Over the last three decades, India has made significant strides in establishing itself as a major player in the world economy. Despite its rapidly evolving economy and expansive capital markets, India’s real estate industry has only just emerged in the global arena. Strong economic and demand fundamentals for real estate have drawn the attention of several global investment behemoths, such as Blackstone, Goldman Sachs, and CPPIB, as well as sovereign wealth funds, such as GIC, ADIA, QIA. However, the sector has always required a higher risk appetite, which can be blamed on the lack of transparency and tinge of fraudulent activity. Vested political interests have prevented this industry from truly maturing. However, the introduction of the RERA Act has introduced a sliver of optimism to the sector by introducing a regulator.
What is RERA?
The Real Estate Regulatory Act (“RERA Act”) came into effect in its entirety at the federal level in May 2017. It was introduced with the purpose of reforming the real estate industry by enhancing transparency, holding developers accountable, and strengthening the consumer’s position. For enforcement, RERA Act must be enacted at the state level; by end-2018, RERA Act had been notified under the federal law in 28 states and union territories out of 36 total. Key highlights of the RERA Act include:
- Regulatory authority: the law makes it mandatory for each state and union territory to form its own regulator – the Real Estate Regulatory Act Authority (“Authority”) – and create rules for its functioning. The aim of the regulator is to protect the interests of stakeholders, collect data and create a platform to address consumer disputes and grievances.
- Real Estate Appellate Tribunal: implemented by each state, this entity aims to expedite dispute resolution by providing a platform to air grievances. Members of the judiciary and technocracy will take on roles here.
- Registration: all new and existing real estate projects must be registered with the respective state RERA. This also includes projects which have not obtained their completion or occupancy certificates. Registration is conditional on marketing the project. Moreover, real estate brokers must also register themselves with the Authority.
- Escrow Account: at least 70% of project receivables must be maintained in an escrow account, monitored and certified by a professional, which are earmarked for project development costs only. The developer is effectively held accountable to the consumer because it limits developer’s misappropriation of funds for other projects or personal gains.
- Compliance: various compliance measures are enacted which provide for enhanced transparency, such as requiring the consent of consumers for changing development plans and transferring ownership.
- Quality: with a defect liability period of five years mandated and more at risk if quality standards are not maintained, an increase in the quality of real estate product in the market will increase.
- Transparency: developers are required to provide periodic updates to the regulator which consumers will be able to view on the RERA website. This includes sharing information on project plans, government approval process, land title status and use of sub-contractors.
- Standardized sale agreement: this imposes liabilities on the developer and consumer for any default on payment or deliverable.
- Penalty: if the RERA Act is violated, penalties, in monetary terms (up to 10% of project costs) and even jailtime, will be enforced.
Aches and Pains
Almost two years into the RERA Act, implementation has been slow – both at the state government and developer level. Although several states have adopted the Act, only 13 states have set up permanent regulators while the remaining have “interim” authorities in place. Political misalignment and inefficiency in the bureaucracy have slowed down this process.
For developers, the adoption of the RERA Act has resulted in significant time and cost outlays. Since sales contracts cannot be executed prior to the receipt of project approval (which was previously allowed), developers need to revamp the way they manage their liquidity and find short term financing options. This has also slowed down project timelines. In order to register new and existing projects, significant paperwork is required to submit project and developer due diligence items. Additionally, there will be a need for increased project overhead due to greater monitoring and reporting costs.
In the short term, there has been disruption in the sector affecting developers, consumers and financial institutions. Combined with the fallout of other domestic factors including rising construction costs and demonetization¹, developers are having trouble completing existing project and meeting finance costs. Some consumers are not receiving possession of their investment because the developers are defaulting, while lenders and equity partners have had to sort through their balance sheets when their liabilities/assets stop performing.
What can be expected?
Although much needs to be resolved and implemented at the grassroots, the RERA Act comes at a critical juncture when the real estate industry in India is maturing and becoming more institutionalized. In addition to more check and balances, there is much to look forward to from an investment lens:
- Consolidation of developers: larger, institutionalized players in the market are expected to emerge. These players will be better able to manage cash flow mismatches and have the bandwidth as well as financial wherewithal to deliver quality products. The days of the small fry are over.
- Increased transparency could lead to lower cost of external debt finance because of lower risk associated with the unknown. However, the cost of equity is likely to increase because of higher upfront capital required towards project approval and land acquisition.
- Greater institutional investment: greater accountability and more visibility into the project development reduces completion risk which has often hindered foreign and domestic institutional investors.
If the Act is not be diluted at the state level and effectively deployed, the potential upside is well worth the short term pains currently visible in the market.
Notes:
¹In November 2016, the Indian federal government issued new ₹500 and ₹2,000 banknotes in exchange for invalidated ₹500 and ₹1,000 banknotes. This was enacted to limit the shadow, cash-based economy in the country. This resulted in cash shortages and significant disruption for several months.
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