RBI curb on 80:20 schemes will break builder-investor nexus

Mumbai:On his last day as RBI Governor, D Subbarao surely had the last laugh.

In what could be seen as a move to prevent India's very own sub-prime crisis, the Reserve Bank of Indiahas asked banks to desist from upfront disbursal of sanctioned housing loans to builders and insteadlink housing loans to stages of construction of a project to protect the home buyer and the lender from additional risks.

Construction-linked payment plan (CLP) requires the customer to pay instalments to the developer based on a predetermined rate of progress of the project, usually related to construction-related milestones.

The RBI directive is a body blow on realtors who were hugely dependent on so-called 80:20 schemes to boost sales when demand is low and also to raise some money when all their fund sources were running dry.

How 80-20 schemes work

 RBI curb on 80:20 schemes will break builder-investor nexus


In an 80:20 scheme, the buyer pays 20 percent of the purchase price upfront initially and the balance on possession irrespective of when that happens. As per the advertisements, under the scheme a buyer need to pay EMI for two years.

When an under construction flat is booked under the scheme, the buyer need not pay any pre-EMIs. The builder agrees to pay interest on the borrowers' behalf for a specific period of time while the bank disburses the entire loan amount to the builder. The loan, however, remains in the name of the buyer.

In effect, the builders were getting loans at cheaper rates, that too at a time when funds are difficult to come by. A complete win for them.

These schemes are normally offered in the pre-launch stage of projects.

Why builders resort to such schemes

Simple reason is lower demand and sales.Due to sky high property prices, genuine buyers have stayed away from real estate and sales have been down 50 percent over the last three years.

This in turn resulted in a high inventory which had to be liquidated to raise funds.Data from consultancy firm Knight Frank shows that financial stress of listed real estate firms was at an all-time high in the March quarter and it would have taken at least seven quarters to sell their stock off. Little wonder that most of the sales in the June quarter were realised through these subvention schemes.

In 2012, at least 100 more projects were launched in Mumbai offering such subvention schemes, according data by real estate research firm Liasas Foras.

According to Pankaj Kapoor, MD, Liasas Foras, such schemes were launched as a financial product to bridge the gap between affordability and artificially inflated prices. "If there is no buyer, you have to bring in parity and this was a form of discount to buyers," he said.

Disadvantage buyers

The very fact that it is offered only during the initial construction stage implies it is extremely risky for the buyer. If the realtor defaults, the liability falls on the consumer since the bank loan is his name.

"More often than not builders use the money disbursed not for completion of construction but to fund another land buy or another project, and rather than end users investor participation was more since they only had to pay 20 percent upfront and could exit the project after five years of completion for a profit. It was a win-win for the builder and investors but the end buyer was stuck if the project was delayed or if the builder used the funds for other projects" said Kapoor.

And now the RBI too has realised that this real estate bubble could bow up in its face if builders begin defaulting on loans.

"Since the loan is in the name of the buyer of the house, any delayed payment of interest by the builder harms the credit score of the buyer instead of the developer," RBI said yesterday.

A banking source told Firstpost that the 80:20 schemes were used to indirectly route fund builders at a lower interest rate and as it was a 'home loan', it carried less risk.

"Construction finance should not, through any innovative structuring, be available to developers at the rate of interest being offered on individual home loans. Further, complete up-fronting of construction finance to developers, even before the ground is broken, is dangerous," Deepak Parekh, chairman of HDFC, had said in the annual report for 2012-13.

How the RBI move will impact builders

Clearly, builders who had been relying on this scheme to generate project funding will be hit hard if banks abolish it.

With low sales, liquidity crises and the general elections coming up, the 80:20 scheme was the savior for several realtors as they were able to finance construction costs at a cheaper rate via home loans without any accountability to either the consumer or the lender.

And without it, the cracks in the realty sector are bound to show up.

As expected, developers are not happy.

"The scheme has been doing good for the industry and the customers. It will impact the sales in a huge way. Abruptly issuing such circulars, advising bank against established practices only harms the sentiments and disrupts business plans. This will be a setback for projects affecting end consumers," saidLalit Kumar Jain, chairman of developer's lobby Confederation of Real Estate Developers' Associations of India (CREDAI) and chairman and managing director of Kumar Urban development Ltd.

Jain added that since such schemes only constitute 5 percent of sales ans 20 percent of cashflows, it will surely hit builders had.

Others feel that while established players may be able to ride the storm, smaller players will be the first to default.

"Established developers with the capacity to complete projects on the basis of their own resources and traditional funding will still be able to honour their commitments to their customers. But the shake-up that the industry is experiencing now is going to make it very hard for new entrants to gain a foothold," Kishor Pate, CMD - Amit Enterprises Housing Ltd told Firstpost.

Builders were looking up to the coming festival season to increase their sales, deleverage their balance sheets and improve their cash positions. But the RBI's clamp down is surely going to delay launches.

Samanthak Das, Director of Research, Knight Frank India feels such subvention schemes are just short-term discounts. "But they are unsustainable in the long-run as it exposes the weak financials of builders. In the long-run builders will have to launch projects at the right price and the right location. The RBI has done the right thing and these schemes should be stopped all together," he said.

An industry source told Firstpost that builders like Lodha, Indiabulls, Omkar, Sunteck, Runwal, Ackruti will be the most effected in Mumbai, especially those who have launched townships offering such schemesin far flung suburbs such as Panvel, where habitation is at least 7-10 years away.

And if you thought the National Capital Region (NCR) was safe, think again. Township projects in Noida, Greater Noida, Ghaziabad, Gurgaon etc will be impacted the most since projects have been launched at price points way beyond the actual value of the land, a Delhi-based real estate broker told Firstpost on condition of anonymity.

In fact, he said banks had exposed themselves to massive risk by financing projects in the NCR market which is driven by investors.

What it means for buyers and lenders

Experts say the RBI move will make property market more transparent and will surely reduce the level of speculation and churn in the realty market

"This move by the RBI is aimed at protecting the interest of property buyers who are not aware of the long-term financial implications of such and similar schemes. It is definitely meant to advance the cause of greater transparency in the Indian real estate sector, and also to protect the financial institutions that provide funding in it," said Shobhit Agwarwal,Managing Director - Capital Markets, Jones Lang LaSalle India.

Bearing the interest payment for buyers, builders were able to artificially hold up prices. Now, with the absence of cheap funding via home loans, the builder will be under immense pressure to cut prices.

"These schemes were meant to aid investors not end users. Hence ready-to move in projects, which have remained stagnant through the year, will remain stable but the real impact will be felt in the under-construction market where investors will be looking to exit at a project but will find it diffucult to resell unsold properties. With the RBI curb, expect a 20-30 percent correction in this space," said Anshul Jain,Chief Executive - DTZ India.

"RBI has done very well to prevent the collapse of the banking sector. Without intervention, India's very own sub prime crisis would have not only taken the financial system but also home buyers down with it. The RBI has taken a strict call keeping in mind this real estate bubble which will protect end users from artificially inflated property prices," added Kapoor.

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Updated Date: Dec 23, 2014 19:23:56 IST