Bottom Line: Fiscal management is the key that can deal with the perception issues, restore the buyers’ faith and goad Indian real estate to respectability which could further lead to industry status.
Over leveraged balance sheets affecting the operational expenses, debt hurting the profits, liquidity crunch bringing the projects to standstill and funds being diverted for expansion plans…these are some of the issues that have eroded the trust quotient of the Indian real estate and given lending credence to the perception issues.
Today, fiscal management is the key missing link in the sector and the blame goes as much to the developers’ pipeline visibility as to the lack of organised funding in the business. With no bank to fund the major input cost of land and even construction funding norms getting rigid, the developers are often left with no other option but to borrow at unreasonable high cost, thus throwing the fiscal prudence to the dustbin.
Financial realities
- Fiscal management has been biggest concern of Indian real estate
- Fiscal management means balance debt-equity ratio and beeter operating cash flow
- Fiscal management also leads to lower cost of funding
- Post the regulator and escrow account fiscal indiscipline expected to end
The realty analysts and the financial market experts agree that lack of fiscal management is an important issue for many developers. They, however, maintain that those who are over-leveraged and are highlighted in media deserve this but what goes unreported by the media is that a majority of the developers are fiscally very prudent and many companies can even be classified as ‘zero debt firms’.
This school of thought believes that important issues that need to be addressed in the Indian real estate are lack of transparency in the market and issues related to corporate governance in firms; skill development in the work force; timely and transparent approval process; clear development norms; digitisation of land records; and provision for easy access to affordable capital for the industry.
Developers, on their part, maintain that the Indian real estate is yet to get an industry status despite being the largest contributor to the country’s GDP. As a result, developers find it difficult to raise finance from banks and organised institutions. They have to rely on unorganised sources of funding for their projects. Besides delay in process of approvals and the wide gap between conceptualisation of the project and sale of flats results in the shortage of funding for projects. The developers are hence compelled to raise funds from unorganised sectors. Once the sector gets an industry status, developers will be able to raise funds from the organized sector.
Amit Oberoi, National Director, Valuation & Advisory Services and Research with Colliers International says that real estate development is a high risk business due to the lack of certainty related to the approval process, changing market dynamics and consumer taste, and the obvious associated (and many times unforeseen) challenges in the construction business. Due to these factors predicting timelines becomes difficult. However, this cannot be an excuse for fiscal indiscipline. A prudent entrepreneur should factor these while raising capital for the project. Also many have over-leveraged themselves to fund expansion or acquisition of newer land parcels.
“The Indian real estate market needs to adopt global best practices (such as selling on carpet area basis), enforce self-regulation through industry bodies and peer pressure. It is also imperative that the government lays down unambiguous guidelines for development norms and ensure a transparent and timely approval process. Additionally, reputed bodies like RICS should work towards educating future generation of professionals on the practice of real estate. Most stakeholders in the industry want to run an ethical and professional practice,” says Oberoi.
Manju Yagnik, Vice Chairperson, Nahar Group has a caveat here when she insists that fiscal discipline is a case to case basis scenario. Branded developers follow fiscal discipline as they generally get their funding from organised sources. Pipeline visibility to some extent can be blamed for lack of fiscal discipline as there is a huge gap involved between conceptualisation of the project to the sale of the project.
“Over leveraging of balance sheets cannot be applicable to all the developers but to only certain set of developers, especially small time or mid-ranged developers. Builders of repute are generally not involved in over leveraging of balance sheets. Over leveraging of balance sheets takes place when there is mismatch on the funding of ongoing projects and the actual funding reflected in the balance sheets. However, this practise is not carried out by reputed developers as it affects the reputation and brand of the developer,” says Yagnik.
The moot point today is whether after the regulator in office and escrow account getting mandatory, there will be better fiscal management in the business.
JC Sharma, VC & MD, Sobha Limited says that the Real Estate (Regulation and Development) Act will certainly promote transparency, accountability and efficiency towards execution of the projects. According to the Act, 70 per cent of the booking amount received for a particular project should be deposited in an escrow account. In principle the concept of having an escrow account linked to a particular project gives a certain guarantee towards its completion in time which is a very important aspect in today’s market scenario.
“It will force fly-by-night developers to practice efficient fiscal management of the projects. This will eventually discipline the industry towards better fiscal management and bring in overall trust in the sector. However, it is anticipated by some quarters that it may be a cumbersome process to take approvals from the regulator for getting the deposited money released each time. This might lead to delay in project completion for want of timely release of funds,” says Sharma.
Fiscal mismanagement has been one of the key reasons for poor perception of the sector. In the absence of a regulator, certain small scale and fly-by-night developers have been following unethical practice of diverting funds collected from a particular project for other undisclosed purposes such as land purchase, backlog completion etc. This has given a bad name to the whole sector and has created trust deficit among various stakeholders.
Fiscal prudence means controlling the financial activities of a project and effectively utilizing the funds with an aim to enhance shareholders’ value. Due to poor perception of the sector owing to lack of transparency and accountability, lenders find it a risky proposition to fund residential projects. Therefore, they add premium on their lending rate in order to hedge high risks. This increases the overall cost of capital for the borrowers.
Financial analysts suggest that the debt level should ideally be maintained at half of the equity. A ratio of 0.5 is considered to be safe, leading to low cost of borrowing. For a highly leveraged developer, it becomes difficult to get more funds; in case he/she manages to do so, the credit terms would not be favourable. Considering the present challenging business environment, it is important to ward off expensive debt.
A section of developers nevertheless even defend the fiscal mismanagement maintaining that over leveraged balance sheet does not count much if the developer is delivering quality product on time. Those developers that have delivered as promised and on time command a premium in the market and have seen faster absorption rates. The market does factor brand when valuing a product.
However, the fact remains that in majority of the cases over leveraged balance sheets and lack of fiscal discipline is the key reason behind the project not being delivered on time. There is hardly any case study where the developer with messy financial condition has actually delivered the project as promised.
By: Ravi Sinha
