Are real estate builders getting desperate for money?

Jul 23, 2015

- By Vivek Kaul

Vivek Kaul
One of things that I have maintained in my columns on real estate is that for real estate prices to fall, the funding of builders needs to dry up. And that seems to have started to happen.

Let me share two recent examples that I came across (I request The Daily Reckoning readers to share more examples, if they know of any).

A real estate company is running an advertisement for homes they are selling in a central suburb of Mumbai. This advertisement essentially talks about giving only 20% of the price of the home at the time of booking. It also talks about no income eligibility and no bank formalities.

What does this mean? It means that as long as you are willing to pay the company 20% of the price of the home at the time of booking, they will not ask any more questions. They will not try and check whether you have the capability of paying the remaining 80%.

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What does this tell us? One the company is unable to sell the flats and raise the money upfront. And two, it is now so desperate for money that even 20% of the price is fine with them.

So, this was the first example. The second example is slightly more detailed. A friend forwarded an email he got from a housing finance company. The housing finance company assured him a return of 48.5% over a period of two years, if he invested in a new project in the National Capital Region.

The proposal is as follows. The investor needs to pay the builder a total of Rs 1.27 crore. Of this, the housing finance company is willing to finance around Rs 1.1 crore through a home loan. The remaining Rs 17 lakh has to come from the investor's pocket.

Since the property is still under construction, the investor taking on the home loan will not have to pay an EMI but a pre-EMI. A pre-EMI essentially means paying only the interest on the home loan. The principal repayment kicks in only after the investor/buyer takes the possession of the home.

In this case, the housing finance company has promised that the builder will keep paying the pre-EMI for a period of two years.

What happens at the end of two years? If the investor does not want to take a possession of the home, the builder will buy back the home and close the home loan. He will also pay the investor Rs 8.25 lakh, over and above the Rs 17 lakh that the investor had initially put in.

This means a return of 48.5% over a two year period, which is not a bad deal at all, from the investor's point of view. At least, prima facie that is what seems to be the case.

But what is really happening here? The housing finance company is helping the builder indirectly borrow home loans at a significantly lower rate of interest. Why is it doing that? I can only make a guess here. And I feel that builder is actually in a mess and the conventional borrowing channels (of banks/HFCs etc.) are not ready to lend to him anymore.

Other than paying Rs 8.25 lakh to the investor at the end of two years, the builder is also paying the pre-EMI on the home loan. At 10% interest, the pre-EMI will work out to around Rs 11 lakh per year (10% of Rs 1.1 crore) or around Rs 91,667 per month. The internal rate of return on this loan works out at a little over 14%, which is much better than the 30-40% interest that builders have to pay when the borrow from informal channels. Hence, in that sense borrowing at 14% is a steal, even though it seems to be on the higher side. Further, the builder may already have been borrowing from informal channels, and may have been looking to limit that borrowing.

It is also possible that the builder needs to repay an earlier loan that he had taken from the housing finance company and is not in a position to repay the loan. The housing finance company instead of recognising it as a bad loan and going after the assets of the builder is essentially bailing him out and postponing the problem.

The HFC and the builder are both buying time. Who knows what will happen two years down the line?

As far as the investor is concerned, he is being taken for a royal ride with the housing finance company telling him that this is an "assured buy back scheme". The disclaimer at the bottom of the proposal clearly states that: "The information/product(s)/service(s)/offer(s)...as contained herein are provided /offered by third party and are subject to their respective terms and conditions and not intended to create any rights or obligations."

So there is no guarantee that the builder will buyback the home and close the home loan two years down the loan. Further, the home loan is in the name of the investor. And the housing finance company will then go after him to ensure that he keeps paying the EMIs or the pre-EMIs. If he chooses to default, then the housing finance companies can go after his other assets as well.

Also, it is worth asking why is the builder borrowing one at a time through what is basically a complicated route for him? The only answer here is that the conventional sources of finance have totally rejected him. And he has no other way out of this mess.

I would request The Daily Reckoning readers to be careful of such investment schemes which sound too good to be true. Any scheme promising a return of greater than 9-10% a year, needs to be closely examined.

To conclude, what the two examples I have shared today clearly tell us is that builders are getting desperate for funding. And their situation is only going to get messier in the days to come.

Stay tuned.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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14 Responses to "Are real estate builders getting desperate for money?"

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Nov 22, 2016

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Sep 19, 2015

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sethu

Aug 2, 2015

Thanks a lot for your write up;
I escaped from being caught in an attractive marketing by a builder.

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Swapnil

Jul 29, 2015

I cannot agree more with Vivek in that the real estate is over priced. However, my perspective is different and maybe you, Vivek, should account for this if you agree. When one buys real estate its not just for the inbuilt toilet, but for the quality of housing, building, amenities like water supply, infrastructure around like roads metros etc., overall locality quality, quality schools, hospitals etc., or so it should be. If one were to compare the other parts of the world where investors can look to buy realestate, take for eg., Dubai, Mumbai is overpriced atleast 10 times!!!

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Indusboy

Jul 25, 2015

I stay in Bangalore and one cannot escape hearing such offers on FM Adverts or newspapers. It is simple economics with a peculiar Indian twist - there is an oversupply of highly priced real estate in the Bangalore market. Whereas the demand for such highly priced real estate is yet to catch up. Basic economic law suggests that the prices will come down. But here is the Indian twist - given the dynamics of RE business in India (Black Money, Corruption in getting permissions, Politician's involved in benami names...) the result will be that there will a lot of incomplete or abondened projects by the builders, who will then not pay back the loans taken from Banks...a lot of tax paying paying middle class will be caught in a catch 22 situation of paying Pre EMIs on flats that cannot be completed, and a few high networth speculators will have their money tied up. Could this result in a big banking crisis? I don't think so. Most of the banks will compromise and sit tight.

Like (3)

Ram Kumar

Jul 24, 2015

You are right about builders being desperate for money. I have booked a flat and construction is in progress. I have been making payments as and when the demand letter comes. Still there is about 12 instalments to be given and now the builder has come with a scheme wherein he is giving 12% interest if I make the balance payment in one shot right now. He will give the interest on the reducing balance whenever the instalments are due.

Like (2)

R k nagpal

Jul 24, 2015

You are. 100% Right. There are confirmed reports that some the developers in NCR particularly GREATER NOIDA /NOIDA are raising bank loans by. Putting. Housing loan files of individuals who are not actual buyers by offering them handsome commission/ offering very hIgh interest on their margin part. This is being done to either complete the project or clear bank defaults .So after 2 years this type of individual housing loans will also default as the actual sales are very weak & property not going to appreciate in near future. Catch 22 Situation.Unfortunately some of the banks/NBFC are aware of the facts but still lending ? Rk nagpal

Like (1)

s venkataraman

Jul 24, 2015

Kudos to Mr Kaul for his enlightening article. Laymen like us would not know the inside truths about such offers/gimmicks of the builders. Such tricks are also played by retailers offering huge discounts/freebies and by banks issuing credit cards offering interest free EMI, transfer of balance etc. What is truth behind these tricks is not clear. We shall be grateful if Mr Kaul could throw some light on this.
Mr Kaul's other articles on economy, black money etc are also illuminating.
Pl keep it up.

Like (1)

R A Raichur

Jul 23, 2015

The bigger risk for the investor is a default by the builder in completing the project. With no asset in hand the investor will have to repay a loan which has put money in builder's hand .

Like (1)
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