Construction FDI: Realtors and benami speculators will gain more than home buyers

The Modi government’s decision to liberalise foreign direct investment (FDI) rules in the construction sector, especially housing, is fine as it goes. In principle, FDI should be welcome in every sector that is not related to national security or is otherwise regarded as sensitive.

But, as usual, what is fine in principle will actually benefit the unworthy more than the worthy: crooked realtors rather than home buyers.

Though the FDI easing is not restricted to housing, it will be less useful in other areas of construction (roads, water supply, street lighting, building of smart cities, etc) till the laws that are actually thwarting these activities are modified first. This means serious amendments to the growth-retarding Land Acquisition Act enacted by the UPA in its dying days. This act makes large-scale land acquisition for public purposes, especially infrastructure vital to housing and transport, almost impossible by being both time-consuming and prohibitively expensive.

Enough has been written on the negatives of the Land Acquisition Act, which apparently no state wanted (read here and here ), and which, one presumes, the NDA will do something about it sooner or later. But easier FDI in the housing sector will do more damage first before benefiting home buyers.

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In fact, the first beneficiaries of this easing will be crooked builders - now struggling to sell property in major cities - and their benami investors, mostly even more crooked politicians. By helping them access more and easier finance, the government is essentially delaying a correction in property prices - and making housing more unaffordable to everybody.

Consider what is being proposed by the liberalisation. Among other things, the minimum built-up area for projects in which foreign investment will be allowed has been reduced to 20,000 sq metres from the earlier 50,000; the minimum size of investment has been reduced to $5 million from $10 million; and the lock-in period of investment will end the minute a project is completed. The old three-year lock-in applies only to incomplete projects.

What this liberalisation has done is to make speculative investments easier for foreign investors, especially non-residents. So instead of allowing only domestic speculators to make money through benami holdings, now even NRIs from the Gulf and small-ticket foreign investors can join the party - all at the expense of the genuine home buyer whose prices will stay elevated and unaffordable. It will encourage more speculation as the minimum investment norms are lower, the early exit barriers are gone, and the pool of available speculators is larger.

This easing will help builders and real estate owners more than home buyers as they can now access cheaper and more finance. The only home buyers who will benefit are those who have already put their money in projects, but builders are delaying completion due to the lack of funding.

Not surprisingly, the most ecstatic responses have come from builders.

The Economic Times quotes Rajeev Talwar, Executive Director of DLF, one of India's biggest value destroyers on the stock exchange, as saying: “The government is bang on (target). We are very glad about the trunk infrastructure completion part as it will bring in asset-based FDI. This will ensure that project developers who have taken FDI are not left with more debt.”

DLF will certainly benefit by being able to reduce its debt load, but how will home buyers benefit if easy money makes builders more reluctant to lower prices and hang on longer to built property? The only way home buyers will gain if the huge debt load and slow sales forces builders to bring down prices to push sales and improve liquidity. But this is exactly what won’t happen is cheap money flows in torrents as a result of the FDI change. The FDI easing will make builders ability to hoard property stronger.

Another real estate worthy quoted by ET is RR Singh, boss of the National Real Estate Development Council. He explains exactly why builders will benefit. FDI easing, he says, will help “developers who are running late with their projects due to the funds crunch. Townships take a minimum of 10 years to be completed, so the relaxation will ensure that funds are not a problem.”

While one need not argue against the real estate sector need for better funding, the problem is that property has become completely unaffordable even to the middle and upper classes because of political control of land supply that enables builders to hoard land and share the inordinate gains with their political backers rather than home buyers.

Issues like higher FSI (floor space index) and easier connections to satellite cities are being left unaddressed by city and state authorities in order to enable the milking of abnormal profits from existing city centre land and redevelopment (read my earlier writeups on this issue here, here , and here ). A simple infrastructure project like building a trans-harbour link for Mumbai has been put in cold storage for a decade precisely because this will dent property values in south and central Mumbai - now the focus of some of the biggest property development projects.

The short point is this: without major land supply and infrastructure reforms, the easing of FDI rules in housing will benefit builders and politicians more than home buyers.