How effective is an escrow account?
While creation of such an account brings in transparency, it does not guarantee that funds will flow in from sales. Projects can still get stuck if there aren’t enough interested buyers
If one were t o go by t he present government’s version of the land acquisition bill, one will find that it allows builders to deposit only 50% of the money collected from prospective buyers in an escrow account as against 70% in the UPA-era bill introduced in the upper House of Parliament in 2013.
This week news reports said that BJP MPs had endorsed that the government abandon 12 of the 15 key amendments to the bill which meant that BJP MPs were virtually asking the government to restore the UPA’s land laws.
No matter which version of the bill is eventually passed, real estate experts are of the view that the practice of setting aside a certain amount in an escrow account before starting a project is not something new and that even if the bill were to impose such a regulation, it may not do much good in the absence of effective implementation.
“While the creation of an escrow account has been proposed in the real estate regulatory bill, this practice has been in existence for a long time.
Most of the private equity players/ foreign investors preferred to have an escrow account for the projects they invested in. An escrow account provides an assurance that the developer, in all probability, would deliver the project on time. Moreover, the PE funds/investors appoint independent agencies to provide assurance on the funds utilisation as well as the progress of t he project,” says Sunil
Mehta, director, infrastructure, industrial and consumer, Ernst and Young (EY).
I f one were t o go by t he present government’s version of the bill, developers have to open a separate bank account ( escrow account) f or each project and will have to set aside 50% of the buyer’s money. This amount can be used only for the construction of that particular project.
“This will go a long way in ensuring transparency in each project and will even lower the risk of lenders, allowing developers to access low- interest debt in the new land acquisitions, since banks do not fund land purchases in India. This is likely to increase the trend of joint development against the current practice of acquiring the land bank by over-leveraging their positions,” says Mehta.
Is the 50% amount much lower than the 70% amount proposed by the UPA in an escrow account? “A 70% cut might have been excessive in the case of cities where the developer has already invested a considerable amount in buying land; if developers have to wait for one to two years to begin the project before getting all the approvals, it would have impacted their cash flow position,” he adds.
What this means is that setting aside 50% to 70% of the amount in an escrow account might not make sense for metros like Mumbai or Delhi where land costs are huge, but might work in cities such as Meerut, Vishakapatnam or Sohna Road. Therefore, this amount should have been made more flexible depending on the location and the land price of the project and the format to be constructed. A luxury project will cost much more than an affordable one.
C r e a t i o n o f a n e s c r ow account creates transparency in the money flow and makes it mandatory for the developer to deposit a certain amount in the account and use it for a specific purpose. While it may ensure that project construction is financed to a certain extent, it cannot make sure that the funds to be realised from sales will also flow in. “The project can still get stuck if there are not enough buyers. The success of the project entirely depends on the finance model and the project feasibility. The escrow account as a concept worldwide is a mechanism to ensure funding is available for a specific project to be completed or a mechanism to ensure funds of a particular project are utilised for that project. However, the mechanism is only effective if the same balances – both the interest of the funding agency and the developer are ensured and there is a set of good diligence procedures that are exercised at the time of setting up the fund and every subsequent disbursal is adequately controlled,” adds Neeraj Bansal, head of real estate and construction, KPMG in India.