A clash between a betrayed home buyer, an abandoned lender and a cash-strapped developer is imminent.
Khyati Shah purchased an apartment in Raj Infinia in Mumbai. The transaction was executed for a price of Rs 1.98 crore in 2013 through a subvention scheme wherein the developer was liable to pay the pre-EMI till possession of the flat. From March 2019 however, the developer, Rajesh Lifespaces, stopped making its payments while not giving possession of the apartment to the home buyer. The bank, ICICI Bank, thereafter started sending demand letters to Khyati for making the pre-EMI payment. The matter went to the regulator. RERA, on January 8, 2020, ruled in favour of the home buyer and asked the bank to deal directly with the developer for the pending payments. Meanwhile, the project is stalled.
The reason I mention this case is to highlight a phenomenon that is poised to torment an already battered real estate market – the unravelling of subvention schemes. Developers who took responsibility of making pre-EMI payments on behalf of the home buyer and who will be unable to do so due to lack of sales. And projects will get stalled.
What are subvention schemes? Loosely put it’s a tripartite agreement between builder, buyer and a bank wherein:
Step 1) A buyer books an apartment with a small down-payment in an under-construction project.
Step 2) Buyers then take a loan from an empaneled lender on the condition that the developer bears the pre-EMI until possession.
Step 3) On the date of possession of apartment, the builder’s responsibility on payment to the lender ends.
Step 4) The payment date to the bank from the buyer starts. Effectively, until possession – there has been very little payment from the pocket of the buyer.
Trouble is brewing
While subvention schemes have been relevant for almost a decade, it was between 2015 and 2019 that it became the real game in town with almost every semi-major and major project offering it. Its utility lay in the fact that the buyer did not have to pay rent and EMI at the same time. The buyer had to make EMI payments only after possession by when he would no longer be in a rental apartment. The RBI banned it last year for the very reason that has occurred between Khyati Shah and Rajesh Lifespaces: Default and its accompanying complexities. A default by the developer can be either due to siphoning of funds or merely not being able to service the pre-EMI due to lack of sales. The Raj Infinia project has sold only 48 percent of inventory according to data submitted to RERA.
With market sentiment and sales taking a further downturn after the COVID-19 pandemic, it is certain that Rajesh Lifespaces will not be the only developer who will default on its commitment. That means unchartered territory. The reason is simple: RERA has ruled in favour of the buyer. It’s unlikely that the bank will not appeal in a higher forum since the tripartite agreement mentions that the ultimate liability rests with the buyer in case of a default by the builder. Reliable data on the extent of subvention loans in MMR doesn’t exist currently, but my estimate is that the number will be in the range of Rs 35,000 – 55,000 crore for the region and around Rs 1,00,000 crore at a pan-India level. More of that in another article.
How widespread will this phenomenon actually be for real estate developers and homebuyers? In my view three indicators need to be watched for to determine that a) Buildings with sales of less than 50 percent b) Possession date c) Number of towers with a focus on subvention.
Data from Propstack, a real estate database platform, shows 14,577 towers in MMR have sold less than 50 percent of their inventory. Among these towers, as many as 5,178 towers are scheduled for completion in 2020 and 2021, according to data submitted to RERA. That means a significant amount of the investment by the developer has already taken place and completion is around the corner. Almost every developer executing these 5,178 towers will be vulnerable although it will be the subvention loan-driven towers that will be ripe for legal wrangles and complication. Exact data on the number of towers offering subvention doesn’t exist but in my view, it would be around 20-30 percent. With that assumption, it means that there are 1,000 –1,700 towers that are going to be vulnerable to a default by the developer with a lender subsequently hounding the home buyer. Do keep in mind that most developers already have taken construction finance from lenders and their priority would be to fulfill that obligation first rather than the subvention-related EMI payment.
Legal wrangles on the cards
A clash between a betrayed home buyer, an abandoned lender and a cash-strapped developer is imminent. With lenders then stopping further disbursements on already agreed subvention deals, the liquidity tap for developers will dry up and projects will run a high probability of getting stalled. The only option then to raise capital for the developer will be sharp price cuts. But as I noted in an earlier column, even steep price cuts in the post -COVID-19 demand environment when unsold inventory is 300,000 units may not be enough. The pain for lenders and developers was already underway – with subvention schemes unravelling, it will engulf the home buyer as well. Mumbai real estate is set to get a taste of what Noida has been feeling over the years: Stalled projects with protests by home buyers.
Homebuyers of Raj Infinia will find a lot of company in the next 18 months.
When not busy with his newstoon platform Snapnews, Vishal Bhargava is a real estate enthusiast who views and reviews new projects. The views are personal.