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A Real estate research company name Liases Foras, had published a report on the total disposable income which real estate developers were expected to make in that year. A careful analysis of the report, stated that if the developers did not increase their margin, they would find it difficult to repay their interest obligation. If the report was true, the developers were more likely to default unless there was a large scale intervention.
Tracing the origin:
GDP growth was very high during 2004-2008 and thus to take advantage of the growth opportunities several new projects were launched using much of borrowed capital. These were projects in sectors like steel, power and real estate. These set off the biggest investment boom before the advent of the Global Financial Crisis in 2008. The most affected were the companies which had borrowed huge amounts to fund expensive projects. Real Estate developers, thinking that the boom would continue perpetually, borrowed excessively and stocked unproductive inventory.
Interest costs increased in the economy, due to two factors :
- In domestic Borrowing due to RBI intervention
- Borrowing from aboard due to rupee depreciation
Where is the Stress?
When interest rates increased, the real estate sector should have seen a downturn which did not happen as the property prices were raised even more which isn’t a good sign since the appraisal in property prices was credit driven. This also increased the value of their inventory which created room for more debt.
As residential property prices went up, rental yields declined from 8% to 2%. With a home loan interest of 10%, a lot of money would be lost if housing prices don’t appreciated disproportionately.
Sweep it under the rug:
Eventually, some developers began to show stress and the best measure would have been to force them to pay. However, if they were not able to pay, bankruptcy should be filed which would mean showing NPAs in bank’s balance sheet which isn’t acceptable in the banking circle. Thus, the banks started evergreening loans and started giving loans to fund interest obligations on previous loans. Eventually RBI intervened and the first casualties were reported from the infra and the power sector. By 2015, Ambit capital explained why real estate sector was to face a slowdown. This was because the lending had dried up and unsold inventory had to be sold at throwaway prices. This was believed to bring the price correction which was long overdue.
However, this did not happen. As banks did not lend, NBFCs and private equity stepped in to fill the void. There were a few bankruptcies but there was no pressure on housing prices. However, these doesn’t mean that there was nothing wrong with the sector. When the real estate act, 2016 was passed, it restricted the developer’s ability to raise cash from prospective buyers and penalized them for late delivery of homes. This put pressure on land prices as the demand was almost non-existent from the real estate sector. This was followed by demonetization and then GST and the real estate sector was in a state of helplessness.
NBFCs were funding those projects which had not even started and thus were risky contrary to public sector banks which were funding projects that were in the later stages of their devlopment. Due to the stress in the real estate sector, NPAs were pretty obvious to show up. However, they resorted to ever greening of loans to save themselves from NPAs. One way by which, optimists think, prices can be corrected is through affordable housing.
The problem is that the institutions engaged are NBFCs which are not backed by the government and thus, hiding these NPAs can prove to be disastrous. At the same time, most NBFCs are engaged in short term borrowings to fund long term debt which is a situation of asset liability mismatch.
The ILFS crisis has made it difficult for NBFCs to raise loans. Thus, the real estate developers will have nowhere to go but to sell their inventory at lower prices. The recourse might be affordable housing but the expensive stock accumulated during the boom needs to be revalued and there would be NPAs and price declines coming in the near future.