FINANCIAL LOCKDOWN OF SMALL AND MID-SIZED REAL ESTATE DEVELOPERS

valainafrancis

4 years ago

Dr. K.S. Chandrashekar
Ex Chief Town Planner DNH and Real Estate Professional

For all the right or wrong reasons, India is going through an unprecedented financial lock down since Feb 2020 and all the real estate developers across the country, particularly the small and mid-sized developers are the worst sufferers. As of now, the lockdown is expected to continue till the beginning of October 2020 but can be even further prolonged depending on the government’s policy and the strategy for the recovery. So, the question arises – what does a real estate developer do during the ensuing period? Given the fact that the real estate and the construction sector contribute to more than 15% of India’s economy, how is this lockdown going to affect this overall revenue? How are the developers going to generate revenue?

The government had announced in April that a set of guidelines for the real estate sector is in the works, but we have not heard about anything on the subject since. It could possibly be a simple set of guidelines, but a stimulus package may not be out of the picture. I want to highlight a few areas of concerns that the government must examine carefully in order to ensure the survival of this sector, specifically for the smaller builders. Recently, the government held a meeting with the National Real-Estate Developers Association (NAREDCO).

My experiences in Mumbai as well as in other small towns has helped me to grasp and compare the problems in a different perspective. The issues in bigger cities are rather different than that of small and medium towns. Therefore, my analysis and thoughts may not be necessarily be applicable for well-established builders in metropolitan cities. The example quoted below as well as the statistics behind it will not relate to these cities where the gap between the break-even cost and the sales cost is wide.

TOUGHER TIMES FOR REAL ESTATE SECTOR

There are several projects across the country that are supposed to be under construction but have been stopped at the moment. Revenue growth in the last quarter has almost been zero. There are further predictions indicating the following things that can possibly occur-

Labor Cost: It is a well-known fact that most of the construction workers are migrants from Uttar Pradesh and Bihar. Considering the present situation, there is chaos in all the states borders and most migrant labours have returned to their home town leaving their jobs and the places where they earn their livelihood. It is certainly an incredibly difficult path ahead for these labours as there is no set date for when they can return to work and make a living. So, the developers’ work will be entirely dependent on the local availability of labour. The demand and supply will not match and the labour rates will double or increase in a geometric ratio. None of the small and mid-sized builders will be able to match the rates that the bigger sharks will have to offer. This will ensure that these builders who are already facing a severe revenue crisis will be unable to compete and unfortunately, some will eventually perish. Furthermore, there is a threat regarding starting construction again because of the onset of the monsoon. With no Labour available and the beginning of monsoon, most of the sites will not be able to start construction and therefore earn no income for another at least four more months. In addition, the interest on bank loans and EMIs will be another burden for which no relaxation will be available. In such a scenario, the overall construction cost is expected to increase by at least 20 to 25% compared to the original cost. The additional burden will hold the developers responsible to provide housing, food and other facilities to the labour which is also an additional cost.
Material Cost: Due to the onset of monsoon and restricted movement of the trucks on roads, the raw material rates have already increased by 10 to 15% depending on the location and availability of the material which is an additional liability to the developer. It is also expected that the time frame for the supply of these materials will also get affected harshly due to the scarcity and transportation time. Any delays in shipping also add an additional cost of the increased labour hours.
Incentive Cost: Following the lockdown, it is expected that only the apartments that have already been constructed will retrieve their previous sales figures. The customers will be expecting discounts and special-offers due to the volatile nature of the market. All incentives in sales have their own costs that will get added to the price of the apartment. Supposedly, a 5% discount will be the most conservative estimate, thus, reducing the profit margin further.

Collectively, all the above aspects are going to hit the real estate sector brutally. I would like to establish my argument using a small example showing the cost-differences from a medium sized town near Gujarat.

ITEM	EXISTING COST PER SQUARE FEET	COST AFTER LOCK DOWN	REMARKS
Land	350	350	This shall be constant the land rate is real time of a particular site in a medium sized town near gujarat very close to state highway
Construction	1100	1320	Expecting a 20% rise in cost due to labour and material
Sales, marketing and admn	110	115	The 5% incentive is added as cost
Interest on loan	80	100	Interest calculated @12% per annum payable in 24 months in the existing scenario which will increase to 30 months post lockdown
Total	1640	1885	From 1640 per square feet it will rise to 1885 per square feet

* Impact of GST on construction and marketing cost is not included in the overall cost.

The above table clearly shows an increase in the overall project costs. The present market price of an apartment in the same area is Rs.1800 per square feet which is further negotiated by customers. The developer in the above case can only earn a profit if they had pooled in the land much earlier in the process providing them with the benefit of cost-cushioning. Rest of the developers will be unable to continue their projects in the above scenario. This may result in them being unable to compete in the market and having to sell their product in a lesser price and incur loss. Under this scenario, in order to survive in the market, the developer will have two choices:

To delay the project and wait for the market to stabilise and then compete in the sale prices with big; or
Compromise on quality, materials, amenities and complete the project as early as possible.

Both the scenarios are not ideal. The first scenario will impact the interest on the project loans and there will be no sales since work is stopped. Most of the small and mid-cap developers may not be able to bear this cost meaning that they will have to adopt the second scenario where there might be some sales. They would be forced to come out of the crisis earning a minimal profit at best.

WHAT SHOULD THE GOVERNMENT DO:

The Government has announced a 20 lakh crore relief package to all sectors which is almost equal to 10% of the GDP. After analysing the announcements made, it seems that there is nothing to this sector which shall favour any of the developers as well as to the middle class citizens of this country who actually are the demand generators. It’s really a sad situation. There is no doubt that many of the small builders will perish. The government has to look in to this matter seriously and again review their commitment to this sector and the middle class citizens of this country. However, I would like to recommend the following to the government:

I. Financial Package:

At this moment, cash resources in terms of availability is almost zero. Without cash flow, business cannot flourish and at the same time you also need cash resources to spend.

Based on the project construction on site, the government should pump-in financial relief package to builders whose construction is stopped mid way and had started at least six months before the lock down. The funding will only be for the incomplete buildings on a case to case basis. It should be the banks’ responsibility to fund such developers and monitor these disbursements regularly.
The government shall provide at least a six-month moratorium period to start the repayment of the loans. The loans shall be returned within 36 months.
The unsold apartments in the building can be held as security by the banks.
Those who have already obtained a loan for the buildings will have to be given a six-month moratorium period for resuming their repayment without any extra costs on interests etc.
The interest rates for this special package should be less than the current interest rates charged by the banks on project loans.
The government should consider reduction in GST rates on building materials particularly cement and steel. The govt should not forget the fact that the construction cost is very high and for affordable housing, it may not be a very good scenario.
The Government should also allow the input tax credit on the 1% GST given to affordable housing category.

II. Social Reforms:

This is the right time for the government to contemplate other reforms that may be required to aid the real estate and the construction sector.

Quality control has been a major distress in this sector. If a developer wants to earn more profit on their project, their first recourse is to attack the quality of construction. There are several cost-cutting options in terms of the quality of materials, quality of finishing and so forth. In this regard, a genuine builder who wants to provide quality results is unable to compete in the market because the developer reduces the prices and sells off his inventory without maintaining any quality of the building. Therefore, I strongly recommend to the government to issue a bench mark for construction and categorise the buildings in to quality index based on which the pricing can be compared. The Customer will then understand where to buy and how to compare the pricing.
Due to this untoward pandemic situation, the government should adopt a socialist policy for at least one year in determining the labor rates, material costs etc so that the vendors and labor suppliers do not take advantage of this present scenario.
I would also suggest that all labor suppliers should be registered with their labor force and link the labor force with their Aadhar cards so that many other system also can be put in place such as the PF, ESIS etc which at present many of the labours are deprived off.

The government should not forget the fact that this sector contributes around 15% of the economy and if they are not supported at this time of crisis, the survival ratio of this economy will decrease and may be in doldrums. I only hope the government understands the concerns.

Dr. K.S. Chandrashekar

Ex Chief Town Planner DNH and Real Estate Professional

Dr. K. S. Chandrashekar has been a central government officer and an expert in project management. He has prepared multiple regional and master plan for the UT of Dadra & Nagar Haveli, during his stint as Chief Town Planner and Ex Officio Joint Secretary (Urban Development). He also holds expertise in preparing the Development Control rules and has executed several infrastructure projects. In addition, he held several senior posts – Chief Executive Officer of District Panchayat, Chief Officer of the Municipality of Silvassa and Joint Secretary (IT), Director of Operations for a real estate company in Mumbai to name a few. He currently runs his own company, executing real estate projects in Silvassa and also advises developers on real estate management, including but not limited to feasibility studies.

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