The worst time for the already cash deprived real estate sector does not seem to get over, even before 2020 we were noticing a lot of blood bath in the sector with many projects getting into NCLT issues and a lot of complaints filed from customers, suppliers etc, in last few years we have seen too many big names completely sweeping out of the market.
The sector has otherwise seen a lot of changes in the last 3-4 years, specially post-implementation of RERA by state governments, by and the large pretty unorganized sector has started witnessing a huge shift towards turning more organized and accountable to its customers.
Although there is no dearth of funds available for the sector, ranging from Banks to NBFCs to AIFs, the sector has seen a real divide where more and more funds are available for few good names and others in need are completely deprived off. Entry of new players or special purpose funds like SWAMIH (Stress Window for affordable and Mid-Income Housing), an initiative by the Government of India, through SBI Caps Ventures and few other investors has opened a whole lot of opportunity for stuck projects irrespective of the fact that they are in Metros or Tier 2 and 3 cities, this came as a lifeline for many deeply troubled projects, but as I said the requirement of funding is too huge in the sector compared to what is available and more importantly how it is available.
To begin with, let’s understand the Industry from the perspective of funding, let’s try to take an illustration where an entrepreneur thinks of installing a manufacturing unit, what will he do post making a feasibility report of the project? very obvious, he will work on the financing for the project, widely known in economic terms as ‘Means of Finance’, where he will bring in some equity and rest to be financed by any bank or financial institutions like SIDBI etc. Have you ever seen or heard of any feasibility report which covers its capital cost ie cost for installation of plant and machinery etc through future sales of the output which this factory will generate, you will probably laugh at this proposition, now just look around, this is what is happening in almost every real estate project when you launch a project, substantial portion of your ‘means of finance’ are covered by the collections project will be able to generate during its construction through sales it will make in the open market.
I am absolutely not saying it is wrong and that before the start of the project, a sensible developer must have 100% means of finance arranged and not at all depend on sales collections but the fact is today majority of projects are feeling the heat because they did not work on financial closure before launch and dependency on collections through sales was pretty high, today what we lack as an industry are basic guidelines as to what percentage of collections from sales during the course of construction and that too at what stage shall be taken into account for working on financial closure of the project, furthermore important is financial planning on cash flows of the project wherein we plot each means of finance requirement every quarter also backed by contingency planning. So project A in the same micro-market can have cashflow planning considering 40% will come from sales collections however project B can take this to as high as 70%, basis developers confidence of making better sales.
Why I am emphasizing on above fact is only because of the simple reason that post covid or in these times of pandemic how we look at real estate project financing needs to change completely, as the sector needs to have better management of the projects getting launched and it will not be about price but about a delivery, which means we will see more and more organized bigger players like Godrej, Mahindra, TATA launching more projects and will start moving from only metros to tier 2 towns as well, this will make the survival of smaller players even tougher, how I see is a clear split in the type of projects getting launched, one side we will see larger, more organized, with better infrastructure getting launched by such corporates and smaller projects, low rise developments within city types getting launched by smaller developers with only limited geographic presence.
In both cases developer, no matter corporate or smaller will have to have complete financial closure before they launch any project with very limited dependence on receivables from sales during the construction period of at least phase I of the project, which means every project has to be managed in a phased manner and at least for first phase dependency from sales practically needs to be zero.
So we have many funding arrangements available in the market, its just that lenders are very very selective and they will continue, rather will become more strict in funding any new project after pandemic due to uncertainty in sales, therefore it is not about money but conviction with the way developer proposes to raise funding, which becomes more convincing when he approaches lender with better cash flow analysis showing financial closure for the project, which means more skin in the game, better equity, here we must keep in mind that equity is directly proportional to the size of the project which is the case for any industry, bigger plant you plan, larger investment you need to put in, but so far in real estate this does not hold good with same equity one developer can plan half a size of a project and another can plan double size of the project if his sales are better, but that sales nos are only estimates basis his past strength, will this location or product will be able to do same wonders is left to chance only.
To conclude, with my experience more than your history to repay and delivery and your brand, lenders these days give weightage to the project per se and evaluate that independently basis possible financial closure, therefore it is better that every project is conceived as an independent company, so better be in separate SPV (Special Purpose Vehicle), better to keep it simple and small rather than large townships, even if you are planning township, better to design it in smaller projects with separate RERA nos and committed completion dates etc.
In the end, the sector is sure to rebound but it is up to developers to learn from the pandemic and prepare themselves better for changing times as to me it is not about how big you play, it is about how well you play, so don’t only focus on what million sq ft are you constructing and how many projects are ongoing but focus on how planned you are in terms of ongoing projects and how sooner you can give the delivery with least possible cost, where obviously delay is huge cost primarily due to heavy interest burdens, so it is easy to make more profits in few neatly managed projects than many mismanaged projects.
very informative.