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22 Nov 2016

Impact of RERA and Demonetization on India’s Real Estate sector

After a roller coaster ride that lasted almost three years, the Indian Parliament passed the Real Estate Regulatory Act, 2016 (RERA) in March this year. The passing of RERA brought cheer to millions of Indians, especially those who were at the mercy of Builders/Developers for their apartments/flats. People across India have high expectations from RERA and its effective implementation. They have come to view this regulation as a major milestone that will grant them relief from the raft of issues that they have been facing while interacting with various builders and developers.

It is well-known that black money accounts for a significant chunk of real estate transactions. This has often contributed to a pricing bubble and high variability in prices. The recent decision by the Government to withdraw old Rs500 and Rs1000 currency notes as a broad-based attack on curbing black money has raised additional expectations among people looking to buy property. There is now greater and more widespread hope that black money hoarders will disappear, “cash transactions” will become history and that most transactions, including those related to purchase/sale of real estate would be through banking channels and with money that is legally accounted for.

As such, there is currently a strong sentiment in Indian society that the demonetization scheme would bring down the high real estate prices. I however hold a different opinion. In my view, there are some latent inflation factors both under RERA and the Demonetization scheme that are likely to hit the Real Estate Sector hard.

The following are some of the requirements under the RERA that might actually push up real estate prices:

  • Litigation and encumbrance free land and project;
  • 100% compliant project;
  • No deviation from the plan/project sanctioned;
  • Restriction imposed on appropriation of advances received in the project;
  • Price stability;
  • Defect liability;
  • Insurance liability;
  • Penal provisions leading to liquidity seepage;
  • Liability of the Developer to maintain the essential services in the project;
  • Time bound projects; and
  • Other RERA compliances.

Likewise, the Demonetization Scheme too has some inflation factors, which are as under:

  • The incidence of non-cash transactions will result in a steady increase in overall construction/transaction costs on account of the following reasons:
    • higher outgo on account of stamp duty, registration fee, capital gains tax and GST (once it is introduced) as the entire price (and not just the “white portion”) is liable to be taxed;
    • increase in land acquisition cost due to tax factors;
    • in the cost of construction materials, contractors and construction laborers due to tax factors;
  • The cash crunch faced by developers/builders and the impact of unsold inventory on their balance sheets will force them to borrow money at higher rates of interest.

In my opinion, the foregoing factors will steadily push up the cost of land procurement as well as cost of construction and completion of projects. These factors, along with the uncertainty relating to further actions against “benami properties” will compress demand at least in the near-term. A dip in demand will, in turn, affect the start of new projects (even by those developers/builders who possess the financial strength and have access to land banks). The net result, in my opinion, will be a decline in the Indian Real Estate market for the foreseeable future.

On the other hand, it is possible that some factors may act as instigators of deflation, making prices favorable for apartment buyers. Such factors include:

  • Inability of Developers to sustain their business in the face of continued recession, triggering distress sale of inventory;
  • A dip in interest rates consequent to the liquidity surge in the banking sector over the past two weeks as a result of the Demonetization scheme;
  • High liquidity available with private financial institutions/NBFCs leading to easier or more favorable lending norms; and
  • Curtailment of unfair, differential real estate pricing patterns due to strict implementation of RERA.

 The luxury segment in the residential sector may be worst hit due to spillovers of the Demonetization Scheme.  

Despite the seemingly adverse scenario and headwinds facing the Real Estate sector in India, there is hope that as direct and indirect consequences of the RERA and Demonetization, various fundamental and structural forces will help boost the Real Estate market across India in the not-too-distant future, despite interim blips. According to me, these benevolent forces are as listed below:

  • Implementation of RERA restores popular trust in Real Estate Industry as a safe investment vehicle;
  • Erosion of the traditionally dominant position of Developers/Builders and creating a level playing field (and perhaps even one that is in favour of Buyers); Transparency in transactions leading to a win-win situation for both Developers/Builders and Buyers;
  • Broad parity and uniformity in pricing;
  • More thrust on affordable housing;
  • Regulated and Accountable Real Estate Agents/Facilitators;
  • Timely completion of the projects and nil/reduced incidents of deviations from the plan sanctioned by the planning authority thereby leading to better planned development of our towns and cities;
  • Improved quality of construction and workmanship; and

Healthy competition among Developers/Builders that creates a more customer-friendly environment than ever before

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