal bill in India.

As things stand in Real Estate sector in India, there is this need to clean up the sector. Property transactions, construction, track record of real estate developers, soaring home prices, housing shortage, etc. are issues that require immediate clean up. And it is in this environment, what we need is a set of leaders who can change or rather clean the existing system and processes. These leaders can be real estate developers, architects, policy makers, or entrepreneurs looking to enter the realty sector in India. What can these new set of leaders learn from the spectacular achievement of Aam Aadmi Party?

• Take big risks:

Just like Arvind Kejriwal stood against Sheila Dikshit and did not play safe, the leadership in real estate sector needs to take big risks. For example, a builder can come into the real estate sector and act transparently and professionally. Why don’t we still see any real estate developer selling their projects based on the carpet area? Why don’t anyone of the developer state the actual project completion time instead of the industry trend of 3 years? Each one of them knows that the project will be completed in close to 5 years, then why don’t they say it when selling the apartments to customers. Most developers still play safe and the result is that we have a real estate sector which is perceived as corrupt.

• Efficient execution:

Aam Aadmi Party did not have the resources to compete with well established political parties such as Congress, and BJP. Neither, they had money, nor the backing of big corporate houses. Still, they had the passion, hunger, and discipline to win against all odds. Remember how the established parties will use volunteer by paying about 5000-6000 Rupees in reaching out to voters. AAP simply inspired the existing resources such as volunteers and media to take their message forward to the voters. Similar results can be achieved in realty sector with the contribution of honest government officials, set of developers, and media. The sector would go a long way if few of the government officials simply don’t sit on project approval files and sanction the real estate projects on their merits rather than on black money, and the developers focusing on completing the existing projects rather than building the land bank by diverting the funds.

• Putting pressure on the existing system and processes:

Aam Aadmi party declared their funding, processes, volunteer model on the website for everyone. They also carried out internal surveys and declared the survey results along with the methodology and data for anyone to scrutinize. Even after the election results, they had been consistent in their approach to sit in the opposition rather than form the government by any means. Contrast this with the political maneuvering we see in India wherein MLAs and MPs are bribed, traded to form governments. Similarly, a set of real estate developers and entrepreneurs can stand on their principles of fair practices, no bribe, timely execution and delivery of projects. And all of this will put pressure on the established developers to fall in line and ultimately sector as a whole will benefit.

• Perseverance:

Aam Aadmi Party simply did not get lucky and did so well in elections in a year or two. They had been at this anti-corruption movement for about a decade. From Anna Hazare to Arvind Kejriwal, they have persisted with their idea of cleaning the system. Real Estate sector demands that kind of perseverance to truly achieve results. Policy makers will not change over-night and bring in transparent systems of project approvals, financing, taxes, etc. One has to persevere and put pressure on the system continuously by leveraging the support of media, and customers.

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Why US like sub-prime (housing) crisis will not happen in India?

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta

If one were to observe the recent trends across real estate sector in India, he/she would realize that market is slow. Damn slow. From increasing unsold stock of housing units to slowdown in office space absorption across major cities in India, the trend has been depressing to say the least. Will it lead to price correction? Yes, we predict so, read "Real Estate Bubble in India" to get a sense.

However, question to be asked is “will prices fall so dramatically that it leads to US like sub-prime crisis”? And the answer is BIG ‘NO’. Why? Let us explore!

First of all what is a sub-prime crisis?

It was about 5 years ago, some of us were in business schools and the shocking news of Lehman Brothers going bust filled the classroom. Most of us were new to business jargon like ‘sub-prime’, ‘securitization of home loans’, ‘derivatives’ and therefore could not grasp the solid reasoning behind the banking crisis. However, as days passed by, we began to understand this better by discussing with professors; peers; and reading articles. One of the better anecdotes that explains US sub-prime (housing) crisis goes like this:

“Linda is the proprietor of a bar in the city. In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around and as a result increasing numbers of customers flood into Linda's bar. Taking advantage of her customers' freedom from immediate payment constraints, Linda increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively.

A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Linda’s borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral. At the bank's corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide.

No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling items.

One day, although the prices are still climbing, a risk manager (subsequently of course fired due to his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Linda's bar. However they cannot pay back the debts. Linda cannot fulfill her loan obligations and claims bankruptcy.

DRINKBOND and ALKBOND drop in price by 95%. PUKEBOND performs better, stabilizing in price after dropping by 80%.

The suppliers of Linda's bar, having granted her generous payment due dates and having invested in the securities are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor.

The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties (and vested interests). The funds required for this purpose are obtained by a tax levied on the non-drinkers”.

Well, simply, replace unemployed alcoholics by home loan seekers, Linda with a housing company, and throw in a mortgage company and investment banks with all their financial engineering skills. And what you had was major financial crisis.

Why can’t it happen in India?

Reason 1: Black money

Yes, it’s actually true that no matter how much we curse the existence of black money into the real estate sector, but it actually won’t allow a sub-prime (housing) crisis to happen in India. In US, banks started to lend 100% of home value at lower rates in initial years (known as teaser loans in India) to borrowers and this led to default when home prices fell. However, in India, even if a bank lend 100% of home value to its borrowers, a borrower will still have to pool in the equal amount of cash to buy the house at market value. 

For example:

A housing deal takes place between a buyer and seller and the market price is Rs 80 Lacs. However, as per the government circle rates, the home value on paper is 35 Lacs. Due to high stamp duty charges, the buyer will not report the actual value of Rs 80 Lacs to the registrar office. And the seller will not report the actual value of 80 Lacs in order to save on capital gains taxes. Therefore, what we get is a property which is worth Rs 80 Lacs, is actually registered at Rs 35 Lacs. The remaining 45 Lacs is paid in cash by the buyer to the seller. So, even if the buyer’s bank offered 100% of home value which is 35 Lacs on paper, the remaining 45 Lacs is arranged by the buyer. And who on earth would walk away from this home where he/she has invested 45 Lacs of their cash even if the home prices dip.

Reason 2: RBI Policies

Reserve Bank of India (RBI) has put in place certain policy measures which until a few years ago looked conservative to many people. But these very measures will not allow the Indian banking system to lend aggressively and these measures are:

• In India Banks provide home loans for about 70-80% of property value. The remaining 20-30% has to be arranged by the buyer. Whereas, in US this norm was relaxed and banks began giving loans equal to the entire value of the house.
• In India, banks check the credit worthiness of the borrowers and lend only to people who have income records and have the capacity to pay EMIs. Whereas in US, home loans were granted to people with no documented income, job or assets. 
• In US, banks came up with teaser loans (interest rates are low in initial 4-5 years and then are aligned to market rates). Borrowers were happy to get home loans at sub-prime rates; however, they found EMIs too hard to pay as soon as the interest rates were realigned to market rates. And they simply walked away. In India, the concept of teaser loans is not allowed.
• Non-recourse debt in US. This kind of debt is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the collateral. However, in India, the borrower is personally liable. In other words, banks can seize his/her other assets to recover their claim.

Add to these above reasons, the fundamental issues of housing shortage and emotional attachment of owning a home will make sure that housing sub-prime crisis will not happen in India.

In a nutshell:

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Solutions for reducing the uninterrupted influx of black money into the real estate sector

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta
 

Talking to any common man on the street about real estate sector would draw animated conversations on how the sector is riddled with black money, corruption, and political maneuvering. In this section, we will focus on how the black money enters the real estate sector, its effects on economy, and ways to tackle it.



How black money enters the market?

1. Parking place:
Real estate has become the parking place for businesses to park their unaccounted cash in real estate particularly in residential real estate asset class. Most business houses, small or large, even though claims to be doing the business by rule of law but would under-report their profits to save on tax. And that under-reported income would land in the real estate sector which tends to raise the prices of real estate in a land scarce country like ours.

2. High rates of stamp duty and registration charges:
Stamp duty and registration charges account for 12.5 to 15% of property value in most states across the country. As an example, the property with market value of Rs. 1 Crore would elicit Rs. 12.5 to 15 Lacs for stamp duty and registration charges. However, the circle rates (or government decided rates) of property in most cities are much lower as compared to the market value of the property. There lies the incentive to under-report the true market value of the property to save on stamp duty and registration charges. The amount saved is paid in cash to the seller and that cash is again ploughed back into the real estate sector giving rise to a vicious circle leading to ridiculously exorbitant property prices.

3. Capital Gains Tax:
Most of us have observed the real estate deals wherein cash forms the significant part of whole deal. There are instances when cash constitutes as high as 75% of the total property value. Now, cash transactions are encouraged in real estate sector to save on capital gains tax which is 30% of the total gains. There is data available which suggests that more than 70% of that cash is again ploughed back into the real estate sector leading to rapid appreciation is real estate prices. The comprehensive knowledge of capital gains tax including exemption on profit from home sale can be found from following sources.
Capital gains tax exemption makes sale of house more profitable
Tax exemption on profit from home sale


Effects of black money

1. Unaffordable prices of property:
The entering of black money leads to irrational prices in real estate sector. In a country, where demand for affordable property is high and land supply is limited, the whole influx of black money spirals out the prices of property to a level which is almost unreachable for the middle class families. We all have seen how housing prices have multiplied in many cities across the country in the past decade and yet the rental prices haven’t kept the same pace of appreciation.

2. Negative impact on economy:
Real estate is an asset class where money is invested; it sits there and over a period of time produce capital value appreciation on account of true demand in a rational economy. However, when black money or the excess money enters the sector, it not only drives the property prices to irrational level but also leads to deviation of funds from productive sectors. This excess money which has been the subject of greed could have been invested in entrepreneurial ventures, business expansion plans, or if reported genuinely can be collected by government in the form of tax revenues. This would result in circulation of that money into the economy and subsequently expansion of economy creating more jobs, more demand, and production of goods and services.


Ways to eliminate the black money

1. Decrease of stamp duty and registration charges:
The reduction in stamp duty and registration charges can result in proper reporting of the true market value of the property. Even though, government revenues may get affected on account of reduced stamp duty and registration charges, it can however be compensated on accounts of capital gains tax.

2. Paying in Cheques:
We all have been inspired by Anna Hazare movement against corruption; however, we would do that cause a great justice by doing our bit when it comes to property transactions. What can we do? Well, quite simple, Stop paying or accepting in cash when it comes to property buying or selling. The simple yet practical step would reduce the entering of black money into the property sector and would drive away the speculators from entering the market to make quick bucks.

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