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I'm a real estate developer and here's why we can't cut prices

I'm a real estate developer and here's why we can't cut prices

I'm a real estate developer and here's why we can't cut prices
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By Rohit Gera  Jun 24, 2020 12:48:43 PM IST (Updated)

Without realising that the problem is not merely a developer problem but an industry level one, it is extremely easy to vilify and scream at the developer and paint him as the demon.

It is no secret that the real estate industry is in trouble. While there are a number of solutions that are doing the round, the most common one, talks about how developers must slash prices in order to jump-start their sales.

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Without realising that the problem is not merely a developer problem but an industry level one, it is extremely easy to vilify and scream at the developer and paint him as the demon. But we must realise that the problem is not something that can be solved by developers alone. This is a problem that has its roots not only in historical actions by the developers, but also financial institutions, as well as the government .
Before jumping to conclusions and apportioning blame it is important to understand the various aspects of the problem. The first factor to understand is at a logical and motivation level — Since the advent of the Real Estate Regulatory Act (RERA), a large number of developers who delayed delivery of their projects have been at the receiving end of criminal action and many have even had to spend days behind bars. Most businessman do not want to have upset customers, unpaid employees and vendors and banks declaring them willful defaulters. Why would they want to hold on to prices of their apartments if by lowering the prices they could get rid of so many problems? It defies logic. Maybe there is something else going on.
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The government on its part collects stamp duty at the circle rates (ready reckoner rates) and yet expects properties to be sold at below circle rates. This adds to the cost burden on the flat purchaser. In addition to this, if a developer is to sell his property at a discount of more than 10 percent to the circle rate, both the developer and the customer have to pay income tax on the difference between the price at which the customer bought the apartment and 90 percent of the circle rate price. Assume a developer sells at 20 percent below the circle rate. The tax earned by the government is 30 percent of 90 percent of the circle rate. This 10 percent is taxed at 30 percent in the hands of the developer and the customer. Stamp duty on the 20 percent difference at 6 percent is added to the customer burden.
This means a consumer buying a home at 80 percent of the circle rate effectively pays 80 percent plus 7.2 percent towards extra income tax and stamp duty in addition to the normal stamp duty. On paper a 20 percent discount is in fact 13.8 percent. The developer is expected to lower the price but the government still takes its pound of flesh at an artificially inflated value.
While this is a money problem, the bigger issue is selling below the ready reckoner attracts the attention of the income tax department where the assumption is that black money must have been a part of the transaction if the rates are below ready reckoner value. No one wants to attract the department and bring about these problems on themselves.
Talking about circle/ready reckoner rates, it is a well established fact that demonitisation (that happened in November 2016) decimated the real estate market. Yet, ready reckoner rates were increased in Maharashtra in April 2017.
RERA was brought in to protect home buyers and one of the very good provisions required developers to place 70 percent of all customer inflow's in a separate account to be used only for the project. In the case of the rules published by the government of Maharashtra, for projects that were ongoing at the time of introduction of RERA and where the receivables of the ongoing project were less than the cost to complete the project, 100 percent of the amounts realised were to be placed in the separate account. How then is the developer to make payments for other financial commitments in the earlier era when developers were the generally accepted trade practices were completely different?
The financial institutions, the other player in this story, have their own role to play. While the RBI lowered the repo and reverse repo rates, the banks and HFIs transmitted a fraction of this to the home buyers. Why does the government not force the bankers to lower rates?
A new crop of NBFCs who decided to lend to the real estate developers suddenly got caught with severe timing mismatch on their loan book to developers in the wake of the ILFS debacle. Indiscriminate lending at rates that would never be serviced led to the evergreening of loans. This too suddenly got curtailed post ILFS. Many NBFCs pushed up rates further for developers with the hope of getting paid while others stopped disbursement midway through projects despite loan agreements being in place. Why is no share of the blame apportioned to this recklessness?
Every lender is expected to have adequate security as cover for their loans. In this situation, these financial institutions can step in and take over the security provided by the developers. If developers were to lose assets that were in excess of the loans taken, surely they would rather cut rates and sell their apartments at lower prices. It is indeed strange that they don't. Maybe they are not an irrational bunch of entrepreneurs but there is a deeper problem that is stopping them from cutting prices.
Developers are told they should cut prices and consider the losses as a business mistake and move on, that losses are a part of business. However, when banks who are also businesses, make mistakes by lending to projects that in hindsight were mistakes, the blame is on the developer. Why is it such a huge issue to permit banks to take haircuts where necessary? After all, mistakes and losses are a part of business Unfortunately, a bank taking a haircut on a loan is viewed as looting the Indian tax payer. This prevents bankers from proactively engaging in healthy negotiations to share the burden of the mistake and move forward.
Over the past five years, property prices have been flat to negative across most markets in India. Developers have had to bear increased costs on account of inflation. In addition, the government came up with GST which lowered the overall input costs. Threatening manufacturers with anti-profiteering provisions, the government forced them to pass on the benefits to consumers. Thereafter, the government decided to lower the GST for home buyers but decided to not permit the pass through of the input GST costs incurred by the developers to the customers. This increased the cost burden and eroded profits further.
One look at the balance sheets of the listed developers will tell the story. In looking at the distribution of every rupee of inflow that a developer gets from sale of real estate, the largest share goes to the government — the Centre (GST, Income tax), state (Stamp duty) and local government (development charges, premiums and property taxes).
My intent is not to suggest that developers are not contributors to the problem. I only hope to draw attention to the fact that if the government wishes to use the real estate sector to help in kick-starting the economy and generate jobs, it will require an inclusive approach where all stake holders get together and resolve the challenges. Otherwise, we will go through another round of name-calling until our attention shifts to the next challenge, and approach this problem once again in the future when things have got much worse.
The writer is a real estate developer and the managing director of Gera Developments
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