If Home Loans Are Growing, what is the Problem with Real Estate?

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The government shared some data earlier this month in the Lok Sabha, which has led to this column. Take a look at Table 1. It gives us the total home loans given by public sector banks and housing finance companies over the last few years.

It was further pointed out as a part of an answer: “As per the data compiled by National Housing Bank, the growth in housing loans of public sector banks and housing finance companies during the six month period from 1st July, 2017 to 31stDecember, 2017, has been about 34% as against 12% during the corresponding previous half year.”

Table 1: Total amount of home loans given by public sector banks and housing finance companies.It would have been great if the government had shared the total amount of home loans given out between July 1, 2017 and December 31, 2017, instead of just sharing percentages.

Also, on a slightly different note, the National Housing Bank needs to share home loan lending data (both banks and housing finance companies) on a regular basis, which it currently doesn’t. While, the Reserve Bank of India shares the total amount of home loans given out by banks, no such data is regularly available for housing finance companies.

Anyway, getting back to the point. Between July 2015 and June 2016, the home loan disbursement grew by around 25%. Between July 2016 and June 2017, it grew by around 13%.

Since then, growth rate has improved considerably, which tells us that the ill-effects of demonetisation which plagued the sector, are on their way out to some extent.

Now contrast this to data recently released by property consultant JLL. As of December 2017, a total of 4.4 lakh housing units remained unsold in seven major cities. Delhi along with the National Capital Region came on the top with 1.5 lakh unsold homes. Mumbai, Delhi-NCR, Chennai, Hyderabad, Pune, Bengaluru, Kolkata were the seven cities covered in this survey.

How does one contrast the JLL data with the increase in home loans being disbursed, is a question worth asking. There are several explanations. One is that homebuyers are no longer buying under-construction properties. Take the case of the JLL data, only 34,700 units are ready-to-move-in flats. Hence, people are not interested in buying properties which aren’t totally ready. Why?

The answer for this is very simple. Many builders in the last decade have taken money from prospective buyers and not delivered homes. And the prospective buyers have seen what has happened to the earlier set of buyers, and does not want to make the same mistake again. Nobody wants to get into a situation where the biggest investment of their life gets stuck and doesn’t go anywhere.

Given that many people bought real estate as an investment over the years, and kept those homes locked, my guess is, it is that inventory which is now being cleared, to some extent.

This loss of trust between the real estate companies and the prospective buyers, is the basic problem at the heart of India’s real estate crisis. And the data suggests, the lack of trust continues to prevail.

Further, the growth in home loans is basically coming in the affordable housing segment. As the Affordable Housing Report released by the Reserve Bank of India (RBI) in January 2018, points out: “Affordable housing is currently driving home loan growth in India… Housing loans up to Rs 10 lakh recorded robust growth in 2016-17, primarily driven by the public sector banks.. While the number of beneficiaries for loan amounts up to Rs 10 lakhs has increased sharply in 2016-17, the number of beneficiaries for higher value loans of above Rs 25 lakhs has, in fact, declined marginally during the year.”While the bulk of the lending still happens in the greater than Rs 25 lakh category, the growth actually is coming from the sub Rs 10 lakh segment, which is where the real market for homes in India is. Of course, much of this growth is being pushed by the government (which is why the government loves public sector banks) and is not happening in the top seven cities that JLL covers.

What this again tells us is that if home ownership in large cities has to pick up, the prices need to still fall from where they are. Also, buyers are not interested in buying under-construction property and that is something that the real estate companies need to realise and do something about. But that would mean a substantial change from their current way of operating. It hits at the heart of their current business model. And all change is a slow process.

This appeared on Equitymaster on March 22, 2018

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The Javed Akhtar Syndrome in Real Estate

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Poets usually write poems on love, breakups, betrayal, friendships, alcohol, the women serving alcohol, the world at large, politics and so on. But very rarely does a poet write a poem or a couplet on the unaffordability of real estate in India. But Javed Akhtar has done that:

sab kā ḳhushī se fāsla ek qadam hai.
har ghar meñ bas 
ek hī kamra kam hai

A loose translation of this in English would be as follows: “Everyone is just one step away from happiness; Every house has just one room less”.

Given the fact that Akhtar has spent a large part of his adult life in Mumbai, the above couplet reflects or rather captures the sensibilities of the city that never sleeps, very beautifully.

Dear Reader, you must be wondering, why am I talking about a couplet written by Javed Akhtar on a rather muggy Tuesday in Mumbai. Allow me to explain.

Over the weekend, I met a friend who wants to sell his one-room-kitchen (a very Mumbai thing) apartment and buy a one-bedroom-hall-kitchen (one BHK) apartment. Basically, he feels his current apartment has one room less and he wants an apartment which has one room more than his current one.

Of course, the transaction cannot be carried out, unless he is able to sell his current apartment. The money generated from that will partly be used to pay off the current home loan. The new apartment will be bought with whatever remains after selling off the current apartment and repaying the home loan; along with this a fresh larger home loan will have to be taken. Over and above this, some financial savings accumulated through investing in mutual funds through the SIP route, will also have to be used.

My friend had bought the apartment for Rs 50 lakh, nearly three years back. He is looking at a price of at least Rs 60 lakh. In fact, more than looking, he is specifically anchored on to that price and won’t sell for anything less than that price.

As Garly Belsky and Thomas Gilovich write in Why Smart People Make Big Money Mistakes and How to Correct Them: “Anchoring is really just a metaphoric term to explain the tendency we all have of latching on to an idea or fact and using it as a reference point for future decisions. Anchoring can be particularly powerful because you often have no idea that such a phenomenon is affecting you.”

This is not the first time I am discussing the phenomena of anchoring in real estate, nevertheless, this example is interesting and different, because anchoring, as we shall see, is happening at multiple levels.

My friend is anchored on to a price of Rs 60 lakh because he feels that at that price he will be in a situation of no-profit no-loss, while selling his current apartment. The extra Rs 10 lakh, over and above the price he bought the apartment for, should take care of the home loan EMIs and the maintenance charges paid, over the last three years. This is his logic for being anchored on to a price of Rs 60 lakh.

The trouble is that at that the few buyers who have approached him do not want to pay more than Rs 55 lakh, while my friend remains stuck on the Rs 60 lakh figure.

In this case, the transaction is what we can call a relative transaction. The money that my friend gets for selling the current apartment will be used to buy a bigger apartment in the same locality that he lives in.

If he waits too long to get a price of Rs 60 lakh, chances are that the price of the bigger apartment that he wants to buy will also go up. Currently, the bigger apartment is available for a price of around Rs 80 lakh.

I tried explaining this point to him without much success. In fact, after I explained this point to him, my friend told me that he had a buyer who was willing to pay Rs 60 lakh. The trouble was that this prospective buyer needed to sell an apartment in another city to be able to raise the amount.

This buyer, because my friend had become anchored to a price of Rs 60 lakh, was also anchored to that price. Given that he was a senior citizen, he was not in a position to raise a home loan. Hence, he needed someone to pay Rs 60 lakh for his flat to be able to purchase my friend’s flat.

No one was willing to pay Rs 60 lakh for the flat. In this case, the prospective buyers were willing to pay anything in the range of Rs 55-60 lakh. But that was clearly not enough. And given this, the sale of both the flats remained stuck.

This example clearly shows as to how anchoring works at multiple level and not just at one level, as is often believed. This anchoring essentially stops the market from working. The more general conclusion from this example would be that anchoring working at multiple levels, is one of the reasons why the buying and selling of real estate has slowed down majorly.

The sellers (not necessarily the builders) are still expecting prices that their homes were worth until a few years back. But the buyers, who have paid more than their fair share over the years, are currently not willing to pay the price that the sellers want.

Ultimately, this anchoring on to a specific price will break down. It’s just that it won’t happen overnight and will take some time.

Until then writers like me will have enough masala to keep writing on real estate.

Keep watching this space!

The column originally appeared on Equitymaster on November 14, 2017.

India’s Real Estate Conundrum

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Economic forecasting is a difficult business. It is even more difficult when one has to answer something as specific as: “when will home prices become affordable?”

Almost, anyone interested in buying a home currently knows that home prices are expensive. This, despite the fact that homes aren’t selling, and builders are sitting on a large number of unsold homes. But, they don’t seem to be in a hurry to cut prices.

Conventional economic theory suggests that when something is not selling, prices need to be cut, to attract prospective buyers.

But this does not seem to apply in the case of Indian real estate. Why? In the period between 2002 and 2012, real estate prices in India went up at a break neck speed. A significant portion of the real estate transactions was carried out in black.

Hence, while buying a home 20-30 per cent of the price had to be paid in black (i.e. in the form of cash). The money that the builders made in this form, has ensured that they continue to be liquid i.e. they have enough cash going around to meet their day to day expenses.

In the process, they are in no hurry to cut prices. But builders are not the only one who have a stake in this real estate game. Over the years, many individuals have become real estate investors as well. ”

Real estate returns across the country have either been very low or in negative territory, over the last few years. Also, once we take the risk involved in owning real estate and inflation, into account, investing in real estate starts to make financial sense only when the returns are greater than 10 per cent per year. Now that kind of return has been elusive on this investment.

Hence, the question is why are real estate investors holding on to the homes they bought as an investment, even when that investment is really not throwing up any return. It would simply make more sense for them to sell the home and invest the money somewhere else. Even something as simple as a fixed deposit is likely to earn more.

But before we figure out why these investors are not selling, let me tell you a little story. Recently, I was in Bali for a small family holiday. I wanted to buy a wooden carving, which I had taken a fancy to. The seller’s asking price was 6,00,000 Indonesian rupiah (around Rs 3,000). I started at 2,00,000 rupiah (Rs 1,000) and stuck to it. The seller kept dropping his price, till he came down to 2,50,000 rupiah (Rs 1,250).

After that we kept haggling for a good five minutes, but he stuck to his price. He wouldn’t drop it further, come what may. He had become “anchored” to that number, due to some reason. And this anchor ensured that finally I had to up the price I was willing to pay to 2,50,000 rupiah and seal the deal.

Anchoring is a very important concept in real estate. In his book A Man for All Markets, Edward O Thorp writes: “Anchoring is a subtle and pervasive aberration in investment thinking. For instance, a former neighbour, Mr Davis (as I shall call him), saw the market value of his house rise from his purchase price of $2,000,000 or so in the mid-1980s to $3,500,000 or so when the luxury home prices peaked in 1988-1989. Soon afterward, he decided he wanted to sell and anchored himself to the price of $3,500,000.

Mr Davis became anchored to this price of $3.5 million. The trouble was that home prices started to fall pretty soon. But Mr Davis had become anchored to the high price and he wouldn’t sell.

The Indian real estate investors are going through a similar phase right now. They are anchored on to the high real estate prices they saw nearly five to six years back. The trouble is no buyer is willing to buy at that kind of price.

In fact, this psychological dimension in real estate, makes it even more difficult to predict, when home prices will become affordable, despite it being very clear that real estate prices are due for a huge correction.

The column originally appeared in Bangalore Mirror on October 25, 2017.

A Real Estate Story That Everybody Should Read

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I am in Delhi these days.

And Delhi and the National Capital Region around it, as you would know, dear reader, have their share of real estate stories.

There are stories of builders who have taken the money from prospective buyers and not delivered.

There are stories about builders who have taken the money from prospective buyers and simply disappeared.

There are stories about builders who have taken the money from prospective buyers and abandoned construction midway.

There are stories about prospective buyers continuing to pay their EMIs with no idea of when their dream home will be delivered. Meanwhile, they also continue to pay rent.

There are stories about builders now demanding a bailout from the government.

All in all, the overall real estate story in Delhi and the National Capital Region, is a mess.
Nevertheless, recently I came across a slightly different sort of story, which tells us the different kind of problems that people face with real estate and why sometimes there are really no solutions to a problem.

One of my relatives, who are now very old, have lived a good part of their lives in a DDA colony in South Delhi. The flat was bought in the early 1980s at around Rs 2.5-3 lakh and is now worth close to Rs 3 crore. Of course, South Delhi is a great place to live.

All the everyday amenities from banks to vegetable vendors to milk booths to medicine shops etc., everything is within walking distance and almost everything you can think of is home-delivered.

But the relatives I am talking about here are now old and want to move to a different part of Delhi, to be close to their immediate family, which stays there. That part of Delhi is much cheaper than South Delhi. A similar sort of flat can easily be bought at around 40-50 per cent of the price in South Delhi.

If things work as smoothly, as they are supposed to in theory, this would mean selling the flat in South Delhi for around Rs 3 crore, buying a new one for around Rs 1.5 crore and paying a capital gains tax on the remaining Rs 1.5 crore. And then, they can live happily ever after.

Now only if things were as smooth as that.

As I well known, no real estate transaction can happen in Delhi-National Capital Region in full white money i.e. the full payment is made through a cheque, demand draft, bank transfer etc. A part of the transaction will always have to be carried out in black, which means a payment needs to be made in cash.

How would a Rs 3 crore sale go? Around Rs 1-1.3 crore would be paid in black. The remaining would be in white. Typically, when this happens, the black money is then used to buy more flats, and this is how the vicious cycle of black money continues.

In this case, the flat in the new locality costs around Rs 1.5 crore. Of this around Rs 50 lakh will have to be paid in black. And the remaining in white. This means that of the Rs 1-1.3 crore of the original black money received, around Rs 50-80 lakh will remain.

This is a lot of black money for someone who has never really dealt with black money. What does he do with this black money? At his age, there is no point in investing in more flats (given that the real estate sector is down in the dumps and also the fact that more money would be needed to do the same) or buying gold for that matter.

Given this conundrum, the sale is stuck. At his age, there is no possibility of a home loan as well.

In fact, this is an excellent example of a situation where an individual is asset heavy and liquidity light. Of course, in this case, he didn’t arrive at this situation because of the choices he made. Over the years, that is exactly how the situation turned out to be.

A part of Delhi, which no one really wanted to go and live in, turned out to be its most posh part, over a period of three decades and more. And given, this real estate prices sky-rocketed. A flat which cost Rs 3 lakh, was worth 100 times or Rs 3 crore, nearly 35 years later. This means a whopping return of 14 per cent per year (without taking any maintenance cost into account). In fact, at its peak price nearly five years back, the flat would have gone for anywhere between Rs 3.5-4 crore.

Of course, from the investment point of view, it has been a superb investment. But 35 years later, the situation is such that the flat cannot be sold. And this is a lesson for everyone who believes that real estate is the best way to invest.

The biggest problem with real estate is that it lacks the liquidity of other forms of investment, even though the returns might be superb. While, in this case my relatives can continue to live in this flat, so it doesn’t matter much. But there are other cases when people need liquidity to meet expenses, like the higher education of their children, their weddings, a medical emergency, and so on. In a real estate market like the one that exists today, selling a property quickly at the right price (if at all there is anything like that in Indian real estate) is never easy.

Of course, one can always take a loan against property, but then even that has to be repaid and the regular income may not be good enough to repay that loan.

This is something that everybody who swears by real estate as the best form of investment, should keep in mind.

Real estate may not have the liquidity, when you need money the most.

What happens then?

The column originally appeared on Equitymaster on October 24, 2017.

 

 

The Delusional Optimism of India’s Real Estate Companies

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Daniel Kahneman, the Nobel Prize winning psychologist, in his brilliant book, Thinking, Fast and Slow, writes: “One of the benefits of an optimistic temperament is that it encourages persistence in the face of obstacles…[The] confidence [of the entrepreneurs] in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

This optimism of an extreme delusional variety has been visible among India’s real estate entrepreneurs. For the last five to six years, they have been saying that a recovery in the sector is just around the corner, and the fact that it hasn’t happened yet is because the Reserve Bank of India (RBI) refuses to play ball by cutting interest rates, adequately.
Rajeev Talwar, the Chief Executive of DLF, recently told the Business Standard: “We are in a new economic cycle… When demand picks up, it will take everybody by surprise.”

Niranjan Hiranandani, chairman of Hiranandani group, told the same newspaper: “Any depression will not last long.”

Isn’t a period of five to six years a long enough time?

A report by Crisil Research points out that the absorption of new homes (i.e. sales) in in top 10 cities (Ahmedabad, Bengaluru, Chandigarh, Chennai, Hyderabad, Kochi, Kolkata, Mumbai Metropolitan Region (MMR), National Capital Region (NCR) and Pune) has fallen by 8 per cent per year on an average in the last six years.

What does this mean? It means that if real estate builders sold 100 new homes in India’s top 10 cities in 2010, in 2016, they managed to sell only 63. In absolute terms, this is a fall of 37 per cent. And Mr Hiranandani is talking about any depression not lasting long. I guess six years is a long enough time.

In fact, things haven’t looked good even in the last three months. As per real estate research firm, PropEquity, housing sales stood at 22,699 units during the period July to September 2017, in eight key cities. The sales had stood at 34,809 units during the period April to June 2017. This means a collapse of close to 35 per cent in a period of just three months.

The eight key cities are Gurgaon, Noida, Mumbai, Kolkata, Pune, Hyderabad, Bengaluru and Chennai.

What are the reasons for this collapse? As I have been saying over and over again, real estate prices in India, are beyond what most people can afford and unless this anomaly is corrected, sales will continue to remain sluggish.

Over and above this, real estate companies have really worked hard to break whatever little trust the prospective buyers had in them, by not delivering homes on time.

Further, investors are no longer the driving force in the market, given the sluggish returns in the sector. For a real estate investment to be a viable proposition, after taking in the costs and the risk involved, it should be generating a return of at least 10 per cent per year. And this hasn’t happened for a while.

The overall economy continues to remain sluggish. Take a look at Figure 1, which plots the growth of the non-government part of the GDP, which forms around 90 per cent of the Indian economy.

non govt GDP growth

Source: Centre for Monitoring Indian Economy.

The growth of the non-government part of the economy has fallen from well over 9 per cent to a little over 4 per cent in a period of 18 months between January 2016 and June 2017. This also means that incomes are not going up at the same pace as they were in the past. And given this, it is but natural people are going slow on buying a new home, which is the biggest financial commitment that they make in their lives. During a time when the rental yield (annual rent divided by market price of a home) is around 2 per cent, this makes immense financial sense.

The fear of job losses in the IT industry has also had an impact. The state of the IT industry has a major impact on real estate sales in cities like Pune, Hyderabad and Bengaluru.

In this scenario, the real estate builders have been offering discounts in order to get prospective buyers interested. As Crisil Research points out: “Pressure on residential real estate prices across top 10 cities was clearly visible during H1 2017 [January to June 2017]. While several developers offered upfront per square feet discounts, a few large developers bundled financing schemes and reduced interest schemes to offer ‘all inclusive house prices’. Home buyers, in many cases, were also offered indirect benefits such as reduced floor charges or premium location charges. Taking into account these aspects, the effective price correction was 5-10%.”

But even this 5-10 per cent correction isn’t enough to pull buyers in. This basically means that home prices continue to remain expensive. As I have often said in the past, home sales will revive as and when home prices become affordable, which is currently not the case. For home prices to become affordable builders need to cut prices from current levels. Given that a majority of them are in no mood to do so, it basically means that home sales will remain sluggish in the years to come.

Crisil Research expects that “in the next 12-18 months, prices are likely to remain stable at current levels on account of weak demand and moderation in new supply additions.” This basically means that instead of a price correction, the real estate sector in India is seeing a time correction. If prices remain stable over the years, they lose value once adjusted for inflation and in the process, they might become affordable.
Keep watching this space.

The article originally appeared on Equitymaster on October 16, 2017.

It’s Time Enforcement Directorate(ED) Investigated “Errant” Real Estate Companies for Money Laundering

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Many real estate companies around the National Capital Region have taken money from homebuyers over the years, and failed to deliver homes. Some of these companies have also defaulted on bank loans.

Take the case of Jaypee Infratech, one such company, which has been in the news lately. The company has collected anywhere from 70 to 100 per cent of the price of the homes that they were selling, from around 27,000 buyers. These buyers have paid anywhere between Rs 40 lakh each to Rs 1 crore each, to the company.

On the other hand, the company has defaulted on a loan of Rs 526 crore.

Or let’s take the case of Amrapali Group. One of the group companies (Amrapali Silicon City Private Ltd.)  has defaulted on a loan amount of Rs 59.38 crore. Over and above this defaulted amount, overdue interest and penal interest adds to another Rs 11.77 crore.

This takes the total amount to a little over Rs 71 crore. On the other hand, a newsreport in The Times of India suggests that there are nearly 45,000 homebuyers to whom the Amrapali group hasn’t delivered the promised homes.

A report in the Business Today suggests that the group “owes over Rs 1,000 crore to about 10 banks”.

When a debtor defaults, the banks can file an application under the Insolvency and Bankruptcy Code, 2016, with the National Company Law Tribunal, to trigger the Corporate Insolvency Resolution Process and appoint an insolvency resolution professional.

Under this, the existing board of the company is suspended. The professional has 180 days to come up with a workable solution for the company to be able to repay the loans it has defaulted on. This can be extended by another 90 days. At the end of 270 days if no solution is in sight, then a liquidator is appointed.

The trouble is that currently the homebuyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated. Some suggestions have been made that the homebuyers can be compensated under Section 53(1)(f) of the Insolvency and Bankruptcy Code. This is after workmen, secured creditors, employees other than workmen, unsecured creditors, amounts owed to the central and the state government, etc., have been compensated and before preference shareholders and equity shareholders, are compensated.

In fact, Section 53(1)(f) lists “any remaining debts and dues,” under it. The question is can the money handed over by the homebuyers to these real estate companies be treated as debt? From the legal point of view this does not make sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. Even with this point, the homebuyers come to low in the hierarchy to hope to be compensated at the end of the liquidation process.

In the case of Jaypee Infratech, where the buyers went to the Supreme Court, in order to stall the insolvency resolution process, the Court has directed the insolvency resolution professional to come up with an interim resolution plan within 45 days. This plan is expected to take into account the interests of homebuyers i.e. those people who paid Jaypee Infratech for homes that were never delivered.

The Supreme Court needs to basically decide whether homebuyers can be categorised as financial creditors or not.

But does not answer the basic question: Where did the money that the homebuyers handed over to the real estate companies, actually go? This is an important question to ask because the bank loans that the developers have defaulted on are really very small, in comparison to the total amount of money they have raised from homebuyers and siphoned off.

Take the case of Jaypee Infratech. The company has defaulted on a Rs 526 crore loan from IDBI Bank. In comparison, various media reports and suffering homebuyers suggest, that the company has taken on more than Rs 20,000 crore from homebuyers. Where did this money go?

Given this, the bank defaults and the non-delivery of homes are two separate issues, and they need to be treated separately.

Of course, Jaypee Infratech is not the only company here. There are many other companies. A newsreport in The Hindustan Times suggests that 13 FIRs were filed against six such companies, Amrapali, Supertech, Alpine Realtech Private Limited, BRUY Limited, Today Home Builders and JNC developers, in early September 2017.

The question is where did the money all these companies and others, raised from homebuyers disappear? Did the promoters pad up the expenses and tunnel this money out to buy land? Or did they simply siphon this money off? Or did they use it to complete other projects? And if that was the case, where did the money that was raised for these other projects go? It clearly seems that money has been laundered by promoters of these companies.

Unless, these questions are answered and the homebuyers’ money recovered from the errant real estate companies, there is no way that this issue can be solved.

Hence, the questions listed above need to be investigated. Given that FIRs have already been filed against many real estate companies which have not delivered on homes, under the required sections of the Indian Penal Code, the Enforcement Directorate can register cases against these companies and carry out detailed investigations under the Prevention of Money Laundering Act (PMLA).

Of course, this would mean investigating many companies, but the modus operandi of laundering money in many cases would be similar. At the same time, this can set the record straight for the future. If housing for all is to be achieved by 2022 (or even 2032 for that matter), the private real estate companies need to play an important role in it. And given that, it is important that the errant real estate companies not be allowed to get-away with the crime that they have committed against the homebuyers.

A precedent needs to be set, so that in the future, things like these do not happen all over again. It is also an excellent opportunity for prime minister Narendra Modi to revive his fight against black money and show some concrete action on this front. The hard-earned money of most homebuyers has been laundered and converted into black money and that needs to be tackled.

The column originally appeared on Equitymaster on September 18, 2017.

How Do You Solve a Super-Mess Like Jaypee Infratech

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The real estate company Jaypee Infratech will go through insolvency proceedings. Earlier, this week, the Supreme Court asked the insolvency resolution professional to take over the management of the company. The insolvency resolution professional has also been asked to submit an interim resolution plan within 45 days. This plan is expected to take into account the interests of homebuyers i.e. those people who paid Jaypee Infratech for homes that were never delivered. In doing this, the Supreme Court modified an earlier order.

Here is an excellent example of messy situation which has probably got messier.
Jaypee Infratech has defaulted on a loan of Rs 526.11 crore from IDBI Bank. At the same time, the company took money from 32,000 prospective homebuyers with a promise of delivering homes. How much money was raised from these homebuyers? The numbers in the media vary from Rs 17,000 crore to Rs 25,000 crore.

This basically means that an average buyer paid Jaypee Infratech anywhere between Rs 53 lakh to Rs 78 lakh. That is clearly a lot of money. The Bankruptcy and Insolvency Code in its current form does not leave anything for the buyers. The homebuyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated.

From the legal point of view this makes sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. But then given that thousands of families are involved, should only the legal view prevail is a question even though tricky, worth asking. The Supreme Court now needs to decide whether the buyers are financial creditors or not.

Of course, the bureaucrats who wrote the bankruptcy code did not take the real estate sector and the way it operates, into account.

Let’s consider the situation with Jaypee Infratech. It has defaulted on a loan worth Rs 526 crore. The company would have offered an asset(s) as a collateral or a security against this loan. This asset can be sold and IDBI Bank can get the money, back. Of course, it may or may not get the entire defaulted loan amount back. This would depend on the current market value of the asset(s) offered as a collateral.

Of course, in the current scheme of things, the homebuyers are nowhere in the picture. The insolvency resolution professional has to come up with a plan that can correct for this scenario. One of the things that could possibly be looked at is to handover the project to another builder who can complete the project. But this builder would need more money for it. Where will this money come from? Will the buyers who have already paid anywhere between Rs 53 lakh to Rs 78 lakh on an average, be in the mood, to handover more money? More than the mood, will they have more money to handover? We aren’t talking exactly about small amounts here.

Further, if there is talk of compensation from selling the collateral, what sort of compensation can the buyers look at? The asset that Jaypee Infratech must have offered as a collateral was for a loan worth Rs 526 crore. How would that be enough to compensate 32,000 homebuyers who had invested anywhere between Rs 17,000 crore to Rs 25,000 crore in total, with Jaypee Infratech.

Another option is sell the half-built apartments (or in whatever shape they are in) to a new builder and then use that money to compensate the buyers. Of course, in this case, the buyers will have to take a haircut (i.e. they will not get their full money back). Also, will other builders be ready to buy in this environment where the real estate sector isn’t exactly going anywhere.

Jaypee Infratech defaulted on the loan it took from IDBI Bank. It also took a lot of money from homebuyers and did not deliver apartments. Where has all this money gone? Has it been siphoned off? Has it been used to build a landbank? Has it been used to complete previous projects? If it has been used to complete previous projects, then where did the money collected for those projects, go? Or has it been diverted to other group companies?

The bankruptcy and insolvency code in its current form does not allow for a forensic audit of companies which have defaulted on bank loans. But that is precisely what is required in case of Jaypee Infratech to figure out where did such a huge amount of money disappear. The amount that has been siphoned off from buyers is so huge that it cannot be repaid using the assets that may have been offered as a collateral against the bank loan which has been defaulted on.

Of course, any forensic audit will take time. But there is hardly any other market based solution that can be arrived at. Further, a situation as messy as this one is, cannot be set right in a short period of time. Also, it will set the tone for other similar cases, which are bound to come up in the days to come.

In the days to come, there will be great pressure on the government to bailout the homebuyers and if not that, at least compensate them to some extent. The government needs to resist this because if it doesn’t, it will send up setting a bad precedent.

The larger point here is that in this case the bank default is hardly an issue. The bigger issue is the fact that such a huge amount of money has been siphoned off from the homebuyers. The learning here is that the cases of bank defaults and homes not being delivered, are two separate cases and need to be considered separately as well. The central government now needs to work actively towards a market based solution.

Meanwhile many homebuyers will continue paying an EMI on the home loans they took to buy their dream homes. They would be paying money towards an asset which they won’t be getting their hands on, anytime soon. They will also have to continue paying a rent for the homes that they currently live in. Of course, this is not a great situation to be in.

But then that’s how big the mess in India’s real estate sector is. And that is not going to change anytime soon.

The column originally appeared on Firstpost on September 13, 2017.