Noose Tightens Around Necks of Mumbai Developers

The massive cranes around Mumbai are fast disappearing as the real estate industry goes down in to the dumps. Where one slab per month would be raised, it is now down to one in three months. Banks have become very choosy about lending to the real estate developers as investors disappear and home buyers wait for prices to drop.

It appears to be a game of who will blink first, with builders hoping for the prices to recover, and residentual apartments still costing between Rs 15,000 per square feet and Rs 21,000 per square feet in Juhu area of Mumbai, and Malad and Goregaon still commanding between Rs 9,000-15,000 per square feet.

In Mumbai, the same apartments that were on the market for the last 6 months continue to be circulated. For example, a builder demanding Rs 80 crore for a 8,000 sq ft super-built-up apartment has not been able to sell even one unit.

A few builders who have real estate purchased prior to 2004, are making optimistic noises, however most of them, for whom the interest rate is ticking, are squirming as the noose is tightening around their necks.

Some of the news in the market is of a the brother of a prominent developer from the eastern suburbs, who has branched out on his own now, is stuck after a US-based bank allegedly stopped funding his projects in Hyderbad and Chennai. Another developer with residential projects in Goregaon, Virar and Thane finds himself pushed into a corner after taking a Rs 100 crore loan from a Kutchi industrialist at hefty interest rate of over 40 percent.

One builder, who shook the property market last year after he paid a phenomenally-high price for a plot in BKC, is also believed to be now on the edge. His investors are breathing down his neck and even the nationalized bank which funded him, now wants its money back. His desperation is now evident because he has started offering brokers a 4 percent brokerage for getting clients, said sources.

In the commercial segment, the lease rental prices in BKC has come down from an average of Rs 450 a sq ft to Rs 325-Rs 350 a sq ft over the past three months, it is learnt. Developers setting up IT parks are also getting worried as they are not getting the price they were expecting, said a broker.

According to housing experts, about $4 billion has been pumped into the Indian real estate market by FIIs and venture capital funds. Another $12 to $14 billion was to flow in within the next 18 months. This will not come anymore.

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Builders Face Cash Crunch as Real Estate Sales Slow Down

A liquidity crunch is slowly hitting developers and builders as property sales slow down, PE firms tighten purse strings, and input costs rise. All eyes are now on the Rs 1500 crore that Lehman Brothers is expected to invest in Unitech's Santacruz, Mumbai, venture [Read story here], and market speculation is that given Lehman's problems and its decisions to move out of mortgage and realty worldwide.

Builders are delaying projects and delivery since there appears to be a cash crunch in the system. Two things are compounding things further: one, rising inflation is going to force the RBI to increase interest rates, and banks will be forced to pass this on to consumers. The thing with real estate is, that once the slowdown sets in, the cycle lasts at least 3-5 years.

Investors, who had purchased apartments with the clear intent of capital gains, are now quickly palming off these properties at 15% discount to the builder quotes. Take Bandra for example. Rates varied from Rs 23,000 to 18,000, are now available at Rs 21,000 to Rs 15,000. The point to note is that this is just the beginning. Once, the rains come in, and the buyers become more objective in their purchases, these rates are likely to slide more.

While six months ago, sellers outnumbered buyers, these days, buyers have become scarce. Compounding this is that PE firms are no longer interested in investing in companies directly, and are prefering special purpose vehicles (SPVs) which are project-oriented.

Real estate companies use the percentage completion method to register sales and profits. Hence, if there is no offtake, and if input costs rise, their margins get squeezed. This means, expect writedowns in their balance sheets. With borrowing rates at 24%, those unable to complete their projects could run into massive trouble.

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EMI Holidays: India's Subprime in the Making

An eerie trend is rearing its ugly face as builders get desperate to prop the flagging sales of apartments. In an echo of what caused the subprime crisis in the US, builders are now luring home buyers with loan options that resemble the exotic mortgages of the US.

Trends reported in Delhi point to EMI holidays, where you book an apartment by paying 10-15% down payment of the apartment's cost - determined by the builder - and arrange for your bank loan. Once you have your bank loan in place, the interest component would be paid by the builder until the flat is ready. Once possession is handed over, usually 18-24 months, you begin paying the balance EMIs.

Even in a seemingly straightforward home loan industry in India, loans can take on subtle flavors not easily visible to the borrower. There are all kinds of caveats loaded in to the agreements which emerge only in the event of a dispute. The EMI itself comprises a capital component and an interest component, which is determined by the bank.

Typically, an EMI holiday means no EMI is to be paid by the borrower until the possession of the apartment is given. This basically means the borrower does not have to pay the capital component until the apartment is in his possession. This non-payment of capital will obviously attract an interest which will be calculated and added on to the balance EMIs, which kick in after possession - there is indeed no free lunch. Home loan borrowers are seldom clear about the underlying structure of these loans.

Now, as far as the interest component of the EMI goes, this would be 'happily' shelled out by the builder. At 10% per annum, it is a steal for all builders, who now have ready access to the cash, since under RBI regulations, real estate funding is not automatically available from domestic banks.

EMI holidays have apparently impressed local Citigroup analysts, Ashish Jagnani and Aditya Narain, who have written glowing reports that such ideas would boost transaction activity. Perhaps they should consult their global chief, Vikram Pandit, who is sulking and brooding about how to make good the $400 writedowns Citibank had to endure, arising from similar kind of loans, which the bank had encouraged in the US.

In my view, EMI holidays are an indirect way of providing builders with funds, and an means to keep housing prices at current ridiculously high levels. Since the RBI has tightened its noose around banks lending for the real estate sector, they have come up with such schemes which contravene the law without transgression. Reports say that such trends are mostly a Delhi phenomenon, but this is not entirely true. HDFC Bank in fact offers a similar scheme for Nahar's Amrit Shakti Project in Powai, Mumbai. [Read the story here]

Experts and industry watchers have clearly sent out the message that EMI holiday schemes are simply a ruse by builders to sell their current inventory of apartments at exorbitant prices. Once you take a loan, home buyers would simply find themselves locked on to a rate, and with the prospect of a decelerating market, it is clear that anyone who buys property at current rates is looking at years of sliding property values.


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