Beginning of Real Estate Crisis in Mumbai

Real Estate Developers under Financial Stress

Real estate developers are at risk of going belly-up as mounting stress in the nation’s credit market dries up funding even for those willing to pay high rates. With the worsening shadow-banking crisis, borrowing rates for most developers have surged to very high levels, in some cases about 20 %. Even at that cost, capital availability is limited. India’s year-old credit woes that began after a shock default by the IL&FS Group continue to linger, with many mortgage lenders struggling to roll over to many developers who were referred to bankruptcy forum. A recent review of real estate developers in the Mumbai Metropolitan Region (MMR), Thane, and Raigad has revealed a dire need for funds. Many developers are ready to sell their inventories at base prices to raise capital. Some have signed development agreements but lack the money to secure necessary permissions, while others have partial construction certificates but are hesitant to start work due to weak sales.

RBI's New Finance Norms adversely Impacts Real Estate Project financing

The Reserve Bank of India's (RBI) proposed guidelines on project financing could significantly impact developers, particularly in the real estate sectors. The draft norms suggest that banks should set aside provisions of up to 5% of the loan amount during the under-construction phase, with adjustments as projects progress. This change could delay loan sanctioning and increase borrowing rates for developers by 100 to 150 basis points. Previously, standard asset provisioning was 0.4%, but the proposed increase to 5% would require banks to charge higher rates to cover these provisions.

Developers with strong credit ratings may face fewer challenges compared to smaller developers, especially those in Tier II and III cities. Top developers currently enjoy construction finance rates below 9%, but these rates could rise if the new norms are implemented, particularly given the current tight liquidity conditions. Developers are likely to pass on any increased costs to buyers, potentially impacting property prices. However, the strong residential sales market, where demand remains robust despite potential rate hikes, may mitigate the impact on developers.

Real Estate Market Dynamics

Those who experienced Mumbai's real estate market from 2009 to 2014 can relate to the current scenario. After the 2008 stock market crash, real estate prices soared from 2009 to 2014, but the market went dry from 2015 to September 2020 due to oversupply and reduced demand from end-users. The market regained momentum in November 2020 due to reduced stamp duty in Maharashtra, the stock market crisis in May 2020, and the need for home upgrades during the COVID-19 lockdown.

In 2024, the real estate market is at an all-time high. Developers have introduced subvention schemes to attract end-users, but actual demand from retail customers is low, as indicated by low turnout at site visits and challenging sales conversions. The market is flooded with unorganized developers struggling for sales, while a few corporate developers report rapid sellouts.

Multiple factors are at play, including excessive competition and inflated prices. As a result, individual builders are selling fewer units per project, relying heavily on customer advances to fund 40-50% of project costs.

Mumbai Home Prices May Fall as Supply Rises

Selling under-construction projects in a trust-deficit market like Mumbai is always challenging, compounded by excessive competition and inflated prices. The real estate boom ended in early 2023, and sales have stabilized at around 10,000 registrations per month, with about 25% being redevelopment units. High expectations for the festive season of October-December 2023 were unmet, primarily due to pent-up demand being absorbed from August 2020 to December 2022, followed by a surge in new launches.

Increased supply from Redevelopment Projects

Mumbai, a city constrained by limited land availability, has seen realtors increasingly turn to redevelopment as the primary means of developing new projects. With its rising population and rapid urbanization, the city faces a significant shortage of land for greenfield development.

In 2021, redevelopment received a substantial boost when the Maharashtra government announced a waiver of 50% on various premiums paid by developers to the authorities, provided they paid the remaining 50% upfront. This incentive spurred a significant increase in redevelopment projects. As these newly redeveloped housing units are now being delivered, the supply of apartments in Mumbai is set to rise.

The term "premium" encompasses various charges levied by authorities for granting approvals. These include the fungible premium, premium for FSI (floor space index), open space deficiency premium, and premiums for additional ground coverage for construction, lobbies, lift wells, and staircases, among others. In Mumbai, developers must navigate more than 20 types of premiums, which constitute approximately 30% to 35% of the total project cost.

Mumbai's changing skyline, with its frequent emergence of new skyscrapers, is drawing comparisons to New York. Redevelopment has played a key role in this transformation. Even listed developers have taken up the redevelopment of old buildings, despite a significant increase in housing supply post-COVID-19. Real estate experts note that the capital values of apartments have risen by 40-50% following the redevelopment of old buildings.

The surge in real estate projects between 2021 and 2023 in Mumbai was largely driven by the redevelopment of societies. Property owners in these societies were compelled to seek temporary rental accommodations, leading to a demand-supply mismatch and a sharp increase in rents, particularly for premium gated communities. As these redevelopment projects near completion, the market is now experiencing an influx of newly available rental units.

This influx is creating an excess supply in the market, with demand not keeping pace. Consequently, prices are gradually stabilizing and even declining in some areas as the demand ratio adjusts. The surge in redevelopment projects is expected to increase the supply of new units (from the free sell quota of developers) by 30-50%.

What Next?

1.?????? Branded Players Likely to Fare Better: Branded developers, with their reputation for timely delivery, are likely to thrive even at elevated prices. In competitive micro-markets, they will need to price attractively to garner sales, while developers without a credible track record will struggle to sell under-construction units.

2.?????? Luxury Market to Tumble: The term "luxury" is often misused in real estate. True luxury projects need a combination of home size, plot size, design, amenities, and finishing. Many so-called luxury projects are overpriced and need price cuts of 20% to attract buyers.

3.?????? Payment Plans to Become Popular: Payment plans such as "Pay 20/30% now, and the rest on possession" are becoming common. These schemes limit the buyer's risk if a project stalls. Builders who do not price it right or offer the right payment plan will continue to struggle.

4.?????? Slow Project Acquisition: Project acquisition by builders has been aggressive in recent months, especially in the redevelopment market. However, with the market slowing down, project acquisition will moderate, although land prices are unlikely to decrease.

5.?????? Aggregate Volumes to Remain Steady: Despite the market's challenges, home sales at an aggregate level will remain steady, although demand will be spread over a larger number of projects, resulting in lower sales per project.

6.?????? Rise in Affordable Housing: Demand for affordable housing will surge due to government incentives in housing loan schemes.

7.?????? Alternative Investments: Demand for land investments, plotted farms, and residential NA plots will rise due to lower prices, alternative asset classes, and the need for holiday homes and green living spaces.

Is Now the Right Time to Enter Real Estate?

For actual users, the current market is favorable due to high supply and tight competition, allowing for better negotiation and purchase prices. For investors, however, it is not the right time, as purchasing at a discount is futile without end-user demand, leading to blocked funds.

CA Harshad Shah, Mumbai [email protected]