5 years of RERA: Will the Housing Finance Institutions step up for round 2?

How can a financial institution price a loan at the same rate of interest for projects with a different risk profile?

The Real Estate Regulation and Development Act (RERA) was enacted at a time when confidence in the real estate sector was at an all-time low. Hundreds of thousands of home buyers had invested their life’s earnings in projects that were not being built for one reason or another. The diversion of funds from one project to another was more the norm than exception. In some cases, sales of apartments were done even before land was acquired.

The real estate development business, seemingly an easy avenue to make money, saw an influx of opportunitistic fly by night operators who wanted to cash in. These fly by night operators had little interest in giving the customer anything more than the bare minimum promised could not be bothered with construction quality.

The RERA addressed these issues. Not allowing developers to sell or market a project before registering with the authority, which in turn was only possible after approvals to begin construction were obtained from the concerned authority. The monies that were paid by the customers to purchase the flats had to go into a designated account and the funds used for the project.

The RERA took into account the fact that most projects were funded by inflows from sales made to home buyers and it was therefore necessary to ensure the monies got used to construct and develop the project.

The provision of the designated account concept assumed that sales would take place and the customer needed protection from a situation where the developer diverted these sales proceeds. It also took into account what happens if the project does not get delivered on time by providing for interest and penalties to the home buyer in this situation, however it did not envisage a path to address cash flow shortages on account of low sales.

The assumption was probably that it is the developers’ problem to ensure that a shortage of funds is not the cause of project delays. The penalty provided in the Act was adequate to ensure that developers would find the funds.

It is time the housing finance institutions (HFIs) funding mortgages offer differential mortgage rates (even if only through the period of the construction) to those projects which can demonstrate financial closure. RERA eliminated the risk of a lack of approvals for projects. The risk not addressed is a lack of funds.

How can a financial institution price a loan at the same rate of interest for projects with a different risk profile?

Financial institutions can raise the rate of interest for projects under construction where financial closure cannot be demonstrated and offer a reduced interest rates on the loans for projects where financial closure can be demonstrated. With a reasonable spread, we would find home buyers gravitating to these projects which were safer, and the safety was depicted in the interest rate they needed to pay. In turn, it would drive more and more developers to get financial closure so that they could sell their homes in the market.

RERA was brought about by the government to solve the problem in the industry. It is time the participants of the industry – the financial institutions — took the next step and joined hands with the developers and protected the customers. Just in case it got lost somewhere, this would reduce NPAs for the financial institutions and also lead to more developers needing to sign up for construction finance leading to much-needed fee based income.

This aspect of factoring in higher risk for projects without financial closure is something that needs to be done.

(By Rohit Gera, MD, Gera Developments)