RERA: With state govts diluting key provisions, can the Act protect buyers at all?

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The Real Estate (Regulation and Development) Act, 2016, or RERA for short, has come into effect from May 1, 2017.

In large sections of the media, the RERA is being projected as a saviour for the home buyers. But will it turn out to be like that?

Will builders stop taking home buyers for a ride?

Will home buyers get the same home and facilities, which had been advertised, and which had been paid for?

Will the home buyers ever come to know what is the exact size of the home that they are paying for?

Will a builder still manage to not finish the project and disappear with the money he had taken from home buyers?

Will builders stop demanding black money?

The RERA is expected to make things better for the prospective home buyer, at least in theory. But in practice it’s off to a bad start.

While RERA is a central Act, land is a state subject. The Indian constitution divides legislative actions into three lists: a) union list b) state list c) concurrent list, on which both the state governments and the union government can legislate. Land is a state subject. Construction of homes requires land. And given this, the different state governments need to come up with the operational rules to implement RERA.

And this is where the entire idea of RERA protecting the interest of the home buyers seems to be going for a toss. First and foremost, even though the Act has come into effect from May 1, 2017, many state governments are yet to notify the operational rules in order to implement RERA.

A Crisil Research note titled Most states miss RERA deadline and dated May 2, 2017, points out: “Despite continuous monitoring and follow up by the Ministry of Urban Development and Housing, Government of India, only nine states (Andhra Pradesh, Bihar, Gujarat, Kerala, Madhya Pradesh, Maharashtra, Odisha, Rajasthan, and Uttar Pradesh) and six union territories (Andaman and Nicobar Islands, Chandigarh, Dadra and Nagar Haveli, Daman and Diu, Lakshadweep, and National Capital Territory of Delhi) have notified their respective Real Estate (Regulation and Development) Rules, 2017.”

Given that Union Territories are largely in control of the union government, it isn’t surprising that the operational rules are in place. But only around one-third of the states have notified the operational rules of RERA. And this in itself shows how serious state governments are about implementing RERA.

Further, even those states which have passed operational guidelines have diluted the Act in the process. As per the RERA, an ongoing project  is basically a project “for which the completion certificate has not been issued” on the date of commencement of the Act. This basically makes sure that many home projects which are work-in-process come under the Act.

Several states have diluted this definition. Crisil Research points out: “Andhra Pradesh, Kerala and Uttar Pradesh have altered this definition in their notified rules.” In case of Gujarat, the operational rules do not mention any definition of an ongoing project.

The operational rules of the Haryana government also dilute the definition by stating that projects which have applied for a part completion certificate or an occupancy certificate will not come under the RERA, if the certificate is granted. This has led to many builders rushing to get an occupancy certificate to ensure that their project does not come under the Act.

As a newsreport in The Economic Times points out: “Developers in Haryana are making use of the window provided by the draft state RERA rule, published on Friday [April 28, 2017], to get out of the ambit of the regulatory authority. On the first working day after the draft rule was announced, over 50 applications were submitted with the department of town and country planning (DTCP), seeking occupation certificates (OC).” In the days to come, many more applications are expected to be submitted. This has basically made a mockery of what RERA was trying to achieve.

There are other dilutions that have been made as well. As Crisil Research points out: “According to the central legislation, the model sale agreement is required to specify 10% advance payment, or charge an application fee from buyers, while entering into a written agreement for sale. In addition, in case of any structural defects arising within five years of handing over the possession of project to buyers, developers will be liable to rectify such defects without further charge. However, there is no clarity on these clauses in most states’ RERA notifications.”

Another important clause in RERA is the escrow account clause. As the Act states: “seventy per cent of the amounts realised for the real estate project from the allottees, from time to time, shall be deposited in a separate account to be maintained in a scheduled bank to cover the cost of construction and the land cost and shall be used only for that purpose.”

Hence, 70 per cent of the money taken from the home buyers by the builder needs to be maintained in a separate escrow account and needs to be used only for the purpose of building the homes. Also, this money needs to withdrawn in proportion to the percentage of completion of the project.

This is a key clause in RERA and was put in to stop the builders from raising money for a project and then using it for other things like completing an earlier project or paying off debt that was due.

The operational guidelines of many states are not clear on this. Like the operational guidelines of Gujarat, do not mention the norms for withdrawal of money from the escrow account of the project. The operational guidelines of Kerala state that “70% (or less, as notified by the government) of the amount realised by developers to be deposited in a separate account.” There is no clarity on withdrawal of money from the escrow account. This is true even for the guidelines issued by Madhya Pradesh.

Over and above this, RERA recommends imprisonment and fines for non-compliance with the Act. Several states have diluted this as well. Long story short—while the idea behind the RERA might have been noble to protect the buyers from the builders, but the state governments have managed to dilute that core purpose to a large extent.

The column originally appeared on Firstpost on May 3, 2017.

 

 

Why The Real Estate Act Will Remain Ineffective Until The Builder-Politician Nexus Is Broken

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In the first half of Vidhu Vinod Chopra’s 1994 release “1942: A Love Story,” there are a series of characters saying: “Shubhankar Da aane waale hain (Brother Shubhankar is about to come)”. The movie is based around the freedom struggle and the hope every time the lines are said is that the man called Shubhankar will come and set everything right.

Shubhbankar, played by Jackie Shroff, does come, just before the interval shot. Things become messier after his arrival, though eventually, like in all good Hindi films, everybody lives happily ever after.

Dear Reader, you must be wondering why am I talking about a 23-year-old movie which everyone has forgotten about by now, except for its marvellous songs composed by RD Burman.

Well, The Real Estate (Regulation and Development) Act, 2016, or RERA for short, has come into effect from May 1, 2017.

And it is expected to play the role of Shubhankar in the real estate sector in India. It is expected to come and set everything alright, at least that is the impression that has been given by many real estate experts in the media. But how correct is that?

RERA is basically a central Act. Given this, state governments do not need to pass separate Acts in order to implement it. But land is a state subject and given this the rules needed to implement the Act, need to be formulated and notified by the state governments. Many states are yet to come up with these rules.

As rating agency ICRA points out in a research note: “Except Uttar Pradesh, Gujarat, Madhya Pradesh, Maharashtra, Andhra Pradesh, Orissa, Bihar and the Union Territories, most have missed the deadline to notify its rules under the… Act.”

This tells us how serious the various state governments are about implementing the Act. Over and above this, the RERA mandates that every state set up its own real estate regulator. It so happens that Madhya Pradesh, Maharashtra and Rajasthan, are the only states up until now to have set up a real estate regulator. “Certain other states have set up interim regulatory authorities (as permitted under the Act),” ICRA further points out.

Also, as a newsreport in the Mint points out, Maharashtra is the only state that has set up a website where the real estate developers can register to set up new projects under the RERA.

Given that most states haven’t gotten around to setting up the real estate regulator and a website, this is something that will take time as they go around meeting the physical infrastructure and human resources requirements of the regulator as well as the website. And given this, RERA will not actually be implemented across large parts of the country, for some time to come.

Also, states which have formulated the rules to implement the RERA have diluted them in comparison to the rules framed by the union government. Take the case of Gujarat. Only projects launched on or after November 1, 2016, come under the aegis of the Act.

On the other hand, the central government Act defines ongoing projects as projects “for which the completion certificate has not been issued” on the date of commencement of the Act. This essentially allows many projects which are still work in progress not to come under the RERA.

Haryana, another state ruled by a BJP government, has done something along similar lines to help keep ongoing projects outside the ambit of the RERA. Projects which have applied for a part completion certificate or an occupancy certificate will not come under the RERA, if the certificate is granted. This, as was the case in Gujarat, is another ploy to get around the central government Act’s definition of an ongoing project.

In Maharashtra, a new nomenclature called proposed plans has been introduced and proposed plans instead of sanctioned plans can be submitted to the regulator. In the case of RERA only the term sanctioned plans has been used and only sanctioned plans can be submitted to the regulator.

As per the RERA any changes made to the sanctioned plans needs the written consent of allottees in the project. As the bare Act points out: “Any other alterations or additions in the sanctioned plans, layout plans and specifications of the buildings or the common areas within the project without the previous written consent of at least two-thirds of the allottees, other than the promoter, who have agreed to take apartments in such building.”

In case of Maharasthra, the usage of the term proposed plan is basically being seen as a way of getting around the written consent of the two-thirds of the allottees, if the builder goes around making changes to the project.

Over and above this, the Maharashtra rules point out that a phase of a project “may consist of a building or a wing of the building in case of building with multiple wings or defined number of floors in a multi-storeyed building/wing”. This has again been done to give flexibility to the builder to operate in the way he wants to, without following the letter and spirit of RERA. It allows the builders to keep developing projects on a piecemeal basis, something that they excel at.

In Delhi, the rules allow the builder to give details of only those legal cases where courts have already given a deicision. He does not have to provide details of cases which are still on. This directly contradicts Section 4.2 (b) of RERA which essentially states that the builder needs to provide: “a brief detail of the projects launched by him, in the past five years, whether already completed or being developed, as the case may be, including the current status of the said projects, any delay in its completion, details of cases pending, details of type of land and payments pending.”

In the time to come more such dilutions will keep coming out. The trouble right now is that operational rules of all states are not available in English and hence, it’s difficult to get a pan India perspective.

So, the question is why are state governments diluting the implementation of the RERA? The simple answer lies in the fact that there is a nexus between the builders and the state governments. Currently, the regulations governing the real estate sector vary from state to state and are inherently complicated. Given this, anyone wanting to be even a marginally serious player in the real estate business, needs to be in the good books of local politicians. This also explains why there are no pan India real estate companies. Forget pan India, there are no real estate companies which operate through an entire state.

The politicians also see real estate to be a cash cow which helps them generate money to fight elections as well as enrich themselves. This explains why regulations governing the sector continue to be complicated. In many states, the politicians are builders themselves though they have other individuals fronting for them. In such a scenario expecting the RERA to be implemented properly is nothing but day dreaming. For politicians, it makes sense if RERA is not implemented in letter and spirit. Given that politicians benefit from builders, a diluted RERA is their way of a quid pro quo.

If RERA has to be implemented properly the nexus between the politicians and the builders at the state level needs to be broken. And for that to happen, one of the first things that state governments need to do is get rid of change in land usage regulations that are currently in force. Only once this happens will things start to roll.

To conclude, Shubhankar Da may have been effective in 1942—A Love Story, RERA in its current form will become yet another regulation which won’t achieve much.

The column originally appeared on The Huffington Post on May 3, 2017

Price Fixing and the Law of Unintended Consequences

 

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One of the beliefs that governments and regulators have is that they can control prices. All that is needed is a government decree fixing the price of a particular product and everything will fall into place.

But is that how things eventually work out? The answer is no. The first point here is that letting the market work and evolve a certain price of a product is very important, otherwise it leads to unintended consequences.

The law of unintended consequences essentially states that purposeful actions of the government have unintended or unanticipated consequences, the noble intentions of the government notwithstanding. Take the case of glass production in the erstwhile Soviet Union. Everything was government owned and like other things, the government produced glass as well.

The idea of course was to produce different types of glass and enough glass. The trouble was that there was no pricing mechanism in place, which could inherently coordinate the demand and supply of different kinds of glass. All that was in place were government diktats.

As Swaminathan S Anklesaria Aiyar writes in From Narsimha Rao to Narendra Modi—25 Years of Swaminomics: “In the absence of pricing mechanisms, Soviet planners set physical targets of glass production in terms of weight, factory managers started producing the heaviest sorts of glasses to meet plan targets. This meant shortages in terms of square feet.”

The planners then decided to shift the targets from tonnes to square feet in order to correct for this unintended consequence. “Alas, this induced factories to produce the thinnest glasses to meet targets, and much of it shattered,” writes Aiyar.

The point being that when the government tries to interference with a pricing mechanism of a product, it has unintended consequences which are not good for the overall economy. Aiyar provides another excellent example of this phenomenon, in his book.

He talks about the days when India had only two car companies Hindustan Motors and Premier Automobiles. Those were also the days when the government fixed the price of a new car. And this had unintended consequences.

As Aiyar writes: “There was a long queue of several years to buy a car, and only people with contacts could get early delivery. The price of new cars was controlled by the government in the 1970s, but not of old cars. So, second hand cars cost more than new cars! As an accredited journalist, I was entitled to a car from the government, and I bought a Fiat car for Rs 22,000 in 1972.  I sold it for Rs 35,000 after five years of use.” These days the moment a car leaves a showroom it’s price comes down by as much as 30 per cent.

Nevertheless, the government continues to believe in price control mechanisms. Recently, the National Pharmaceutical Pricing Authority, put a price cap on stents which are used to open blocked arteries in the heart. Of course, those who pass such diktats have really no idea of how any market economy works.

Companies in the high-end stent business now want to withdraw stents from the market because these high-end stents are no longer viable at the price set by the government. Also, as happens in most cases where prices are capped, eventually the market for stents will move into the black economy. Those who can afford it, will settle in cash, or simply go abroad and get the procedure done and get the best stent available.

The hospitals which obviously made a cut from the stents that they sold can simply charge more for other procedures, in order to ensure that their revenues don’t fall. From the little anecdotal evidence that is available that has already started to happen. There have also been newsreports of high-end stents disappearing from the market.

In a column in the Mumbai Mirror on February 18, earlier this year, Dr Sanjay Oak had made a very sensible suggestion when he said that the government should “adopt an a la carte approach, making available stents at Rs 7000, Rs 28000, Rs 85000 and uncapped”. The way things currently are, the government diktat treats all stents to be the same.

And this as we have seen is having and will continue to have unanticipated consequences.

The column originally appeared in the Bangalore Mirror on May 3, 2017

Viral Acharya is Right About Re-privatising Public Sector Banks

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Late last week Viral Acharya, a deputy governor of the Reserve Bank of India (RBI), said: “Perhaps re-privatising some of the nationalised banks is an idea whose time has come … this would reduce the overall money government needs to inject as bank capital.”

Regular readers of the Diary would know that we have said several times in the past that public sector banks should be privatised and the government should get out of the banking business, which it is clearly inept at.

Of course, the question is why has Acharya used the term re-privatising rather than privatising. Indira Gandhi nationalised 14 private banks on July 19, 1969. These banks had deposits of Rs 50 crore or more and among them accounted for 90 per cent of the banking business in the country. The funny thing is that at the time this happened, the then RBI governor LK Jha had no clue about it.

As TCA Srinivasa Raghavan writes in Dialogue of the Deaf—The Government and the RBI: “Volume three of RBI’s official history says that on July 17 she [Indira Gandhi] asked LK Jha, the RBI governor to come over to Delhi. Jha thought he was being asked to discuss social control and he took with him a comprehensive note on the subject. When he offered it to Mrs Gandhi she told him ‘that he could keep the note on her table and go to the next room and help in drafting the legislation on nationalising the banks.’”

In 1980, six other private banks were nationalised. This time the recommendation came from the then RBI governor, IG Patel.

Now getting back to what Acharya said, re-privatising is something we have advocated in the past. And it makes sense at multiple levels. We now have nearly two decades of evidence that suggests that the new generation private sector banks which were first set up in the mid-1990s, are much more efficiently run than their public-sector counterparts. Yes, there have been cases like the Global Trust Bank, but on the whole private banks are better run than their public sector counterparts. Even the old generation private sector banks, which are very small, are reasonably well run.

Take the case of the bad loans situation that currently plagues the Indian banking sector in general and the public sector banks in particular. As on December 31, 2016, the total bad loans of the public sector banks (gross non-performing assets (NPAs)) had stood at around Rs 6.46 lakh crore.

For the private sector banks, the same number stood at Rs 86,124 crore. Of this, two banks, ICICI Bank and Axis Bank, accounted for bad loans of Rs 58,184 crore. Of course, given that public sector banks give out more loans, it is not surprising that their bad loans are more.

The total loans of public sector banks are 2.9 times the total loans of private sector banks. But their bad loans are 7.5 times that of private banks. If both these set of banks were equally well run, then the two ratios just referred to, wouldn’t have been different.

Between 2013-2014 and 2015-2016, the total net profit made by the public sector banks stood at Rs 56,567 crore and that of private banks stood at Rs 1,13,801 crore. This, even though public sector banks are significantly bigger than India’s private banks.

These data points tell us that India’s public sector banks are inefficiently run. And this inefficiency has cost the government a lot of money over the years. Between 2009 and March 2017, the government has had to invest close to Rs 1.5 lakh crore in these banks to keep recapitalising their capital, in order to keep them going.

Indeed, this is a lot of money and could have gone towards other worthy causes. The basic problem with public sector banks is political meddling. Every government has its favourite set of industrialists and this ultimately leads to the public sector banks and in the process the taxpayer, picking up the bill for this politician-businessman nexus.

As Acharya writes in a paper titled Is State Ownership in the Indian Banking Sector Desirable?: “One, state ownership creates severe moral hazard of directing bank lending for politically expedient goals and of bailouts when such lending goes bad. Second, state ownership restricts the ability of state-owned banks from raising arm’s length capital against state’s stake, strangling their growth and keeping these banks—and certainly their private capital base—smaller than it need be.”

What does this mean in simple English? The economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it.” Hence, managers of government owned banks know that if loans given to businessmen close to politicians go bad, the government will ultimately pick up the tab by recapitalising the public sector bank to an adequate extent. Hence, they go easy on giving loans to borrowers who are likely to default. Of course, there is always the threat of transfers, which works very well. This has happened for years at end.

Secondly, given that the government has to continue owning a certain proportion of shareholding in these banks, the banks cannot raise as much capital as they require. They have to continue to be dependent on the government for capital. And the government of course does not have an unlimited amount of cash. This limits the ability of the government owned banks to raise as much capital as they may require at any point of time.

So, what are the actual chances of the government re-privatising some of the public sector banks, as suggested by Acharya? Zero. While Acharya, I and others, might think that the basic problem with public sector banks is government ownership, politicians don’t think so. This comes from the belief that if you own banks then you can direct lending to areas that you want to. But this as we have seen comes with its own set of costs.

The column originally appeared on Equitymaster on May 3, 2017.

Now that RERA is a reality, should you buy an under-construction property?

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The Real Estate (Regulation and Development) Act, 2016, or RERA for short, has come into effect from May 1, 2017.

With this happening, the question on everybody’s lips is, should we buy an under-construction property? If you plan to buy a home to live in, an under-construction property makes sense because it comes cheaper than a finished one. If you plan to buy home as an investment, given that an under-construction property is cheaper, the returns are always better, depending how early in the construction stage you make the investment.

But that it the theoretical part of it. It comes with the assumption that the builder will deliver the property for which you have paid, and he will deliver it on time. The problem is that this does not always turn out to be the case. Many people in the Delhi National Capital Territory region and other parts of the country, have found this out in the last few years.

In the process, they have ended up paying EMIs on the home loans they had taken to fund their home purchase and the rent on the home in which they continue to live in. The homes they had hoped to live in are nowhere in sight.

But all this happened in era when there was no RERA. Now we have RERA. The real estate sector in the country up until now had next to no regulation from the point of view of the buyer. Buying a house required a lot of leap of faith and prayers at the same time.

The RERA essentially has these five basic purposes: a) to make sure that home that has been bought is delivered on time. b) to make sure what has been promised has been delivered with respect to the actual size of the house, the facilities etc. c) to make sure that the money taken from the buyer is used to build what has been promised and is not diverted to something else, as many builders tend to do. They tend to raise money for one project and then use it to finance another project. d) to make sure that the many permissions required to build a housing project are in place. e) to make sure that if any changes are made to the project, they have the approval of the majority of the buyers.

RERA also makes it mandatory for state governments to set up a real estate regulator. As the Act states that: “Any aggrieved person may file a complaint with the Authority [i.e., the real estate regulator of a particular state] or the adjudicating officer, as the case may be, for any violation or contravention of the provisions of this Act.”

What this basically means that if the builder takes the buyer for a ride, he can approach the real estate regulator and hope to set things right. This is precisely why there have been a flood of acche din articles in the media saying how RERA is going to save the day for real estate buyers.

There are multiple problems here:

a) While RERA is a central Act, land is a state subject. Hence, states are allowed to make the operational rules to implement RERA. Given the nexus that prevails between state level politicians and builders, state governments have already started diluting the basic spirit of RERA. In particular, an effort is being made to ensure that the ongoing projects are not brought under the ambit of RERA. This basically means that many buyers who are currently in trouble will not be able to benefit from this Act.

b) Only three states (Maharashtra, Rajasthan and Madhya Pradesh) have set up regulators up until now. Hence, the process of setting up a regulator is going to take some time.

c) It is important to understand that regulators don’t start becoming effective from day one. Take the case of the Securities and Exchange Board of India, the stock market regulator. It was set up in 1992 and in 1994 the vanishing companies scam, one of the biggest stock market scams, happened. This was followed by the Ketan Parekh scam in 1999-2000. Hence, it takes time for regulators to mature.

d) Also, it is important to know that the regulators don’t necessarily bat for the consumers. The Insurance Regulatory and Development Authority(IRDA) of India, the insurance regulator, for a very long time, turned a blind eye to all the misselling carried out by the insurance companies. It kept clearing investment plans which worked well for the insurance agents but not for the consumers who had bought them. The point being whether real estate regulators bat for the consumers or the builders, remains to be seen. Also, this is something that may vary from state to state.

To conclude, there are many practical things which continue to remain unclear as of now. Hence, if you are looking to buy a home to live in, it makes sense to still buy a fully finished one, rather than something which is under-construction. This may mean compromising on the size or the location, perhaps, but what you will get in return is peace of mind. And nothing is more important than that.

The column originally appeared on Business Standard The column originally appeared on Business Standard online on May 3, 2017.