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Chapter 1

Realty sector is ever green with new technologies and is blessed with eternal demand. It is driven by the changing needs and expectations and by advent of newer technologies. Psychologically, a home gives a sense of possession and security and so, on achieving the affordability it is the first preference for any person over the other investment avenues. Thus, it scores over many other sectors in terms of the market in the sense that the demand is ever existent and is only curtailed by the consideration of affordability. The large investment requirement or the long term monetary obligations play a crucial role in one’s decision to buy a home or lease it. Everyone would like to have a palace and only his economic status limits his expectations. As his economic status grows, the expectations too grow driving him to move to a better home that also indicates his economic status in the society. The same considerations apply for commercial spaces albeit added with business exigencies and viability considerations. Realty sector has always been important driver for the overall economic development of a country. Besides being provider of the basic human need of shelter, the sector is also important as it is a driver for various other important segments of the economy viz.

• Knowledge bank Engineering, architectural & many others
• Core industry Cement, steel, power
• Ancillary Industry Electrical, furniture, home appliances
• Employment Skilled and unskilled
• Urban infra Civic services, transport
• Finance Banking, household investments
List of the other segments having secondary impact would be endless. There is no other sector having such wide social and economic implications.

Significance of the sector though unquestioned is tarnished due to inherent greed of a man for the land. It is probably the root cause driving him to many ingenious ways to generate resources to acquire more and more land. Greed when uncontrolled, results into disaster rather than functioning as a tool for growth. It was again and again experienced in Japan, in UK and the last time in USA, the economic meltdown triggered by the realty sector where the simple demand and supply mechanism for affordable housing got twisted. China’s ghost towns are another example. Realty sector has proven to be a very delicate issue globally. The recent melt down of the global economy causing miseries all around the world has roots in mismanagement of the realty sector. The American realty sector got artificially inflated through over monetizing of properties contributed by credit default coverage for home mortgages. Over valuations ultimately resulted into collapse of the system as a whole was a result of the greed for short term gains brushing aside the exigency of realistic pricing and long term interests of the sector. Further, in absence of in-built control mechanism while structuring the realty related finance instruments drew the collapse as pricing of realty stocks lost its relevance to the affordability consideration. No lessons were learnt from the debacle of the Japanese realty sector not far in the past. Misconception in the banking sector and the finance market in general that ‘property’ is the best collateral turning blind eye to its realistic pricing vis-à-vis its affordability index was lost in Japan where one property was mortgaged to fund acquisition of another looking at the galloping rise in the short term. Not for long, the artificial demand pushed the rates beyond reach of the actual buyers, say, the end users, and holding of the stocks became unaffordable as against the high interest cost resulting into forced sales and the Japanese realty collapsed like a house of cards. Being a non-replenishable and scarce ‘commodity’, realty stock hoarding is a common phenomenon attracting investors with deep pockets. With better foresight, such investors normally make a kill and exit in time leaving the burnt to be borne by the gullible small investors, the system and the common man whether he is an investor or one buying the property.

With increasing population and enhanced disposable income in hand, demand for the realty sector has shown impressive growth, particularly all over the developing part of the world. Retail market in India was valued at INR 16,940,000 million (US$ 308 billion) in 2010 and is expected to grow at a CAGR of 11%. It accounts for 22% of the country's GDP and is the second largest employer with 3.51 crore people. India will need about 12 million additional residential houses in the period 2012 - 16 across India. The demand is expected to overtake supply in five years. Commercial office space demand even assuming modest economic growth is estimated at 18 million square feet in the next five years just for the top 8 cities of the country. Many globally reputed real estate consultancy firms viz. Cushman & Wakefield have reached more or less the same conclusion. The demand is generally misunderstood as to its sensitivity to the price and factually results into human misery by denying affordable roof for the people. The scenario in developing countries like China and India may not be far though the Indian banking is far more controlled limiting its exposure to realty. The prudence, however, may not sustain against greed of the investors. The banking constraints soon collapse one after another getting caught in its’ own web. The fear of booking for the imminent bad debts force it to relax the provisioning norms that, as the history has shown only deepens the problem.

Realty industry operates in a unique environment where its stocks are immovable assets with little control on the market while dealing in a precious assets being land that cannot be regenerated. Globally, realty sector is a complex affair with the requirement of many approvals and NOCs causing project delays while in many economies an element of unaccounted money becoming its integral part and complicating the matters further. Sky-rocketing land prices contradicted by shrinking demand due to high selling rates in India have driven many a private investors away from it. Private equity and venture capital funds are found to be lacking interest in the Indian realty sector for the same reasons whereas the public issue experience has been lukewarm due to lack of transparency and stock valuation issues creating serious doubts in minds of the retail as well as institutional investors. Bank and institutional debt funding for the sector is available on stringent conditions and is normally inadequate and at high costs that has become a matter of grave concern in an uncertain market conditions. Mobilization of investment is critical factor and dependent on the categories of the projects. Realty finance sector is influenced by the major realty corporate players as major part of banking finance is utilized by it and then naturally its performance has impact on the realty lending policies of the banks and the banking regulatory authorities in general. Moreover, the projects of such large corporate are large in value and are township projects or projects located at prime locations in major cities invariably entailing large investments and with a longer period for its completion. As against the large realty corporate, the other realty players do not have large land banks and always on the lookout of redevelopment or joint venture deals with the landlords. Though large in numbers, their capacity to influence the realty market is limited due to the financial constraints as the holding power is limited.
Realty sector in general can be broadly divided into different categories as depicted below.

The funding requirement substantially changes depending on the project category. A large township or realty complex project would require long term funding to sustain through its initial stages of development. It has been experience of the realty sector that larger the project more is the likely delay and so blockage of the funds. The delays are also driven by many external factors besides the changing market conditions. Rarely a schedule for development of a large township project is based on the technical matters but is governed more by the market response as major part of the cost is funded through the bookings. On the contrary, high land cost at the premium locations in metro cities calls for heavy investment from the promoter’s own funds forcing him for speedy sales while retaining a part of the area to book profits later in anticipation of better rates on completion of the project. Project delays have become a serious concern as delivery defaults are now-a-days being severely penalized. Large redevelopment projects, particularly the cluster projects are in a class of its own involving different logistics and up-front funding for meeting requirement of the existing occupants.

Most of the funding needs are met through realty project loans and pre-bookings by high net-worth individuals. The land cost is normally funded through promoter equity supplemented by venture capital or private equity funding. Bank loans for land acquisitions, though considered as stocks are difficult to come by unless substantial additional collaterals are available and the loans are offered as non-priority lending with higher interest burden. Advance bookings as a mean of initial funding has become uncertain today with the recently enacted housing development regulations prohibiting bookings before the project approval. Further, the global political and economic uncertainties have pushed the bullion market with investment in gold that is earning very good returns. It has attracted many HNIs starving the realty sector further. It is probably the only sector where the concept of ‘financial closer’ is rarely considered. Most of the projects are booking dependent and many a times lead them to the doors of high cost private lenders. Cost of private funding either through pre-booking of the flats/shops at a discount or private loans is always at high effective cost ranging between 20% - 36% annually. Increasing interest cost as a percentage of the overall revenue for the sector as a whole would be a fair indication of the likely future turbulent times. The percentage has increased from about 4% in 2007 to 25% in 2009 and falling to 22% for 2010. (Source: CMIE and D&B research). The percentage if adjusted for the non-interest but revenue servicing obligations as expected for a venture capital or private equity funding for realty projects may show very disturbing trend. Such interest or revenue servicing obligation invariably results into creation of artificial barriers for price adjustments through holding back of the stocks by refusing to accept the need for realistic affordable pricing stretching it to the point of collapse.

External commercial borrowing (ECB) is an attractive funding alternative for Indian realty due to its low interest rates and long tenures. Most of the banks in India and FIIs offer ECB funding for various projects subject to the government regulations as applicable for such loans and the industry. Realty sector though not looked favourably for ECB permissibility, the external account deficits many a times forces a Government to relax the rules to ensure maximum long term foreign exchange inflow. ECBs are always fraught with the risk of wide variations in the exchange rates and LIBOR linked interest rates as well as the bank spreads. Further, other contingencies like pre-payment charges, commitment fees, cross currency and interest rate hedging for the respective foreign currency adds to uncertainties in arriving at the cost. The current global economic scenario is too volatile to predict a 5- year future LIBOR or currency rates with any dependable band of variation. Realty sector does not have any income in foreign currency as even where the sale consideration received in foreign exchange. The sales are always linked to the present selling rates in the local currency converted into a foreign currency at a rate as of that date. Many a times the Government pushing a local industry for foreign currency loans is itself a sign of impending tough foreign exchange rate scenario. Further, in case of a potential default, such loans are normally converted into local currency loans on the terms where the borrower hardly has any negotiating power proving it to be a costly funding later. Complexities of realty laws, particularly in India adding uncertainties to the property title issues results into a very few privileged realtors to be capable of availing such funding. Such issues result into the lender asking for collaterals and personal guarantees of the promoters. Moreover, being a loan, it is always linked to the value of the assets mortgaged thereby restricting overall availability of the funds. ECB funding for a financially savvy and agile realtor would be a boon and can save a lot on the interest cost.

Real Estate Investment Trust as are functioning today in the developed countries was considered as a solution. Lack of confidence of the unit holders as investors in the trust fund has not allowed the concept to take roots in India so far. Risk exposure for the unit holders and on the other side the expected high effective cost of finance for the developers has worked against it. Moreover, the concept was originally based on sharing of the rental income that may take long time to take roots in India. A typical Indian is attached to his ‘Vaastu’ expecting it to be inherited down the generations. He does not treat it as a ‘house’ but as his home.
In spite of its importance the sector remained unsupported for a long time in India and even the support is now visible mainly for its demand side. For a balanced growth, both sides of the sectors need to be supported to avoid market anomalies as are presently evident. TROT product is an effort in that direction. Precise data on investment in the Indian realty sector is not known but can be estimated at about Rs. 3.5 trillion for 2011-12. Bank and institutional exposure to the realty sector is about Rs. Rs. 2.5 trillion. Foreign Direct Investment in the sector is estimated at about Rs. 380 billion.

So far there is no instrument to attract household investors to the realty sector other than through public issue of equity or debt. Their expectations are always low but needs to be supported by assured liquidity, reasonable security and easy exit route. Potential for mobilization of retail investment can be easily viewed from the 12th Plan estimates of the household annual saving projections pegged at Rs. 810,000 crores for investment in financial and physical assets. TROT product with its unique structure balances the interest of the investors, realty developer and the home buyers minimizing the chances of occurrences of distorting industry scenarios. Development of Realty Sector is important as it not only meets the basic human need for shelter but touches many other aspects of the society. Importance of the realty sector can be gauged from a single factor that 25% to 40% of household income is generally spend on realty either as rent or home loan interest and repayments or investment in realty related businesses.

‘TROT product’, an innovative realty retail product, has been conceptualized, designed and developed to provide a viable solution while offering unique hedging benefits with assured returns for the household investors. Euro or US Dollar denominated TROT products can also be a viable alternative for the ECBs as it effectively curtails the risk of adverse variations in the interest and the exchange rates. TROT products would be more suitable for township projects, realty complexes or premium realty projects in Metros and Tier-1 cities in India. Small, standalone projects may not be possible to be covered under TROT product due to the one-time cost and restrictions on the areas to be earmarked for TROT product holders. Realty projects of saleable build-up areas exceeding 50,000 ft2 would ideally fit to be covered under TROT product though smaller projects can also be covered albeit with a marginally higher cost. However, the major players are those who shape the industry and the sector adopting this innovative instrument is sure to be a step in the right direction.
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