Real Estate Act: Bringing transparency in an opaque sector

Published: Fri, 05/27/2016 - 08:24

The Real Estate Act will bring much needed cheer to home buyers across the country

Nikhil Thiyyar Delhi 

In September 2007, Rahul Gupta, a consultant with McKinsey Knowledge Center in Gurgaon, ponied up all of his savings and bought a flat in a leading real estate developer’s highrise tower. Nine years later, circa 2016, he is still waiting for his flat to be delivered. As it turned out, the real estate developer did not obtain the necessary approvals for the project. Not only does Gupta have to pay a steep monthly EMI for the home loan he took, he also has to bear the unnecessary burden of paying rent.

The Real Estate Bill, which has been pending for a long time, was passed by the Rajya Sabha on March 11, 2016. In what is decidedly welcome news for people like Gupta, it has many provisions which purport to safeguard the average property buyer’s interests. The need for the Bill arose because of the current malaise afflicting the real estate sector in India.

There are three basic problems: excess inventory, rising Non Performing Assets (NPAs) and shrinking demand. The most troubling one is the sharp plunge in the demand for residential spaces. As sales remain tepid and cash flows uncertain, a number of real estate firms have fallen into a potential debt trap and are borrowing heavily. This will seriously affect the credit metrics of the entire sector.

As for excess inventory, the real estate market has been among the sectors worst hit by the economic downturn, which, coupled with high interest rates in the face of persistent inflation and delays in securing mandatory government approvals, has kept wary homebuyers away for the last couple of years. Unsold inventory in the National Capital Region (in and around Delhi) in January-March 2016 rose by 12.63 per cent. As many as 235,908 apartments went unsold.

These problems are largely the result of lack of regulation. In the past decade, following high growth, real estate became the hub for profiteers who appropriated land in the name of mindless development, took large loans from banks and did not bother to check if there were any demand-side constraints. These were the same set of conditions which led to the global financial crisis of 2008.

The Real Estate Act, therefore, aims to correct the problem by making the sector and market forces adhere to demand and consumption patterns and deliver on them. This includes provisions such as a) penalty for delays in possession, b) compulsory registration, c) consensus-oriented building and revision of building plans/architecture, and so on. It also aims to protect the home-owner/buyer by ensuring strict penalties for the developer in case of breach of the provisions of the Act. Last, it intends to sanitise competition in the sector by forcing compliance with law through the Real Estate Regulatory Authority (RERA), thereby ensuring that only financially viable developers offering sustainable projects survive in the market.

The Act will bring a long-needed structure to the real estate sector. In this context, the exemption of dividend distribution tax for real estate investment trusts in the 2016 Budget should also be seen as an incentive for the industry to comply and welcome the regulations. 

The Act provides for mandatory registration with the Real Estate Regulatory Authority (RERA) in each state. This will ensure that all property transactions are above board. Moreover, all registered projects must provide the details of promoters, layout plan, land status, schedule of execution and status of various approvals. The RERA in each state will also seek to enforce the contracts between buyers and sellers, acting as a fast-track mechanism to settle disputes. The most important safeguard in the Act is that 50 per cent of the buyer’s investment has to be deposited into an escrow account which must be used only for construction purposes. The Act also prohibits developers from making changes to the building design until two-thirds of the allottees agree. For a largely unregulated and unaccountable real estate sector, the Act is hugely welcome.

However, multiple challenges remain. If they are not tackled, the Act will be another example of legislation that is noble in intent but shoddy in implementation. The Act has a long way to go as far as the sanctioning process is concerned. Builders face more red tape now. Developers have long been lobbying with the government for single-window clearance. The Act does not address this at all. Given that the implementation of the Act is up to the states, a set of centrally mandated laws coupled with state-specific regulation could mean that the bureaucratic nightmare for builders is not going to abate anytime soon.

While the Act aims to penalise developers for delay in possession, it does not mention what happens if the delay is due to failure of government agencies to give timely approvals. More clarity is also needed on the changes that will have to be implemented by projects already under construction. There may be projects which are compliant with existing provisions but not with the new regulations. For instance, what if a builder has used less than 70 per cent of project accruals for the given project and diverted that cash flow elsewhere?

In India, especially in the metros, land cost is a major part of the project as opposed to construction cost. The Act makes it difficult for developers to accommodate variations in the cost of land and cost of construction ratios across different cities. While the RERA does lay out a dispute resolution mechanism, as the experience of consumer courts has shown, it is likely to get clogged with complaints pretty soon. Regulation and regulators can hardly be a substitute for energetic and enterprising market forces. Regulatory overload can lead to a dismal quality of service, as evidenced by the electricity sector. A decade of overregulation has led to stressed corporate balance sheets across the board.

As transparency and disclosure norms begin to get implemented and over time become more stringent, the real estate business will cease to be a high-margin, low-risk business. Moreover, operational margins will reduce considerably due to the clause of maintaining an escrow account, increased compliance requirements and so on.

The regulation will only oversee new properties which are coming into the market. Second-generation or older properties have been left out of its ambit. The financial penalty for any contravention of the provisions is 5 to 10 per cent of the estimated project cost/building cost. Thus, clarity on the definition of the project cost/building cost could help avoid ambiguity at a later stage.

There is also no inclusion of any guidelines regarding the operation and maintenance phase of the project until the handover to the Residents Welfare Association (RWA). The cost and services components of this phase of the project are included in customer agreements, and the level/extent of the service provided has often been a key area of concern for customers and developers alike. There is still a need for a clear definition of the term ‘structural defects’ to avoid any ambiguity or misinterpretation in the future. Though the Act is a welcome move, it falls short of holistically regulating the real estate sector and addressing some of the fundamental issues associated with it.

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The Real Estate Act will bring much needed cheer to home buyers across the country
Nikhil Thiyyar Delhi 

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