Will 2018marktheconsolidation for smaller developers?
LONG TERM Massive consolidation can be a onetime cleanup to ensure the healthier growth of realty
Consolidation is the process of combining anumber of separate parts into asingle, moreeffective orcoherentone. Wheneverthere is consolidation in anysector, the general perception is that everything is going down the drain. However, the reality is that this process usually happens at the fag end of an industry downturn andactuallyhelpsincatalyzinga much stronger come-back.
Therealestate sector is aclear case in point. It is emerging from a prolonged slowdown coupled with landmark policy inputs whichhavebeguntoedgeoutthe ‘small fry’ - essentially creating an environment of large-scale consolidation of tier II and III developers. This dynamic alone will define 2018 as a year of massive positive change for Indian real estate. In 2017, the overall Indian economy and the real estate sector, in particular, were well and truly shaken up by a series of unprecedented reforms andstructural changes. Without a doubt, demonetization, RERA and GST will go down in the annals of Indian real estate history as the ‘trishul’ that struck at theveryheartofunregulatedreal estate players and practices.
Understandably, theyresulted in panic among many of the smaller players. If we take just the case of RERA, it becomesevidentwhythiswasthecase. RERA enforces financial discipline, transparency, accountability, customer centricity and compliance, andthese wereeither completely alien concepts or at least completely avoidable philosophies for the smaller (and often dubious) developersactiveonthe marketthen. WhileDeMonblew the lid off the top of the cauldron of blackmoneyinthesector, only a handful of the players in the Indianrealestateindustrywillbe able to ride the tide in the postRERA/GST Era - for the following reasons:
RISING COSTS AND COMPLEXITY
RERAandGSTnecessitatearadical change in the methods of doingreal estate business. There is amassivefocusoncompliance, documentation, processes, etc. whichwillincrease the costs and complexity of business operations. Inaddition, developers will have to invest significantly in upgrading their billing systems, CRM, etc. aswellastrainingtheir vendors, contractors and other stakeholderstoensure100% compliance to RERAandGSTnorms.
There are, of course, smaller developers who while not necessarily national players are still very strong in their own local markets. However, most of the smaller players are fringe operators whodonothavethefinancial muscle to update their systems and abide by all the new norms. Most of these players will either look at exiting the business altogether or tag along with large, organized developers.
Under the RERA regime, prelauncheshavecometoacomplete halt. Inaddition, developershave to mandatorily park 70% of the funds received from buyers into any particular project in a separate escrow account, to be used only for construction expenses involving that particular project. The eradication of the entire mechanismof‘rolling’ funds has utterly shaken up the hitherto existing status quoonthe Indian real estate market.
Simultaneously, the crackdown on black money has closed all illegal meansofraising funds, even as PE players interested in Indian housing plays are now doing extremely scrupulous due diligence and investing only in ‘clean’ projects. It is a nigh-impossible marketenvironmentfor the under-equipped player to raise fresh funds.
Smallerdevelopers, especially tier II andtier III developers, will face the brunt of these norms, resulting in a liquidity crisis which will necessitate their exit from the business.
BURDEN OF STALLED PROJECTS
In the pre-RERA regime, there was no particular law to ensure that thedeveloperscompleteprojects as per commitments. They had more than sufficient scope for endlessly deferring completion by stating reasons such as approval delays, change in norms, etc. In reality, capital collected from their customers was ‘rolled’ to purchase new land or construct other projects.
As a result of such dubious processes and false promises, many homebuyers were duped and as per estimates, there are around 57,000 units in 170 stalled projects across the top 7 cities of India.
With the exceptionally strict compliancenormsunderRERA, the task of completing their stalled projects is going to be exceptionally dauntingformany tier II andtier III developers who haveverylittleinherentfinancial muscle. Theseprojectswillinevitably be sold on an ‘as-is’ basis to large developers and/or converted into other assets such as plotted developments. In any case, large-scale consolidation of assets is on the cards.
DEBT REPAYMENT PRESSURE
Withsubduedrealestatedemand for the past few years, many developers have leveraged their balance sheets to an extent that has made it impossible for them to manage their debt repayment schedules. Withsomedevelopers already declaring bankruptcy, banks and FIs are also keeping a close watch on the repayments and are completely unwilling to takeanyadventurousrisks. With massive pressure to repay their existing debt, manytierIIandtier III developers are likely to declare bankruptcy in the near future - again, pushing the cause of large-scale consolidation.
Massiveconsolidation, tantamount to a one-time clean-up before the sector embarks on a journey of healthier growth, is verymuchontheagendaoverthe next couple of years.
RERA and GST necessitate a radical change in the methods of doing real estate business