The retreat of liquidity

30-Jul-2015 #Globalwealth Source: India Inc

by Deepak Varghese

The Indian real estate market operates with severely limited liquidity from the banking sector as banks are not permitted to lend for either land acquisition or before all plan sanctions are obtained.

In other words, it is limited to working capital backed by receivables (off-plan sales), which leaves more than half the liquidity to be financed by private lenders, non-banking finance companies and domestic real estate funds (as international funds can only participate in equity).

Until 2013, with investors continuing to buy into real estate as a part of their investment portfolio and many in the National Capital Region (NCR) region buying it even as part of a trading portfolio with a goal of selling before delivery, the developers would show this as sales to raise funds. Sales have been slow to the investor community since late 2013 and 2014 has been a tough year for end users, especially in the ITES sector – who have been typical buyers in Bangalore, Chennai, Pune and parts of NCR. As a result, developers have been struggling to show sales receivables as collateral and the project’s unsold stock to raise funding from private sources. This is creating a dangerous situation as construction is slowing down substantially, similar to the situation that hit Dubai in 2009.

While delays in projects were typically between six and 15 months and consumers have somehow got used to such delays, the current scenario looks to stall smaller developments indefinitely. They could hit a point of debt overhang which they may never be able to recover.

The 2009-2010 period had quite a few small Foreign Direct Investment (FDI) compliant offshore private equity funds that made investments in the $5-$10 million range in the mid-sized developers in the key cities. Given that typical fund life ranges from five to seven years, 2015 is turning out to be a year of exits for most of these investments. Considering that the regulatory environment for plan sanction in the past five years across key cities has given reasons for severe delays in plan sanction, it is a wonder if these funds have made returns of any kind. With the liquidity scenario of developers being fragile already, this could be the tipping point for disputes and projects coming to a standstill.

The above situation means that bankers understand quite well that they have been burdened by rising non-performing assets in general. What was typically a public sector bank problem is now hitting the leading private sector banks too – with one of the banks being the target of a sell recommendation by a large equity brokerage house.

This is getting the banks to be even more cautious towards the real estate sector by tightening lending criteria even further and for cases where sanctions are in place, the banks are finding excuses to delay disbursement of loan tranches.

While it has been a buyers’ market for over a year in this sector, the new caution is that there are very few developers that one can now trust to deliver. Even if the intent exists, like the mutual fund sector, the disclaimer that past performance does not assure future performance has now come into play.

Deepak Sam Varghese, founder-director of Moonbeam Advisory, is a career banker with nearly two decades of experience in retail and private banking. He is a specialist in banking services and wealth advisory and has been advising domestic and non-resident Indians (NRI) in Mumbai, Delhi, Dubai, Singapore and London, where he was based. Now Bangalore-based, his special emphasis is on financial advisory in real estate transactions, advising investors and developers in key Indian metros.

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