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India's Big and Messy Real Estate Ponzi Scheme, Just Got Messier

Sep 11, 2017

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Over the last few years, many real estate companies across the country, particularly in Delhi and the National Capital Region (NCR), have taken money from home buyers and not been able to deliver promised homes on time.

Some of these companies have also taken loans from banks and defaulted on those loans as well. Basically, these companies have taken money from home buyers, they have also taken loans from banks, and still been unable to deliver the promised homes. In some cases, real estate companies have already booked sales on homes they are yet to deliver.

The question is where has this money gone?

I think there are two answers to the question. 1) Promoters of real estate companies have siphoned off a part of the loans they took on from banks and the money they took from buyers. 2) This money has been diverted for other uses, like completing previous projects and buying more land (or to put it in real estate parlance for building a formidable land bank).

Banks are now looking to recover their bad loans from real estate companies. And at the same time, the buyers are also hopeful that someday their dream homes will be delivered to them.

There are several interesting issues that crop up here:

a) It is now more or less clear that the real estate companies had been happily running a Ponzi scheme. A Ponzi scheme is basically a financial scam in which investors are promised very high returns. The money being invested by the second set of investors is used to pay off the first set. The money invested by the third set of investors is used to pay off the second set and so on. A Ponzi scheme runs until the money being invested in the scheme is greater than the money that is going to redeem the investment of the early investors. The moment this reverses, the scheme collapses.

The real estate companies essentially followed this model. They announced a new real estate project and then raised money against it. This money was then used to buy more land or simply siphoned off. Then a new project was announced. The money raised against the new project was used to complete the earlier project. Of course, I am simplifying things a bit here, but that was the basic modus operandi.

The key in this method of selling homes was the ability to keep launching new projects. Over the years, as real estate returns fell, the ability of real estate companies to launch new projects came own drastically. Once this happened, they couldn't raise enough money to complete their existing projects. And this led to many buyers being left stranded in a rented home.

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b) The inability to deliver on promised homes along with low returns has put off people from investing in real estate. The falling interest in owning real estate becomes clear from the savings figures as well. As per the recently released annual report of the Reserve Bank of India, in 2012-2013, savings in physical assets made up for 14.4 per cent of the gross national disposable income (GNDI). By 2015-2016 this had fallen to 10.7 per cent of the GNDI. GNDI is a concept similar to GDP which also takes remittances from abroad and food aid into account.  India's GNDI is around 1.03 times its gross domestic product.

c) A bulk of the buyers had bought homes by taking on home loans from banks. They are currently paying EMIs against these loans. They are also paying a rent to live in the homes that they currently do. Given this, they are monetarily stretched. Further, they are paying an EMI for an asset which they haven't got as yet and will probably never get in the form they had originally envisaged.

d) When prospective buyers take a home loan from a bank, the home they are buying is the collateral or the security against the loan that is taken. In many cases, the real estate companies have offered these homes against which home loans had already been taken, as a collateral to the banks, and taken on more loans. So, the buyers have been taken for a ride here. Also, the question is how have banks allowed dual financing on the same asset?

It is worth remembering here that many real estate companies which have defaulted on banks loans and delivering homes, worked on a pay as you build model. This basically meant that these companies got paid in instalments from the buyers at every stage of construction.

Hence, the homes were technically owned by the buyer (or to put it more specifically the bank from which the buyer had taken on a home loan) and could not have been offered as a collateral, without the consent of the buyer. Nevertheless, that seems to have happened. This is something that the banks need to explain. (In case you want to understand dual financing in even more detail click here and here).

e) So, where does that leave the buyer? Recently, bankruptcy proceedings have been started against Jaypee Infratech which took money from more than 30,000 buyers and did not deliver on the promised homes. At the same time, it has defaulted on bank loans. The Supreme Court has stayed these proceedings.

The Bankruptcy and Insolvency Code in its current form does not leave anything for the buyers. The buyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated. From the legal point of view this makes sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. But then given that thousands of families are involved, should only the legal view prevail is a question even though tricky, worth asking.

Of course, the bureaucrats who wrote the bankruptcy code did not take the real estate sector and the way it operates, into account. This is something that the government should hopefully correct for in the days to come.

f) Suggestions are now being made that like the banks, the buyers should also be ready for a haircut (i.e. be ready to accept a part of the money they had invested with a real estate company to buy a flat and not the entire amount). The trouble with this argument is that for the banks, the bad loans of real estate companies are just a part of their overall bad loans. For the buyers, the money they invested with real estate companies was probably the biggest investment they ever made and if they have to take a haircut on it, they will probably never recover financially from it.

The Supreme Court now needs to decide whether the buyers are financial creditors or not. This is a tricky question, which I shall elaborate on later in the days to come.

g) In all this, the real estate promoters seem to be having the last laugh. A part of the money they borrowed from banks and took from real estate buyers, has been tunnelled out. It is hardly likely that the bankers will be able to go after their other assets (i.e. the land bank they built by tunnelling out money) in order to recover their loans. Hence, they have clearly managed to limit their losses.

In fact, in a fair world, the balance sheets of these real estate companies would have been subjected to forensic accounting in order to figure out where did the money go. But the bankruptcy code has no such provision. If it did that would inevitably delay the resolution process.

And this brings me back to the point that I keep making for all my readers who forever seem to want solutions to all problems; everything in India does not have a clear solution.

Of course, now the central government will have to get involved if this issue has to be sorted at any level. I only hope that they try and arrive at a private sector solution and the taxpayer money is not used in any form. Already, a section of the real estate sector is talking about a government bailout. If the builders in India don't have money, who does?

To conclude, the mess in the real estate sector in India is an excellent example of what follows when a Ponzi scheme goes bust. And as they like to say in Hollywood films, you ain't seen nothin' yet. Keep watching.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

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8 Responses to "India's Big and Messy Real Estate Ponzi Scheme, Just Got Messier"

Sambaran Mitra

Sep 13, 2017

The solution to this problem (in future) is simple. And it does NOT involve government.
First time home buyers should buy only ready to occupy apartments. The extra cost (over the under-construction property) is worth paying.
Second home buyers (investors) should not consider real estate as an investment avenue at all (till law and order situation in India changes i.e. at least 40-50 years more). Real estate satisfies no criteria of a good investment, except possibly capital appreciation (and that too is suspect now a days).

Like (1)

MUKUND JAEEL

Sep 12, 2017

Why can't land bank of real estate promoters be used as a collateral by banks instead of flats ? In that case, no construction should be allowed on such land bank till all the loan granted against it is fully paid off. This will prevent creation of large scale land banks and therefore prevent siphoning of buyer's money for the purposes of creating land banks and make larger amount of money available for completing ongoing projects.

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Krishnamurthy Suresh

Sep 12, 2017

I allways thought there is something fishy about you and your writing. This is another another of such a case.

The state played a foul trick on the people. While I buy a flat through a coop society I do understand that I need to
pay a service tax ( as per the law existing then,now replaced by GST) because the society as an entity gets the land
gets the building plans sanctioned, engages a contractor to get the building constructed and hands over one flat
to me. All along the society has been acting on my behalf and profits if any contains my share therein as well.

2. When a buyer buys a flat from a builder, the builder first buys a piece of land ( even before the land use is changed to residential)
registers in hisown name, gets plans sanctioned as per his desire and in his own name. carries out construction
as per his profit model ( independent of my wishes and desires). But he is allowed to collect money from the flat buyers in stages
for the flat that has not come into existance at all.

The action of allowing the builders to sell non-existing flat is supported by the government and as a quid- pro- quo, the government collects fat amounts
towards service tax, while the builder is actually not att al providing any service. Thus for a flat I purchased in Coimbatore, Tamil Nadu last year , I ended up paying Rs 2,00,000 plus, for an imagined service rendered by the builder.

3. If the government is serious about regulating Real Estate business in India, this practice of collecting money from flat buyers, against a mere promise ( this is clearly in the nature of wager and so must be declared illegal) must be stopped. Our great Naidu Garu did not do so. The reason of course is that if we accept that the builders actually sell and do not provide a service, the service taxx ( now rechristianed GST) that the state extracts out of unsuspting public would be lost to them.

Also sucha a prohibition of collecting money from flat buyers till the completion puts an end to a major segment of blak money market. For raising loans from bank, the builders need first to provide his shre of capital and thus, creating land banks gets controlled.

So you see, there is a case for forcing the state to return the service tx collected from flat buyers, the entire process being an exercise to benefit the builders.


Like (1)

shalabh singh

Sep 11, 2017

...and then add the menacing financial holocaust which has been initiated by the banks through this strategem called Assignment Deed where the bad loans are transferred to another bank on a consideration of barely 10-11% of the overall portfolio of NPA held by the Assignor bank to the purported Assignee bank(refer to the highly debatable SupremeCourt Case authority of APS star V Union of India 2010(10)SCC 1). In effect an NPA which remains irrecoverable by the original lender bank called Assignor has been conveniently transferrred to Assignee for unlocking the NPA value(sic).And this transfer is at the cost of State exchequer by not even registering it as per The State Registration Acts and Stamp dutyon ad volerem consideration is eveded apart from no capital gains or business gains tax as per provisions of IT Act 1961 sec 2(47). In fine, these alleged unlocked value of funds of the NPAs shown as Current assets on the original value of NPA against which only 10-11% has been actually paid now with the Assignee banks(largely and substantially the players are these newer Private sector banks KMB ,ICICI et. al.) is further used to fund these loans towards Housing and other personal loans, not as financial units of an SPV/SPE (like ARCIL)but as clear loans on the presumption of higher rates to fifnance the liability incurred towards the original lender banks. The meltdown spells doom.And we shall soon see the irreversible spectacle of sub prime loan hurricane.Brace for it. Prevent or Perish

Like (1)

Surendra Pai

Sep 11, 2017

Interesting info about SCOUNDRELS in Construction industry. But nothing new about it. Nothing in this bloody stupid India is possible WITHOUT THE ACTIVE CONNIVANCE AND GENEROUS BLESSINGS OF POLITICIANS - majority of whom are born thugs, cheats of the first order and professional liars. The politicians include from the PAST and PRESENT day too. This country has already gone to dogs. Today, India is known to be one of the most lawless, disorganized, undisciplined and corrupt countries in the world - beyond repairs for several centuries to come. British rule, for that matter, was far better than what rotten democracy we have today which gives you nothing but hell. Britishers at least taught our seniors (dead/still alive) how to eat properly, how to drink properly, how to sleep properly and FINALLY HOW TO BE IN ANY "Q" obediently, calmly and with discipline. Look at today - what sort of HELL we have created for ourselves in the COUNTRY? Shame on this Country and its 3rd rate corrupt, arrogant, greedy and shameless politicians.

Like (1)

dilip

Sep 11, 2017

Real ques is everyone from govt to lawyer to media to police to judge knows that it is a Ponzi scheme. It is magical that not one builder has been arrested or charged with crime. Astounding , don't you think? In the last 70 years every PM has known this but hasn't lifted his little finger to arrest this but has probably ridden himself or herself on the Ponzi scheme and made a quick buck, at least the whole political community has been an integral part of the scheme and one of the main reasons why the scheme has been so successful. It has probably given them much higher returns than even Buffet could get, given that input cost was close to zero for most politicians

Like (3)

Mani Veeravalli

Sep 11, 2017

Sir, The author's view is not correct. In project finance unless the financing bank issues no due certificate, home loan financer cannot finance. To get no due certificate the home loan financer has to release instalment amount through project financer account and the builder has to authorise to release proportionate amount for loan repayments and building construction activity. Before the release of last instalment, project financer will get back his loan amount. Now the new Act has provided additional protection to the buyer of flat

Like (3)

Gulshan Lal Malhotra

Sep 11, 2017

For 100 Cr Project Builder got 75 cr loan from Bank, 100 cr from buyers of home. total is 175 Crs
How buyers arranged money 75 crores from Bank Loan and 25 Cr from his pocket
Where the money has gone 1. 40 crores to purchase land 2. 20 cr incomplete building 3. Luxurious expenses by builder and his families eg Luxurious car for every member of family, Huge House with all ultramodern amenities, Huge office, salary for fleet of unnecessary staff to show off. foreign trips to every member and relatives of the builders.3. Cocktail parties to fleet of sub-brokers 4. Cuts and foreign trips for sub-brokers 5.Finally diversify small fund which had been left to new project as seed money of builder

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