FM will have to break investor-builder cartel to tame realty prices

The investor-builder nexus in India, which has sent property prices soaring despite a lull in demand, may soon have to rethink their strategies as Finance Minister P Chidambaram is on a mission to kick-start the economy.

His first target is the unregulated real estate sector.

According to a report in The Economic Times, Chidambram has asked state-run banks, which have lent aroundRs 1.2 lakh crore to builders, to put pressure on real estate developers to lower property prices as close to five lakh ready flats are lying vacant in the country.

Unsold stock represents unsold units of projects that are being marketed. A healthy market typically has 8-10 months of unsold inventory. But according to Pankaj Kapoor, Managing Director at real estate research firm Liasas Foras, the unsold inventory, measured in the number of months it's gone unsold, in Mumbai alone has climbed to 40 months.

Finance Minister P Chidambaram is on a mission to kick-start the economy. AFP

However, whether the finance minister will succeed in getting the vested interests sitting on unsold inventory to lower prices is uncertain. For the current pricing is the result of the unwholesome business model adopted of these builders. They pass on the risks of unviable projects to financiers, banks, buyers and even investors to ensure their own safety and profitability by deliberately fuelling inflation.

"You must instigate borrowers to demand possession immediately or as per the schedule. You must also find out what is enabling builders to hold on to these vacant flats," a senior banker told ET, quoting the finance minister.

But how can the borrowers be instigated to demand possession when builders purposely delay projects to make their returns during the pre-sale or under-construction period by selling a bulk of the flats to investors for just the token amount? And it is this slush money in the pockets of investors that is enabling builders to hold on to these vacant flats.

Volumes of trading in the stock markets are down. Investors with massive liquidity - both black and white money - are always looking for a safe parking place and capital appreciation over a short period. Financing new projects of builders has been a profitable avenue for this money. The bigger the tower, the better the capital appreciation.

This is the reason why builders hold on to their prices as much of their new projects have been sold out to investors.

Builders, however, appear reluctant to lower prices on account of what they described as rising input costs. "I don't think there's scope for a price cut given the kind of input and finance cost escalation we have already witnessed, unless we recover these costs along with requisite margin," T Chitty Babu, chairman and CEO of Akshaya Home, a property builder, told ET.

While it is true that labour and construction costs have escalated, it is important to note that the developer does not put in his own money in financing a project. Even though the cost of land in cities like Mumbai and Delhi accounts for 70-80 percent of the construction cost, at least 50 percent of the projects are in joint venture with the land owner.

Have the developers paid for the land? The answer is no - or very partially. "Now when you have not paid for the land - and land constitutes almost 70 percent of the sale price - your ability to hold on is infinite," Pranay Vakil, chairman, Knight Frank, has been quoted as saying earlier.

This implies that if the builder has not paid for land, holding on to property does not hurt him. And all this cry about higher interest rates pushing pressure on developers to sell flats at higher prices is just a lame excuse.

Rising interest rates only affects the cost of construction - which is a small part of the overall cost. In the residential space, as long as the flat is booked, the builder makes money against it. Usually a part of the sales proceeds are more than enough to meet construction costs. Slower sales only result in negative working capital where the builder recovers more than what he spent on that particular project, not counting the land. Hence the pinch to sell flats at lower prices is not that great.

However, the cash in the industry is fast drying up. Not because banks are reluctant to finance projects but because investors are now shying away as realtors are not being able to deliver on the high returns they promised to investors. To keep their investors happy so that the fund-flow continues, the builder cartel hikes prices every few months. But since genuine buyers can't afford the prevailing rates, builders are stuck with loads of new homes waiting to be sold.

Even the flow of money from foreign direct investment has died down and there is a spurt in non-performing assets in the sector according to Reserve Bank data. The only way ahead is to break this builder cartel and ensure that it stops diverting the money received from one project into another project or purchase of land.

This can only be achieved if builders start focusing on the actual buyer. Or if the government launches a drive against builders and bats for consumers.