Cash crunch forces small realtors to tap grey market

Caught in a liquidity crunch following a series of anti-inflationary steps taken by the government, including the ban on external commercial borrowings (ECBs) in township projects, the bigger developers are holding on to their properties while the smaller ones are increasingly opting for cash transactions and raising money from undisclosed sources.

Industry watchers say the developers who have enough liquidity to sustain are holding out, even though rising interest rates have hurt their project dynamics. But tier II and III firms, which constitute nearly 80 per cent of the total developers, are asking for higher cash component from home buyers.

"Though the demand has slowed down and the financial strength of developers declined, they are not in a hurry to sell off properties. The next one month will be very crucial as the demand is very high during this time of the year. If it does not pick up now, the prices will fall and developers will be under pressure," said Pranay Vakil, chairman, Knight Frank India.

Left with fewer means of fund raising, the small realty developers are also using funds from unaccounted sources for meeting their commitments towards land purchases and construction.

"The smaller firms have a strong cartel from where they raise illegal money for their projects. Even if all the doors are shut, they can increasingly tap these gray sources," said an executive from a top property investment firm.

The use of illicit funds is not new to the real estate industry. However, experts believe, during the last few months, it has gone up, as most of the small-sized developers had acquired lands in anticipation of greater demand for realty projects.

Most of these developers had also planned to come out with IPOs to raise money. However, the slew of measures adopted by the government, which ranges from interest rate hikes to the tightening of IPO norms for realty firms, have hurt their plans.

"These firms cannot go for IPOs, private equity funding and foreign debt due to lack of clear titles, poor valuation and disclosure standards. We have also advised our clients to stay away from these firms," the executive added.

Ambar Maheshwari, director, DTZ, a global property advisory firm, believes that cash transactions in the real estate sector had gone up in recent times.

"Because of cheap loans available earlier, cash transactions, which are not accounted for, had gone down. After the rates went up, cash-based transactions may go up since developers have to meet their fund requirements," Maheshwari said.

The withdrawal of Section 80 IB of Income Tax Act, under which the developers could claim tax holiday for profits earned in developing land in a minimum area of one acre and individual flats of less than 1,000 sq ft, in the 2007-08 budget was another trigger for developers to go for unaccounted funds.

"In the absence of deduction, developers have to go for higher cash component to avoid taxes and maintain the profit margins," said Rajesh Mehta, chairman, Raha Realtors, a realty consultancy firm.