The recent collapse of a residential building in Thane, Maharashtra, that killed 74 and left more than 60 injured underscores the urgency of bringing a tough regulator for the real estate sector.

At present, homebuyers are at the mercy of unscrupulous builders who often act in connivance with municipal authorities and local politicians. The result: one-sided apartment buyer contract, late delivery of the possession and poor quality of construction. Instances of unfair treatment of homebuyers by builders and developers are a regular feature in all parts of India.

To take another example, a prominent builder in Noida Extension is reportedly forcing its buyers to sign the modified apartment buyer contracts with extended possession date and reduced penalty for delay in handing over the apartments.

“Otherwise, we are ready and willing to refund the entire booking amount along with 11 per cent interest, without any deductions,” says the forwarding of the letter sent to the buyers.

Builders often force homebuyers to sign standard contracts with clauses that stipulate them to pay 15-18 per cent (per annum) as penalty for late payment. The builders themselves agree to pay only Rs 5-10 per month per sq.ft for late delivery, irrespective of the price of the apartments.

Buyers are asked to sign the contracts when the builders have already received 10-20 per cent of the price of the apartment. The agreement typically says that the “booking is provisional and in case of cancellation, the builder will retain the earnest money i.e. 10 per cent of the basic price and refund the balance with nominal interest. “

By that time, builders artificially hike the apartment price by 5-10 per cent in connivance with brokers to jack up the notional loss to the buyers who (not satisfied with the terms of the agreement) may think of cancelling the booking. Obviously, no buyers dare to question for fear of losing the earnest money and capital gain.

As of now, the real estate sector remains under-regulated. Cases related to breach of contract are too expensive to fight and take years to decide. This deters buyers from taking on the defaulting builders/developers.

Demand-Supply Gap

According to the Annual Report of the Ministry of Housing & Urban Poverty Alleviation (2011-12), urban housing shortage at the end of Tenth Plan (2002-07) stood at 25 million units. Large-scale migration to cities such as Mumbai, and NCR, puts further pressure on demand for housing.

Since supply falls short of demand by a huge margin, one can expect housing prices to rise in future, even if in the short run demand for residential units has slowed down because of high asking price and high-cost home loans.

Expectation of price rise and easy play of black money brings more money into the sector. As a result, prices of housing units keep on rising primarily on the strength of investor interest forcing end users out of the market. Sustained inflation further strengthens this process by encouraging people to invest in real estate (or commodities) for better returns.

Laws favouring tenants scare property owners from renting out, especially when capital appreciation is expected to compensate for the loss of rent. This leads to an artificial increase in rentals in NCR or Mumbai that receive substantial migration.

Thus, the lure of capital appreciation and high rental induces people to invest in properties using bank credit.

Of late, PSU banks have remained unwilling to finance overleveraged developers. As a result, private equity has come to play an important role. PE funds often pressurise builders not to decrease price and maintain targeted margins.

Over the last few years, the slowdown in developed countries and depreciation of rupee has encouraged NRIs to invest their surplus funds in India’s real estate sector. All these factors have led to sharp increase in the demand-induced housing price.

Cost-Push Factors

The problem is compounded by slower regulatory approvals that often take years to come and keep supply of residential units artificially constrained in a growing economy with common aspiration to own a house property.

Cost of land is the key element of the cost of construction. Bad zoning policies constrain the supply of land in a city like Mumbai. In the absence of proper regulation, anybody can enter into the real estate business. The large number of bidders pushes the price of land. After getting land at unreasonably high prices, builders jack up the price of the units to maintain their margins.

In addition to the rising cost of land and labour, prices of building material such as cement and steel have gone up immensely in the last 4-5 years, putting further pressure on the cost of construction.

Can rate cut help?

Many believe that a rate cut by the RBI will help the overleveraged builders in reducing their cost of construction. At the same time, it will help credit-dependent existing and prospective homebuyers. This argument is seriously flawed.

The low cost of funding will increase the staying capacities of the builders to hold the prices of housing units at the given (artificially) high levels. Besides, it may induce them to speculate in land dealings.

Way forward

The root of India’s housing problems primarily lies in supply side economics and calls for supply side measures on priority basis. Increase in supply of houses will lower the return on speculative investment through price effect.

Making tenancy laws landlord-friendly will further ease pressure on demand for housing and help in making housing affordable to the end users.

Fixing minimum eligibility criteria for entering into real estate business will reduce the number of bidders for limited supply of land and keep its price under check.

Reducing the age of the building for redevelopment and increasing the floor space index (FSI) can enhance the effective supply of land in land-constrained cities such as Mumbai and bring down cost of construction.

Given the investor interest in the sector, it is time we introduced Real Estate Investment Trust (REIT) to enable individuals to have an interest in the securitised real estate market without directly owning properties.

Possibility of easy exit from investments in REIT will make the real estate market liquid and reduce the influence of black money by channeling small savings into the sector.

Besides, there is an urgent need for a tough regulator to rein in unscrupulous real estate players and protect the interest of the homebuyers. Bringing tougher regulations for the sector can be good politics on the eve of general election due next year. Are political parties listening?

(The author is a research analyst in a global financial services firm. Views are personal.)

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