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Unless a pragmatic approach is taken, capital constraints and customer activism can create chaos.
The Real Estate Regulatory and Development Act (RERA) is by far the most profound change driver for the real estate sector since the Urban Land Ceiling Act came into force in 1976. RERA will force changes in the industry across all parameters:
* Customer quality (five year defect liability period is mandatory)
* Construction delivery (Penalties for delays in delivery)
* Discipline in marketing promises
The greatest impact, however, will be on the financing and capital structure for business in future. The single most expensive item on stock in trade for developer is land. Lack of access to capital and an increasing hunger for a greater return by landlords led to the introduction of Joint Development Model. This model enables a person with Rs 1 crore to stock a land parcel worth Rs 20 crore by paying the landlord a deposit. Thereafter, he can pre-launch sales to secure additional funds from prospective customers, and use these funds to pay the balance deposit to the landowner and secure approvals.
Presently, the industry collects upto 85 per cent in some cases on completion of the structure of the project, giving cash to the developer for the next few projects.
This is about to change with the advent of RERA:
* Developers cannot sell before all approvals are in place. With the tremendous increase in approval costs, huge sums of money are required before any customer advances can be collected.
* The fact that large projects will be broken up into phases, with each being considered as a separate project, means approvals including the TDR for that phase needs to be procured upfront.
* 70 per cent of the sales proceeds are to be placed in a designated account and can only be drawn in proportion to the progress of the project. It slows down cash flow and negatively affects the project’s internal rate of return.
* The risk of delays and cost of compensation to be considered will lead to performing contractors being able to command a premium on their rates, which would push up the cost for the developer.
* The risk of title related to liability further adds to the risk and cost for the developer.
* Under-capitalised developers will find it hard to punch above their weight.
The shakeout in the industry will be good for the consumer in the long run but for transferring the risks he bears today, he would have to end up paying a substantial premium.
The government seems to be resolute in implementing RERA. The biggest challenges would be how current projects will be treated. Real estate continues to be a big contributor to the GDP of the states. Unless a pragmatic approach is taken, capital constraints and customer activism can create chaos and turmoil in the industry. But, these challenging times would provide tremendous opportunity to the well-capitalised, fiscally prudent developers.
Gera is the managing director of Gera Developments.
