India: Does Attempt To Regulate The Real Estate Sector Help

The intention of the Real Estate (Regulation and Development) Bill 2016 (Real Estate Bill) is honest but its execution may lead to faulty results. To have a successful venture it should benefit all stake holders. It is true that the unit purchasers (i.e. purchasers of premises) would, apparently,not have to take approval risk andprobably will receivetimely delivery and, most importantly, will have the assurance that the money that they invest in a real estate project will beused in the project itself, but there is a possibility that these may have a counter-productive effect. The concept of depositing 70% of the realisation received from the unit purchasers to be kept in a separate account and to be withdrawn in a particular mannerafter certification from an engineer, chartered accountant and architect in practice would lead to expensive capital being used for the real estate project as a result of which the lenders before lending to the promoters for purchase of land will have to carry out extensive legal, financial and economic due-diligence,including viability of the project, and will have to take as much risk as that of the promoter, as regards approval and recovery of their principal and interest.

Further, the implication on the lenders ability to take control of a real estate project in view of the restriction on the promoter to transfer their majority rights and liabilities without permission of two-third unit purchasers and the competent authority will be another area of concern for lenders and promoters. Private equity financing of real estate projects, which in many cases is dependent upon the investor's ability to "take over" the project assets, will also face similar challenges. As such, both traditional lenders and private equity financiers will need to carefully consider their transaction structures to ensure that they are able to work within this limitation.

The fact that registration of a real estate project would only be extended for a limited period, on very limited grounds, would only add to the woes of the promoter and the unit purchaser even where they are in agreement on the time extension i.e. beyond the time period permitted by the authority for project completion. The lapse or revocation of registration of a project due to expiry of the extended time period granted by the authority, and thereafter having the project completed by the competent authority or association of person and preference being given to the association of unit purchasers would not in any manner protect the interest of the lenders or the promoters.

In addition to promoters' continuing liability towards the unit purchasers on the title of the land, the additional requirement to procure insurance on title of the land will also increase the cost of the project. Given the absence of any comprehensive title insurance product in India, promoters must hope that insurance companies are able to come up with a product offering in a timely manner - with terms and conditions which arereasonable and palatable (both in terms of risk coverage and premium).

For a delayed project, a unit holder would have the option to continue with the project and be entitled to interest for every month of delay till possession is handed over, or to withdraw from the project and seek refund of principle, interest thereon and compensation as would be determined by the adjudicating authority (in addition to any other remedy available to the unit holder). Such consequences again would force the promoter to load their risk on the price of the units and pass on to the unit holder. The Real Estate Bill also does not prescribe any time period for completion of a project, which is left to the discretion of the promoter. The promoter would be tempted to increase the time period beyond reasonable time to protect themselves for contingencies beyond their control. This again would lead to incorrect decision of the unit purchaser as they may not plan to make prepayment if the call for payment is made by the promoter earlier than what they expected.

The Real Estate Bill also does not deal with calling for money from the unit purchaser in a phased manner on phased completion.

As a result, the future model of real estate development business in India could be as follows: land procured at the cost of the lenders (in all probability by way of equity participation), insurance companies insure land title, and an independent construction company develop the building structure and receive its payment in a phased manner. The construction company's payments would be secured by the escrow arrangement. Promoter would have back to back arrangement with such construction company for the delays and defects and would underwrite those as regards the unit purchasers are concerned.

In short, this bill could ultimately force the traditional real estate promoter to change its business model: withpromoters starting to act like project managers,hedging their risk at every stage - which of course would be at the cost of the unit purchasers.

This article was first published in ET Realty.com

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The content of this document do not necessarily reflect the views / position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at mumbai@khaitanco.com

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