Need for practical funding
solutions
Pre-sales of residential units
is a widely followed practice universally. However, in India developers go a
step further, offering units for sale at a pre-launch stage. During pre-launch,
developers offer investors an opportunity to purchase residential units ahead
of even procuring all necessary approvals.
At times, land title due
diligence or product-mix (retail, residential, commercial) considerations may
still be underway. During pre-launch, developers apprise an inner circle of
brokers/investors that a property not officially launched in the market is
available for sale. While one imagines the news spreads through word-of-mouth
or email, recently we have seen pre-launch announcements made on public
hoardings and in newspapers.
For developers, pre-launch
provides funds, which could be used for part payment of land (or to acquire
another piece of land) or meeting approvals related costs (which in India are
usually higher). Also, developers benefit through test marketing a project
before spending time, effort and resources on approvals, due diligence and
construction. Developers expect to sell 15 - 20% of units during pre-launch.
For investors, pre-launch
provides an upper hand in terms of apartment choice as well as price discount.
Market observation suggests pre-launch investors could earn a discount of about
15% over the base price at the start of construction. In recent years,
investors enjoyed healthy returns by holding from pre-launch until completion
(usually 3-4 years) considering that over the past four years, the price of
residential units pan-India increased by over 50% on average. The risk involved
is related to approval delays, product-mix changes or project cancellation at
worst.
Regulatory impact
In June 2013, India’s Group of
Ministers (the Union Cabinet) approved the Real Estate Regulatory Bill, which
prohibits residential unit sales by developers before obtaining all approvals.
Though still not approved by the parliament, the Bill has aroused debate about
the viability of developers current business practices and the Bill’s likely
impact on land cost and housing affordability. It is pertinent to mention that
the Indian central bank prohibits funding for land purchases to avoid land
hoarding, and pre-launch was an alternative funding mechanism for developers.
Thus, in its current form, would the Bill create funding constraints for Indian
developers?
China scenario
The practice of pre-launch does
not exist in China and banks are prohibited from making loans for the purchase
of land use rights. However, capital markets in China are highly liquid and
developers have many sources of funding.
In china, the government is
typically responsible for land acquisition, rehabilitation and resettlement,
while developers purchase land from government with clear title. Since the land
title is clear, developers can mortgage their land to acquire additional funds
for construction work. In India, however, developers are responsible for land
acquisition and rehabilitation, causing delays, manipulations and litigations.
Bottom line
Pre-launch leads to information
asymmetry and, thus, should be abolished. Simultaneously, there is a need to
provide practical solutions to the genuine funding needs of developers. Either
the bank funding channel needs to open-up, or a better market environment must
prevail to attract more private investors.
