The FDI allowance in the real estate sector was accountable for the boom in the investment and development, which assisted the sector attain new heights in 2007 as well as in early 2008. The trend, however, reversed in the mid of 2008 when the global slowdown resulted in the decrease of inflow of foreign funds. Internal accruals, customer advances, and debt are the prominent sources of funds, of which the self-finance remains quite limited owing to the sluggish demand and customer advances too are rarely available during the initial stages of the project.
This in turn has enhanced the dependability of the developers on the debt from banks as the principal source for funding the project. However, the total exposure of banks calculated as a percentage increase in lending towards real sector projects has declined in recent days.
The Indian real estate sector has always been attractive owing to sturdy economic fundamentals and demographic factors. Plus, in the coming years the sector is expected to fetch higher returns, which will appeal global players to become a part of the projects. Much is being looked for from the new government at the Center that will probably comprehend the demands of this sector.
Vital to note, RBI has expressed concerns over the exposure of banks to this sector saying that the NPA level may increase beyond expectation. The gross NPA of the financial sector is likely to rise 4.6 percent amounting to INR 2.29 lakh crore by September 2014. The RBI reports that the total exposure of banking sector to real estate witnessed a rise of 17.3 percent in 2012-13 amounting to INR 9.33 lakh crore.
Experts from the real estate segment consider that speculators and investors who deploy money during initial phases and subsequently sell the property post completion are responsible for the surge in NPAs. Genuine end-users are less likely to default the loan repayment commitments. Also, the growing NPAs in the corporate sector will result in increased auction of properties. Owing to the slowdown in the real estate sector, sale of mortgage properties would not benefit the lenders. Banks, on the contrary, are more worried about defaults by developers rather than by individuals.
Other prominent measures for the sector include curbing the illicit commitments by developers to the investors by enforcing strict penalties, mandatory guideline to sell the property basis the carpet area, and limiting instances wherein developers during the initial stage project a certain percentage of built-up area, however, enhance the number of dwellings subsequently with the permission of the concerned development authority.
Real Estate Investment Trusts (REIT) have been a prominent investor in the real estate projects globally. They deploy funds in completed revenue generating commercial properties and the earnings are disseminated among the investors. India awaits such a module. REITs have emerged as a convenient investment option for retail investors and even for long-term capital pooling funds like pension funds and insurers, which prefer regular income stream.
Added advantages of the REIT regime include enhanced transparency owing to better corporate governance, disclosures and reporting. Compliance with the standards laid down by the regulator enhances availability of desired information in the public domain. Professionalism with emphasis on risks attached to title and transaction costs is the outcome.
Plus, financing through equity participation would improve the debt-equity balance, beyond providing a vehicle for addressing the issues of NPAs. NPAs sold to REIT will facilitate the realization of the true value with ease of liquidating once the high value of real estate is removed from the books. This is an appropriate time for the implementation of REIT module so as to provide the sector with advanced funding options and help investors to participate in the gains.
The investment would be less risky owing to the fact that funds will not be deployed to under-construction projects and income in form of rentals will be a good hedge against inflation as the underlying asset would adjust itself to the cost of living. Plus, diversification of portfolio of the investors and stability of income source will be the added advantages. Sooner than later, SEBI and government officials will have to consider this route for the overall restructuring and revival of the real estate sector.