Tough times ahead for residential developers with funding and sales

NBFC-bank credit impact on residential realty market will lead to price corrections, project takeovers and consolidation, say experts

The recent liquidity and asset-liability crisis in the financial sector the second half of the financial year has given rise to a credit crunch whose impact is likely to be felt across the residential real estate market, say experts. 

Data compiled shows that sales of residential housing units are up, while unsold inventory has come down during the first nine months of CY2018 (see table). New housing project launches have slowed down to 1.277 million units in three months ended September 2018. 

"Most of the sales have come from the affordable and mid-income housing spaces, while premium project sales in general are slower, as is expected. Affordable housing sales have gone up nearly 50 per cent (in the past six months) and we expect that to continue till FY2022, given the government's push for such projects,” says Tejas Patil, co-head of Real Estate at Sanctum Wealth Management.

Today affordable housing, consisting of units sold for up to Rs 5 million, alone accounts for 55 per cent of the market, while middle-income projects (up to Rs 7.5 million) make up 20 per cent, analysts say.  

Over the past three or four years, the credit market has seen a great deal of volatility as a result of regulatory clean-up of the major banks in terms of non-performing assets, and due to government policies such as demonetisation. 

Being well-capitalised institutions, non-bank financial institutions (NBFCs) and housing finance companies (HFCs) were able to grab some market share from public-sector banks, particularly in residential real estate lending, where NBFCs/HFCs service both buyers and developers. 

The growth of residential real estate will continue to be driven by affordable and the middle-income segment during the coming quarters. 

The table shows that new launches are down 35 per cent to 35,836 units during the June-September quarter of FY2018, as compared to the same period last year. Unsold inventory has reduced during the same period to 780,424 units. 

“There is a slight tapering-off in unsold inventory as developers are becoming cautious of new launches. Going forward, two things are equally important -- one is whether the supply-side, which is under pressure right now, can avail funds, and the second is the mortgage-paying capacity of buyers,” said Arvind Nandan Executive Director of Research at Knight Frank. 

Due to the current crisis in the financial industry, developers are obviously finding it difficult to procure funds as easily as before. 

“The next quarter will be tough for home-loan borrowers because many companies [NBFCs/HFCs] have stopped fresh loans and have even stopped disbursing against loans sanctioned. Even banks are reluctant to lend, and the cost of borrowing for developers will rise as the cost of lending rises for HFCs, NBFCs and banks,” Patil said. 

The challenge going forward is how developers manage their sales and loan repayments in a period of higher business scrutiny by all market participants and higher funding costs and slowing home-loan lending from HFCs and NBFCs. 

“Current complexities in the financial sector have made people cautious and our primary indications for the second half of the year show that there isn’t the usual jump in sales during the festive season,” Nandan said. 

Analysts say that in order to offload their inventory, some developers have, over the past three months, reduced the carpet area the apartment even in projects that have been officially launched, in order to make the ticket-size of mortgages affordable for home-buyers. There could also be massive discounting on the unit price of flats by developers. 

Developers need financing during the construction of a project, which they can raise either through debt or equity finance, while effective sales should ideally cover the costs of delivery of houses or apartments. On the other hand, funds raised via debt or equity go towards capital expenditure of the project, such as land and equipment. 

“We are seeing that debt financing for developers has increased, as equity is very costly and debt has moved from the traditional monthly repayment model to a 'payable-when-able' model,” says Patil. 

In a standard project finance contract, the monthly repayment schedule for the developer to the lender depends on a minimum number of sales per month, say, 10 units. If the developer deviates from that plan, the chance of the loan going bad rises. 

"Under ‘payable-when-able', lenders take control over the cash-flows of the developer so that their comfort does not reduce, even if the number of sales reduces,” he elaborated. 

Project monitoring is becoming increasingly important, according to Nandan. He says, “From now on, scrutiny of developers will be paramount. It’s not just about putting a plan on paper, it's about meeting the financiers' conditions. If the situation persists, we will likely see consolidation among developers as well.”

HFCs and NBFCs will increasingly scrutinise developers’ sales strategies, cash flow management and project execution, and if developers are non-compliant, projects can be taken over by the lenders, as today instruments like the new insolvency and real-estate law empower different stakeholders, say experts. 

Over the next year, new projects will slow down substantially, "Unsold inventory could rise while sales come down as lending both on the retail and developer side has slowed down, given the asset-liability and liquidity issues plaguing the NBFC and HFC space,” Patil said. 

Housing construction: Performance in first nine months of CY2018
	January-June	YoY change (%)	June-September	YoY change (%)
New launches	91,739	46	35,836	-35
Sales	124,288	3	72,472	24
Unsold inventory	497,289	-17	780,424	-11