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Commentary

The Potential Impact of the Real Estate Regulatory Bill: Bad in the Short Term, Good in the Long Term

The Real Estate Regulatory Bill will hopefully be passed by parliament soon, with or without amendments. Here’s the salient points and how it affects the industry:

Registration Mandatory for Builders and Real Estate Agents

  • All real estate project must register with the government, unless they are less than 9000 sq. ft.  or have less than 12 apartments.
  • Current projects that have all regulatory approvals needn’t register
  • Such registration requires approved layout plans, commencement certificates and so on
  • Projects can only be sold after such registration.

Impact: This hurts developers. Let’s face it, none of the current lot has any concept of actual documentation before the project is sold, and “pre-launches” are common, where the developer has, for the most part, decided to build on a random plot of land and probably not even purchased it.

Real estate agents too shall register. This will be fun, because the current requirement to become a real estate agent is: a pulse.

The bill also extends its authority to commercial real estate, so it’s not just about residential property.

Only Carpet Area

Real estate can only be sold by the actual carpet area – so builders have to offer a cost per square foot of carpet area. Currently real estate is sold on pretty much anything. They call it super-built-up area. Which makes sense, because if you want to know how they got to that figure, it requires super powers.

The concept is that people have to not just pay for the cost of what they live in, but the proportionate cost of everything else, like the lifts, the corridors, the common areas, the parks etc. The super-built-up area includes all this and then some figments of the builder’s imagination etc.

This is no longer allowed. You can only buy at a price per square foot of carpet area.

Impact: How can a current project of Rs. 7000 per sq. ft. of super built up area be sold in carpet area? If a 1,500 sq. ft. flat has just 1,000 sq. ft. of carpet area, or lesser. That would put the price at Rs. 10,500 per sq. ft. which obviously will not fly.

At best, the builder will try and adjust the price with other line items like club houses, park charges, lift charges and so on. This may not fly with the regulator. If not, the impact is to the builders, who lose a lot of their margins.

Secondly to existing projects in the area, resale values will change accordingly. The per sq. ft. rate in carpet area will not have applied to a flat already built, and anyone else who is buying will take carpet areas into consideration (not super built-up areas).

The carpet area of a Sobha Project I checked (Halcyon, Bangalore) has floor plans online, where the plan actually shows, for “A1” – a carpet area of about 1,300 sq. ft. But what they bill you is, in their project details page, on 1536 to 1574 sq. ft. That means only 82-84% of what you pay for do you actually get to live in. If this was an existing flat, then it’s sale after the real estate bill could involve selling at 1,300 sq. ft. carpet area, and then, prices will depend on what the market is paying – in effect, secondary prices could fall.

Put 50% of Money Received in Escrow

It is common to see builders take money received from customers (or banks) for one project and actually use it in another. So a developer starts digging in one project, and customers rush to buy; instead of using the money to construct further, he uses the money to fund a new project’s digging, so that he can collect more and so on. The end result is that he has no money to finish the ones he’s already started and then he starts biding his time – which is why projects that should take two years end up taking seven or more.

The Real Estate Bill requires that 50% of all money received be transferred to an escrow account, which is only used to fund construction of that very project. It was 70% in the original bill, and has now been cut to 50%.

Impact: This can be bad but it depends on enforcement. Even if there is an escrow account, how does anyone know if it is being used for construction alone? If you are paying a digging company, is the real estate regulator going to verify that the digging on a per-invoice basis was done exactly for this project? Or if money was used to buy wash basins, the very wash basins that were bought were installed in this project? It’s a little confusing here, and in all likelihood this is going to be a measure where some inspector extracts “hafta” or bribes in order to certify that things were done correctly, and then, everything will go back to the same old thing.

Changes in Projects Needs 2/3rd approval

Any changes in the structural plans or amenities, will need to be approved by 2/3rd of all customers of that project.

Impact: Great for users. Builders are often known to hand over projects with a different area than otherwise applicable, or with a wall that’s no longer there, or such. And they randomly decide to charge for X sqft more than they originally provided, and you have no way to check. For real estate companies this will again suck, because they want to do these things and fleece customers, or because they underestimated costs. Either ways, this clause will be tested by the regulatory system.

The Regulator and Appellate Authority

The government will set up a Real Estate Regulator who can decide cases, pass penalties, approve project registrations and provide online access to consumers, real estate agents and builders.

The regulator will be the place to go when you don’t get your project delivered, when it’s not like it was supposed to be when it was sold to you, or if there are irregularities with approvals or handover of documents.

There will also be a place to appeal any such rulings; an appellate authority. This allows you to get a second set of people rule on a decision taken by the regulator, and typically builders will use this mechanism to delay having pay big penalties (since the appeal process will take time).

The entire edifice of the bill is about how strong and independent these two are. If either one favours the builders, then we will find that the bill is a farce. It is critical to get non-aligned and high-integrity people to head both the regulator and the appellate authority.

Penalties

Failure to discharge obligations by builders will involve fines for them upto 5% of the project cost. Didn’t register the project? A fine of Rs. 10,000 per day, extending up to 5% of the project cost.

There will be further fines specified for different levels of infractions. 

What Isn’t There

There are no title guarantees. Which means if the title of a land is disputed and you have bought into the project, you’re going to get hit. The real estate regulator is unlikely to be able to help much, since title is a civil court issue.

There is also no clear understanding of what happens if builders abandon projects, citing lack of cash. At that point, the real estate regulator should clean them out completely, but we need to see this happen and pass through various other courts before knowing that we have someone really looking after us as consumers.

Also, note that the final bill may have substantially altered text and much of the above may not apply!

Our View

While this is a good bill, much about the effectiveness of it will be in enforcement. What happens when builders default? Will the authority ensure that their other assets are seized so that homeowners can recover something? Will banks have a higher lien on
such recovery than homeowners?

The impact of a real estate regulator will be initially to crimp margins and eventually to destroy the business model of the current “fat” incumbents, but benefit the new lean ones that do very well for consumers. This is a changing zone and a good regulator is required to help the industry. However, looking at the current state of affairs and the oversupply in all big cities, it’s quite likely the biggest challenge now is to get builders to not abandon their projects, which they are likely to do if there is a crash in prices.

And a crash in prices is good, and a healthy challenge for a new regulator. Let’s see how this progresses.

Meanwhile the real estate market continues to suck, and project sales are dropping. We’ll know for sure when results come in, which is the rest of April and May.

So in the short term, the real estate players will hurt, and a regulator who comes in will hurt them more. In the long term, this is a great sign and will probably change the nature of the game.

  • VILAS says:

    Please comment on the component of money paid in cash.Any steps envisaged in the bill that will bring about a change ?

  • Shiv Kumar says:

    No change in the old rule: caveat emptor. Buying into an unfinished housing project will remain as risky as ever.

  • Mehul says:

    Hey Deepak,
    I think the linked Bill document is an older version. It mentions deposit of 70% of amount received in an escrow as against to now amended 50%.
    I checked on the ministry website but seems the version of Bill cleared by the Cabinet is not online. Will be helpful if someone can post a link to it, if available.

  • Gupta says:

    Sobha generally does not give more then 72% of carpet area. It is true atleast for Bellandur projects. Prestige only gives 68%. Among big builders best ratio you would get is around 78-81%.
    I have heard about different intermediaries who pool different investor’s money and invest in project by getting apartment units allocated to them, that business will thrive even more.

  • Vineet says:

    So prices per sft go up because they will now be marked against carpet area ? That will bring about a marked difference between A grade projects (lots of open space) vs B grade ones. I guess the market will become even more distorted with this, B grade projects already have no takers.

  • Anand George says:

    Any impact on banks? They are equally responsible for the mess.. properties are marketed as ‘Approved by XYZ Bank’.. and you can’t hold them responsible in any way if the project stalls, rights not transferred or whatever. You still end up paying back the loan. God alone knows what exactly do they mean by approving a project

  • The Real Estate Bill does not replace anything, it just adds one more (or two, if you count the Appellate Authority as well) layer to the existing layers of “authorities” exercising influence or passing judgments over some aspect of the business. The real estate industry is so large that the regulator will find it impossible to regulate them without building an empire of thousands of inspectors. When this happens, the only result is corruption. There is no way common man will get justice in such a system. Why do we need a regulator to tell that funds should not be diverted to other projects or project plans should not be changed unilaterally? It would have been far better to significantly strengthen consumer courts and ensure that every scoundrel is sent to jail quickly.
    The Real Estate Bill has no provision to bring down the cost of housing. If anything, the bill will end up restricting supply and prevent a correction in prices.

  • Chetan says:

    Dear Deepak,
    Is it then advisable for someone wanting to buy an apartment to wait till this bill is passed as builders need to only charge on carpet area.
    Will the prices not adjust/go up for people holding apartments and who want to resell?
    Regards,
    Chetan

  • Gupta says:

    Should I continue to pay my property tax based on SBA or switch to carpet area, I can save 25% there!

  • kumar says:

    look, there is still only one side that is somewhat clear.
    no war plan has survived the first contact.
    once the government comes out with the bill, the builders will start applying their ingenuity, and i would guess about 90% of the bill will be ineffective by the time they are done with it.
    the regulatory bodies are where most of the magic will play out, and this bill dreams of setting up two of them.
    i find deepak’s view of short term and long term to be overly optimistic, no matter the term, consumer will always end up being the loser.

  • kumar says:

    does the bill contain any punishment for government entities, if they are found to be in the wrong?

  • mint desai says:

    Lot of people think that just because it is going to be cheaper because it is carpet area. I think they are very much mistaken,
    Builder needs to make money. He needs to build common area parking etc. So total price will not change. Just rate will go up.
    In fact lots of places rent has moved to carpet area since years.
    I agree that carpet area is better for the user. however I am not sure how will a more spacious corridors and staircase etc will be sustained if only carpet are is considered.