The Indian Sub Prime - Dangerous

A couple of days back, I was at a friend's office, a big investor in the real estate market. In the course of our meeting, he had an important visitor, a prominent young real estate developer. He had come over to request the investor to help him source buyers "on paper" for an apartment he was building under one of the many deferred payment schemes. Caveat, buyer should be eligible for a housing loan.

The deal:

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The Developer would provide the upfront 10% to 15% amount to the buyer, which would be used by the buyer to pay the down payment and stamp duty and registration. The buyer would then get his loan approved from a bank designated by the developer. Buyer's interest only EMIs would be paid by the developer until such time possession was granted. Buyer would never take possession nor pay the balance equity (if any) as a side agreement would state that it was the developer's responsibility to flog off the apartment upon completion to a real investor/buyer. Since the quoted price would include the embedded interest and carry cost, there would be no real capital gain incidence to the buyer. As a fee for lending his good name and balance sheet, the buyer would get to keep an amount equal to the original equity (funded by the developer in cash most probably) from the sale amount received by the buyer. Everyone goes home happy.

At least on paper.

The buyer may assume zero risk, but ultimately it is he/she who is responsible for the loan servicing should shit hit the ceiling.

The buyer may also be forced to take possession on completion should the developer not find someone to buy the unit on completion. Given the existing surplus stock in the market, the scene may not play as per plan, given that the side agreement is not one that the developer would be too keen on registering.

The buyer may at some stage be asked to pay Income Tax on the loan related interest being serviced on buyer's behalf by a third party (the developer).

The bank may be happy to fund the home loan seeker (buyer), but does it know the real intent behind the developer and buyer agreement? Scary if not and very dangerous if it is in the know.

Well, it may appear to be a potential problem between the developer, buyer and banker. But, the bank is really giving away whose money? OURS mostly, the people unconnected with the transaction.

The developer of course is the only happy person. First, he gets rid of his cash stash (he is hopefully worried that the FM's taxmen will come looking for it). Second, he shows an inflated price sale on paper to keep the valuation of his company high - just in case he can attract private equity players or the public markets. Third, he really has no real default penalty other than loosing the 10% or 15% he routed to the buyer for the purchase. Fourth, he gets to borrow at some 10% rate of interest from the bank as against the 18% to 36% rate from private lenders and private equity. Fifth, there is no real reason for him to finish his project on time - virtually 80% of the staged payments are collected against the civil shell and only 20% held for finishing - whereas the time and costs are nearly in the reverse percentage ratio. Sixth and best, his borrowing has not attracted a personal guarantee or any lien on his company's balance sheet. Sheer genius.  

It is not the first time or the first developer doing this. It is something that is happening each day and the money grab is getting bigger and bigger.

That's not the end of it. I was shocked to hear that the same guy was looking at offering 30% to 40% discount on area market prices to bulk buyers for his ready projects. Except that, even at that discount no one was willing to bite the bait. Obviously, there is no down stream sale visibility for now. Is the realty market really that inflated?  If that is true then the builder community is in deep shit and will take a whole lot of people deep down into the cesspit.

There was a front page advert in a leading daily put out by an online property sales company stating "buy now - prices to rise soon". It's a different matter that the portal is owned by the leading daily, and the mother company of the same daily is probably the holder of the largest inventory of real estate given that it runs barter deals with almost every developer - Full Page Front Page ads against property.

Some may be lured by the free money from the developer and some fall for the marketing glib. But, the danger of an Indian sub-prime grows greater each day.

But what do we care. Our worry is how actor Salman Khan escaped a real life prison sentence and how intolerant the Nation has become. Surely, the revised Real Estate Bill will save us - right? Now there is another scary story in the making.