Castles Made of Sand

Hopes left broken by Budget 2016

A lot was expected from 29th February 2016. The Academy of Motion Picture Arts and Sciences delivered. Leonardo finally got his Oscar. The Finance Minister, evidently missed his mark and the Nifty sank below 7,000. I tried hard to find a straw for the drowning but ended up wondering if this silence was the proverbial last straw.

I say this on behalf of Indian real estate. Low demand, inventory overhang, delayed deliveries, expensive funding options and increasing regulatory pressure ensure there is still no sight at the end of the tunnel. A business frowned-upon by everyone was holding its breath to no avail.

Here is a brief analysis of budgetary provisions that should help everyone plan their next 12 months in Indian real estate.

Mildly Positive Provisions: a quick read suggests that stipulations which seem positive for real estate will not have significant impact on the current market dynamics.  

Exemption from Divided Distribution Tax (DDT) is a long awaited move but REITs may still NOT become a reality. Even if pioneers ventures with a REIT in the next 12 months, it will not have any broad impact on the markets. Only a few Developers/ Financial Institutions own operational, rent-generating buildings in India. This move will start the process of exit for a few, however several finer points still don’t have clarity. To elaborate: 

1. Stamp duty costs: Each state government would view REITs differently. Implications of stamp duty in case of REIT acquiring/ disposing an asset is still not clear. This cost on an average is 6%-8% of the top-line which directly impacts the investors’ returns
2. Capital gains: further clarity is required on how REIT exits would be treated from a capital gains perspective for the trust / investors etc.
3. Free Cash Flow: Most projects who qualify as per REIT norms have either taken Construction Finance (CF) or would have discounted their lease rents (LRD). This would reduce the quantum of distributable cash flows.
4. Instrument for the prosperous: As the minimum lot size here is Rs 2 lacs, REITs will be a new investment avenue mainly for the HNI investor and not significantly impact the capital or real estate markets
5. Alternative markets: a fundamental question that every investment banker would ask their Client is about evaluating options of REIT. Would listing the properties in markets outside India give higher valuation to their assets?
6. Market conditions: Finally, Developers/ Funds should evaluate both the volatile capital markets and low sentiment of Indian real estate markets before venturing into REITs during 2016. Neither seem positive right now.

Affordable housing: how many companies or projects in India qualify for this 100% deduction in tax? Indian policy insists on a regressive approach towards affordable housing. I am yet to come across planned, developed residential projects in Indian metros where the dwelling unit is of 30 sqm i.e. ~ 323 sft of carpet area and provides good living condition. The slum rehabilitation schemes of Mumbai have unit sizes below 30 sqm. The affordable housing schemes in Gurgaon, launched over the past 24 months (yet to be developed), is between 30 sqm and 40 sqm.

1. Residents of affordable housing would always prefer location over quality. A smaller or equivalent dwelling in a better location (even if leased) would be preferred over a house in outskirts with limited or no connectivity.
2. Across the world, Developers who specialize in affordable housing have been able to successfully deliver and manage such projects. India is beginning to see such entities but they represent a miniscule of part of the market. The budget incentivizes one of the smallest segment of the market.
3. Will these incentives attract newer/ larger players? The low margin in such projects is the main reason for Developers from the mainstream to avoid affordable and low-cost housing. Speed of delivery in such projects is a critical factors of success over and above the financial incentives.

Additional deduction of Rs 50,000 on housing loan interest does seem to hit the sweet-spot. A loan amount of Rs 3.5 mn on a property that doesn’t exceed Rs 5 mn is the type of dwelling unit which is still in demand. This is typical middle-class housing. Unfortunately it’s the middle-class which feels the maximum pinch from this budget and might not be incentivized to invest in a house when cost of living is increasing.

Budgetary provision on REITs, affordable housing, tax exemptions mentioned above will not help in recovery of Indian real estate markets. They neither improve the fundamentals nor the sentiments.

Several Negatives: the budget has been cautious in avoiding any direct negative impression on real estate however there are several other provisions which have significant adverse impact. As these are indirect impacts, I would only briefly impress upon them.

1. Ability of salaried classes to buy houses has reduced due to new provisions on PF. Investing in the first-house has always been reason enough for Indian middle-class to dip into the PF pool for making the initial 30% payment.
2. Service tax increase to 15% will impact developers, buyers, vendors and almost everyone in the real estate ecosystem. This further increases the gross costs which in the long run would be loaded on the consumer.  
3. Higher cost of living will chip into the potential savings. Consumers will now pay more for eating out, cars, garments, air travel, water, bill payments etc which will only reduce the budget of middle-class

Fine Print: these provisions have accounting impact on day-to-day running of the real estate business or provide clarifications. These are not expected to have any major impact.

1. Excise duty exemptions extended to Ready Mix Concrete
2. The mechanism for determining the value of land/ building or both for determining capital gains has been clarified
3. Increase in time period of acquisition or construction to 5 years (from 3 years) from the end of the financial year in which such capital was borrowed for providing interest deduction on borrowed capital

Opinion: broad ranging policy incentives (even clarifications) could have been given to re-energize the flagging spirts of the real estate business. One doesn’t need to wait for another twelve months and still measures can be taken for the same. Some of those are:   

1. REIT: a long, hard and comprehensive look should be taken on the standard process to be followed for a REIT listing in India. There are still procedural grey-areas/ gaps which will be address only if someone initiates the process. Role (or the lack of it) of state government approvals/ norms needs to be addressed. In fact norms should make REIT more attractive in India than other regional markets.
2. Affordable Housing: there should be clear distinction between low-cost housing and affordable housing at policy level. To ensure long-term success of affordable housing the following two steps need to be taken:
3. Ensure metro connectivity to all corridors/ pockets of affordable housing. Linkages between such corridors through a fast and efficient transport access is critical to their success.
4. Bye-laws should focus on longevity of such projects. High-density projects with limited facilities and low quality are a recipe for future urban slum.  
5. Increase disposable income of home buyers especially first-time buyers. As easy as it sounds, its best answered by economists.

No one policy change or incentive would be enough to kick-start the business but simple, basic steps are required to guide the industry in the right direction.  

GenReal is a professional real estate services firm established and managed by the senior most industry professionals. The firm specializes in executing large, complicated and difficult real estate assignments across India. GenReal has achieved several other firsts in Indian real estate:

1. Sale-and-lease-back of a commercial building
2. Private equity co-investment (at-par) in a residential project
3. Back-to-back land acquisition and PE funding for a residential project
4. First and only acquisition and disposition of a township