Real Estate Funding Crisis
Reserve Bank of India (RBI) for more than two decades has treated real estate as a sensitive industry and has been tightening the exposure of banking industry by introducing varied risk management policies including enforcing exposure limits per borrower (10%) and disclosures of the same in Annual accounts, adequacy of security cover, stringent capital adequacy and risk weightage norms (ranging from 100% to 150% from time to time), non-financing for land acquisitions etc. RBI has also defined the meaning of Real Estate exposure to include investment in the equity of a real estate company or a Mutual Fund/Venture Capital Fund / Private Equity Fund which in turn invests in the equity of real estate companies. As per RBI report, the lending by Banks to commercial real estate as of September 2016 was 1810 billion INR which marginally increased to 1847 billion as of September 2018. In fact, as of September 2017, it was 1863 billion which got reduced to 1847 billion.
Considering the stringency around Real Estate exposure to be followed by Banks, alternative means of financing the real estate came in the form of lending by Non-Banking Financial Companies (NBFC), Private Equity Funds, IPO etc. However, the IPO route is not feasible for all companies and the cost of capital while raising funds from Private Equity Funds is quite steep, making NBFCs the most preferred option for raising funds. An alternative source of encashing the real estate investments of developers in form of Real Estate Investment Trusts (REITs) have yet to make a significant dent in India due to various reasons.
The challenges of liquidity of real estate developers got further accentuated with the introduction of RERA as developers are no longer able to pre-sell their project which was one significant source of funds without obtaining all the relevant permissions. Added to this is uncertainty on the policies concerning approvals/ timelines by the municipal authorities making the duration of the project life cycle longer resulting in interest outflows, changes in market conditions in the intervening period etc.
The sentiments of buyers/ investors have not remained bullish due to enhanced tax rate under GST (12% against approx. 5% service tax) on under-construction properties, demonetization, increase in stamp duty rate by various state government including by Maharashtra, defaults by real estate players in giving possession as also overall sentiments in the economy certainly slowed the off-take of the real estate. This slowdown impacted the sales of constructed as well as under construction property which in turn has impacted liquidity. Realizing that significant structural changes are being introduced in form of RERA/ GST which will re-define how the industry will operate going forward, it is imperative from the side of Government that such changes are accompanied with suitable monetary policy so that transition becomes smoother and the entire industry does not get into tailspin.
Whilst NBFCs have never been averse to the risk associated with the exposure to real estate sector, the NBFC’s own financial health has been in jeopardy in recent past. The concerns of asset-liability management with respect to maturity mismatches that got fueled in the last quarter has made it even more difficult for NBFCs to lend to the real estate sector. Though every NBFC was supposed to take care of their asset liability position by monitoring the maturity mismatch on a periodic basis, the crisis got accentuated when default in collections resulted in an inability to honor the debt repayments. The illiquid real estate market made it even more challenging for the NBFCs to realize the full value of assets and has thus caused their failure to encash the security in their possession.
Being concerned with increased likely hood of default, RBI is re-examining the guidelines for Asset Liability mismatch to avoid similar situation faced by NBFC going forward. There is already a view by the former Chief Economic advisor that similar for Banks, Asset Quality Review (AQR) should also be carried out for NBFCs. This will further affect the short-term borrowing by NBFC as there is apprehension that quantum of non-performing assets (NPA) due to AQR performed by RBI may increase.
Considering the environment and drying up of liquidity in hands of NBFC, RBI last month permitted to enhance the single borrower limit to 15% instead of 10% in regards to NBFC. However, this measure will be short-term in nature as such facility is only till the end of December& banks will continue to be selective as their eyes will be on how much repayment capability NBFC have in short term. Additional relaxation by RBI to Housing finance companies to securitize their loan portfolio (with 20% to be retained by NBFC) of more than 5 years by reducing the Minimum Holding Period from 1 year to six months is again short-term in nature as such flexibility currently is till April 2019 only. Also, the number of portfolios which can be sold under the relaxed guidelines is also limited as NBFC have already securities good quality available portfolio in recent past and of what can now be sold/securitized, will be challenging due to the stress in the sector. Whilst such measures of RBI are aimed to assist NBFC to raise money but in most likelihood, the funds raised will be directed for repaying the debt rather than lending more to the real estate industry.
The woes of the real estate sector will continue unless there is significant improvement in liquidity through various measures including lowering tax rates and cost of finance, In recent six months though between eight Private Equity players, more than 10,000 crores of funds for real estate has been tied up/ announced, but the question still remains, whether the amount is a just drop in the ocean!
Authored by Sandeep Shah, Partner, N.A Shah Associates LLP