Challenges faced in Real Estate Finance

Real Estate in India accounts for nearly half of Indias capital formation and
generates approximately 30% jobs. India has emerged as one of the few
world economies with a healthy economic outlook, amidst the mood of
cynicism and uncertainties supported by improving macroeconomic
fundamentals like declining fiscal deficit, reducing inflation and narrowing of
current account deficit.
Nevertheless, the real estate sector is gripping on downturn owing to slow
purchases from homebuyers, low absorption across all asset classes and
increasing inventory.
Traditionally, the real estate sector was financed primarily through private
lending by HNIs, bank financing and cash-flows through project sales.Post
2005, diverse channels of real estate financing emerged with the opening of
foreign direct investments in the real estate sector. Driven by high returns on
investments, the sector witnessed capital deployment from private equity
funds as well as strategic investors and foreign developers. Large capital
flows in the form of equity was made available within the market at both
entity and project levels. In addition, key corporate developers accessed
capital markets for funds through stock market listings, in both Indian and
overseas stock exchanges. This led to reduced over-dependence on bank
debt as a means of financing real estate projects in favor of equity and
mezzanine capital structures.
However, by mid 2008, the global economic slowdown had its ripple effect on
financing within the real estate sector as well. Slowdown in sales on account
of muted demand diminished financing from internal accruals and
substantially increased the dependence of developers on external capital for
funding new projects and repaying existing liabilities. Several banks grew
vigilant with respect to extending loans for early stage real estate projects
which led developers to resort to high cost mezzanine debt and equity from
NBFCs and private equity funds for funding project acquisitions. The NBFC
and private equity funding channels have continued to gain importance ever
since with bank credit to commercial real estate and housing sectors
declining from 10 per cent in FY 2010 to 8.1 per cent in FY 2015.
We are seeing a real estate pullback, with prices correcting in most tier-1 and
tier-2 cities alongside sharp drops in transaction and new launch volumes.
The drivers of this slowdown is a mix of supply-side and demand-side factors.
At the supply-side, there has been a lending squeeze by the central
bank. The Reserve Bank of India (RBI) has set threshold for maximum
exposure to real estate, including individual housing loans and lending to

developers for construction finance, for banks at 15 percent, which is quite

low and is curtailing the growth of this sector. Absence of long term funding
from banks is forcing the developers to fund their development projects at
higher interest rates from other sources. This has led to inadequacy in
Working Capital for their ongoing projects. Moreover, there has been a
squeeze on subsidies by the NDA government. Earlier under the UPA
regime, the subsidies grew at a CAGR of 19% p.a from FY04-14. A substantial
portion of these subsidies were used to fund invest in gold and real estate.
Due to the unstable nature of the real estate sector, Investors have lost
confidence in investing Infra bonds making them highly risky asset class.
This is primarily due to weak cash flows, flat sales and stagnant prices faced
by the biggest Infrastructure company. In lieu of this, Government has
recommended REITs which are investment trusts which invest in income
generating real estate assets commercial, residential thereby generating
good returns. Introduction of the Black Money Bill, has also ceased the
investment funding of major infrastructure development projects. Earlier, a
large portion of black money was channelized into Real Estate but after the
Benami Transactions Bill and Black Money Bill passed by the Parliament in
May 2015 it has curbed the accumulation of Black Money further. In addition
to this, FDI is not permitted in an entity which is engaged or proposes to
engage in real estate business, construction of farm houses and trading in
transferable development rights.
To conclude, With the new Government already on wheels, reducing
regulatory hurdles and relaxed policy norms will improve investors
sentiments making housing affordable. Easy funding options and low lending
rate will boost the Real Estate once again.