What Plagues the Realty Sector: Issues and Concerns-I

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Different Truth serialises the issues and concerns of the realty sector in India in two parts. Here, in the first part of the series, we examine three major points on GPPP, Reverse Auctions and Land Pooling. Here’s an in-depth report by Anirban.

The real estate sector in India is one of the fastest growing sectors in the world, attributed to population base, rising income level, and rapid urbanisation. This sector comprises of four sub-sectors mainly housing, retail, hospitality and commercial. While the real estate market contributes to five to six per cent of the gross domestic product (GDP), the other sub-sectors are growing tremendously for the increased infrastructural needs. An adequate infrastructure is a required for sustaining the long-term growth of the economy.

nriThe infrastructure industry is the second largest employer after the agriculture sector. It is expected to grow at more than 30 per cent over the next coming decade, fueled by the growth of corporate environment, the demand for office space, as well as urban and semi-urban accommodations. Non Resident Indian (NRI) investments, Private Equity (PE) investments, and the policies of the government of India have supported such a good growth.

However, easier said than done the realty sector needs a reality check as well. Some conditions are conducive for growth, while some conditions need to be arrested.

Problems in the realty sector

The realty sector is plagued by the following:

  •  Land Delays: There has been a substantial gap in procuring the land after the land islet free. The delay in acquiring the land has created legislative issues for all the parties, and it has contributed to the rising cost.
  •  Lack of Proper Legislation: The lack of the specific laws have left little option on the entire gamut, starting from land acquisition to closing the deal.
  •  Lack of Specific Guidance from the GoI: The void on certain clauses on property litigation and closure of the deal has created to the stalling of some projects as well.
  •  Rising Interest Rates: The change of inter-bank interest rates have subdued the realty sector for a long time, as the buyer interest are actually linked to the bank’s interest rates, rather than the buyer’s affordability.
  •  Micro View of the Housing Schemes: When there is a pocket of infrastructure spending, on a specific geographical location, the micro view on speeding projects was taken into account.
  •  High Taxes: Around 30 per cent of the mark-up price of the realty sector, especially in Mumbai, goes towards the payment of taxes and to other third parties, which are not directly involved in the closure of deals.
  •  Mark-up Problems: The mark-up of houses and flats are around 20-30 per cent of the price, which is another issue of affordability for the buyers.
  •  Nexus in the System: With the entry of black money, all completed or to-be- completed projects have a nexus with the local authorities, which escalate the amount for the closure of the deal.

Proposed Solutions

Some of the proposed solutions to the realty sector are discussed below.

  •  GPPP or Government, Public and Private Partnership
  •  Reverse Auction or Forward Contracts, along with the GPPP
  •  Land Pooling
  •  Proper Legislation and Land Laws
  •  Proper financing

Let’s elaborate these.

Government, Public and Private Partnership (GPPP)

PPP or Public Private Partnership is different from GPPP or Government, Public and Private Partnership. A public-private partnership is a government service or private business venture that is funded and operated through a partnership of the government and one or more private sector companies. GPPP involves the GoI, private players and NGOs/locality in infrastructure funding and raising. The NGOs work in infrastructure funding is detailed below.

An NGO based on the disaster management can own the cleanliness, maintenance and initial funding for any infrastructure projects. Let us assume that we have to build an office space in Kolkata. Alternative investments can flow through the NGO, which, in turn, can get lower priced housing or flats in lieu of the maintenance and access to infrastructure for cleanliness.  The locality can access the infrastructure by crowd-funding a part as well. This allows the reduction of mark-ups and a stake on the access of the infrastructure benefits as well. However, a GPPP is actually administered and maintained by the GoI.

Community based organsiations and co-operatives may acquire, sub-divide and develop land-holdings, construct housing, provide infrastructure, operate and maintain infrastructure, such as wells, public toilets, and solid waste collection services. They may also to some extent develop building material supply centres and other community-based economic enterprises. Such provisions may be provided by high-level NGOs.

GPPP involves a contract between an NGO, a public sector authority and a private party, in which the private party provides a public service or project and assumes substantial financial, technical and operational risk in the project. In some types of GPPP, the cost of using the service is carried by the users of the service and not by the taxpayer. Government contributions to a PPP may also be in kind. In projects that are aimed at creating public goods like in the infrastructure sector, the government may provide a capital subsidy in the form of a one-time grant, so as to make it more attractive to the private investors. In other cases, the government may support the project by providing revenue subsidies, including tax breaks or by removing guaranteed annual revenues for a fixed time period. NGOs may work in collaboration with the government involving the work that is not applicable to the government. This also provides a unique way of funding through alternative channels via the NGOS, for those who may enlist their tax-breaks.

There are usually two fundamental drivers for GPPPs. Firstly, GPPPs are claimed to enable the public sector to harness the expertise and efficiencies that the private sector can bring to the delivery of certain facilities and services traditionally procured and delivered by the public sector and the NGOs. Secondly, a GPPP is structured so that the public sector body seeking to make a capital investment does not incur any borrowing. Rather, the GPPP borrowing is incurred by the private sector vehicle implementing the project. On GPPP projects, where the cost of using the service is intended to be borne exclusively by the end user, the GPPP is, from the public sector’s perspective, an ‘off-balance sheet’ method of financing the delivery of new or refurbished public sector assets.

On GPPP projects, where the public sector intends to compensate the private sector through availability payments, once the facility is established or renewed, the financing is, from the public sector’s perspective, ‘on-balance sheet’. However, the public sector shall regularly benefit from significantly the deferred cash flows.

So, with GPPP, we may:

  •  Enhance situational awareness
  •  Improve decision making
  •  Access more resources
  •  Improve co-ordination
  •  Enhance effectiveness of emergency management efforts
  •  Maintain relationship among the partners
  •  Create more resilient communities

Reverse Auction and Forward Contracts in Infrastructure

A reverse auction is a type of auction in which the roles of buyer and seller are reversed. In an ordinary auction (forward auction), buyers compete to obtain a good or service by offering increasingly higher prices. In a reverse auction, the sellers compete to obtain business from the buyer and prices will typically decrease, as the sellers undercut each other. A reverse auction is similar to a unique bid auction, as the basic principle remains the same. However, a unique bid auction follows the traditional auction format more closely as each bid is kept confidential and one clear winner is defined after the auction finishes.

In the GPPP mode, reverse auction plays an important role in the allocation of infrastructure related spending, especially on maintenance and operations. The work allotted to the NGOs and other public entities actually face a reverse auction, in which the sellers of the services from the NGOs make the bid for certain services towards infrastructure.

A forward contract or simply a forward is a non-standardised contract between two parties to buy or to sell an asset at a specified future time at a price agreed upon today, making it a type of derivative instrument. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price agreed upon is called the delivery price, which is equal to the forward price at the time the contract is entered into. The price of the underlying instrument, in whatever form, is paid before control of the instrument changes. This is one of the many forms of buy/sell orders where the time and date of trade is not the same as the value date where the securities themselves are exchanged. The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands on the spot date. The difference between the spot and the forward price is the forward premium or forward discount, generally considered in the form of a profit, or loss, by the purchasing party.

Hence, when we are in the GPPP mode, we allow the forward contracts in closing deals from the side of the project buyers. The sellers here are the project owners or building owners, which sell the forward contracts to the buyers or customers. A discount price or added price is attached on the price paid to the buyer at the end of the deal. Essentially, it means that accrual of amount from the buyers to return bank loans can be stopped as incremental amount taken from the buyers actually delays the project and raises the pricing of the infrastructure projects.

Land Pooling

What is land pooling? Land pooling is an option where the infrastructure developers develop their own land. Let us take the case of New Delhi NCR, & how land pooling helps in the infrastructure development.

About 25,000 acres of land will be unlocked for development in the New Delhi NCR.

Tracking the city development for a planned growth is a win-win situation for all, especially while taking the rewards of the land’s business values. In this highly competitive and price-conscious real estate market, land-owners may not have the advantage to take the potential of these expensive resources. But, there are some good options.

The first option available to the land-owners is to develop the land themselves. While financial benefits may solely be enjoyed by the land-owner, in this case, they may lack theskill sets and knowledge required to deliver a product in line with the highly evolved needs of the market.

To balance this, the land-owners, as a second option, may enter into a joint-venture with an experienced developer to professionally actualise the plan. However, the joint venture format may severely limit the land-owner’s share of profitability, which would be contradictory to the intention of the policy, which is to pass the maximum gain to the land-owners.

Land-owners may explore a third option, termed Real Estate Asset Management (REAM), which mixes the benefits of a joint-venture and at the same time, de-risks the investment as the ownership of the asset rests completely with the land-owner. The Asset Manager, backed by an experienced and professionally run setup, takes complete responsibility of the asset, just as an investment banker would manage an individual’s or organisation’s investment. End-to-end real estate development solutions, which include project conceptualisation and feasibility, statutory clearances, project management and development, marketing, legal assistance and post-sales management/ facility management etc. are provided by asset managers in such cases. A revenue/profit sharing agreement incentivises the asset manager to go the extra mile to focus on deriving maximum long-term value from the asset.

While the asset management approach to real estate development may be the most attractive, the credibility of the asset manager is the key to the profitability and deliverability of the project. Often, the asset manager will lend his product/corporate brand name to the project, either residential or commercial, to capitalise on the brand equity created from existing developments. This association may also help provide the project the traction necessary to generate the seed capital, crucial to the success of the venture.

With the implementation of the land pooling policy, real estate in New Delhi can be on a trajectory that will have a lasting impact on the city’s growth. In marked contrast to the development-by-acquisition model followed earlier, this growth would be participatory and inclusive in nature and provide equitable socio-economic advancement of Delhi NCR and its inhabitants. With the execution of the land pooling policy set to begin shortly, it is important that the land-owners appreciate the various means available to them to fully extract their resource’s potential.

Here, in the first part of the series, three major points on GPPP, Reverse Auctions and Land Pooling have been discussed. The two other issues would be dealt with in the second and concluding part. Please watch this space, next week.

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Anirban Kar is a technology and business consultant, who has earned his education degree in two continents, the USA and from India. His work started from 2003 in TCS, and comprised
of various clients ranging across geographies. His area of interest is business modeling,
enterprise architecture and investment analysis.