Empty vessels make most noise. Still reeling or trying to
execute the decision taken such as FDI in retail, FDI in aviation, etc. the
government recently announced a plan asking banks to bail out Real estate
developers. I cannot but contain my angst on this suggestion by the government.
Why should we use banks money to bail out in-efficient
businessmen, who have overleveraged balance sheets and unsold inventory? How should
we trust a business which is unwilling to play by market dynamics and is
working on inflated prices without giving a valid proposition to the consumer?
The following are the reasons for the same:
1.
Higher cost of financing
2.
Higher cost of acquisition
3.
Higher input costs
4.
Market cartelization
5.
Vested interests
6.
Lack of financial discipline
They
should all take a lesson from the local vegetable vendor, who also knows that
if by the end of a week or a day he has unsold stock they should lower the
price and sell off to maintain the cycle of business and cash flow. Innovative
accounting such as portraying advances on bookings as Equity too has not helped
them in keeping up their cash flows.
Lets take a look at above factors.
Higher cost of financing: This particular factor takes the
cake as the cost of financing is not giving any respite and the stock prices of
all companies related to interest costs (be it borrowing by businesses and
borrowing by consumer who buys these products viz. Real estate, automobiles,
etc.) are on a roller-coaster ride. The ever bullish psyche of the real estate
industry and the banking (after all they are humans) let them run amok and
flush the sector with excessive funds with banks running after developers to
take their money. This led to two things:
a.
Value of assets rose significantly
b.
Attracted many a fraudulent players who were not
fit to operate
Lot of people made a lot of money, the wise ones stepped
aside and the over-enthusiasts, invested in more assets in far-flung places.
However, the fundamental factor on which this sector thrives was lost, the User
and not the investor was missing. Slowly the first shake-out happened, and the
weaker links in the game started breaking away. The over-leveraged factor and
unsold and incomplete projects started rising, fraud stories started erupting
and a number of companies closed their shutters. The heavy-weights who were
able to sell their inventories survived either due to good relations with banks
or there comes a time when the creditor has to give in the demands of borrowers
to safeguard their money. The ever increasing prices of inventory (developed or
launched projects) made in un-affordable for User and hence was supported by
investors for some time. However, every investor needs returns, and when their
interest depleted with vanishing returns, the funds dried up. At this point, it
should have been logical to lower the price and let the market correct, and here
lies the missing link.
Higher input costs:
This is the double whammy, with ever increasing input costs
and raw material costs due to overall inflation in the economy, this sector got
burdened with higher development costs. Hence, putting further pressure on
margins.
Also, with MNREGA coming in the labour became a scarce
resource and had a better bargaining power, thereby again leading to higher
costs at the hands of developers. However, the parallel economy (black money) must
have kept the market upbeat and the development has still continued despite drying
up of bank funding.
There is difference between cash and per sq. Feet space.
There came a time when the latter was considered cash, but unsold space is a
cost (interest + Opportunity) and should be cleared to maintain cash flow.
Higher cost of
acquisition:
With governments mobilizing land acquisition act for vote
banks, the bargaining power of farmers grew. And like the retrospective tax on
Vodafone, many developers had to not only pay up farmers for the land already
acquired and save their investments. Also, their future investments and plans
basis which they has cleared funding became unviable, thereby again hindering
their cash flows.
Also, many a small developers who were the followers and not
the entrants always entered the markets late on rosy projections and had to
cough up higher prices and work on lower margins, thereby further tightening
their situation. When the projects became unviable, they shut their shops and
ran away with the investors money or are waiting for a bail out
Cartel formation:
The price in an area is beneficial for the other and an unsaid
cartel has been formed in many areas. Also, the ever inquisitive nature of
buyers is keeping the hope alive. For instance in Gurgaon any good development
cannot be found at the buying price of less than INR 8,000 – INR 12000 per sq
feet. This is preposterous as an average selling price of a normal 1500 sq. Feet
apartment would be about INR 13mn. – INR 18mn. Leveraging about 85% of the price
of the apartment comes to about INR 0.12 mn. per month for 20 years. Only a working
professional(s) or a DINK couple with a combined salary of more than INR 0.3mn
per month will be willing to invest or move in. Else an investor will be
willing to invest with a view of rosy return in future. This seems a little
unreasonable for the very fact that even 60% of the total available units will
be able to find “users” for their developments.
Hence, comes in the question about the lowering of prices to
adjust to market reality. Given the fact that is not happening, these
apartments are being rented out as that is more affordable for the user. This
gives the owner a return of about 2.5% per annum, which in no way is anything
to rave about. Hence, it becomes more affordable to rent out rather than own a
house.
However, working on ever enthusiastic attitude of rising
real estate prices, this leads to a systemic risk and hence leads to creation
of cartels so as to not sell below a particular price and safeguard the
interests of few on the cost of many.
Vested interests:
It is not un-common to find vested interests that do not
have any association to the business whatsoever but their commandment does not
let the developed lower the prices. It is as similar to having a non-executive
investor in the company with a majority stake who though does have any
knowledge of the business but wishes for the best returns as comparable to an
e-commerce industry these days. These vested interests invest or park their
surplus (not necessarily on the books income) and are looking for returns till
they do not need the money. These interests too discourage the developers to
offload the inventory due to the returns expected by these ghost investors and
the higher costs as mentioned above
No Financial
discipline:
This is in inherent nature and not a followed diktat. More money
in this sector saw instead of better products, fancy cars, customized holidays,
designer clothing and designer homes for the owners entering the houses of the
developers. Anticipation of income has seen kins of these businesses driving
the fanciest of cars and splurging like there’s no tomorrow.
A financial discipline is most necessary while conducting
any business. Cash flows should be utilized towards bringing efficiency in the
business rather than adding cars to the fleet. Lack of this has dwindled many
developers into bankruptcy and reeling under pressure. Also, this business has
transformed into show business, with the success being measured by the fleet of
cars and the labels one wears. A Sales manager of a real estate (infrastructure
they call it now) I met recently speaks in Millions and drives a fancy car, but
a little probe left me bewildered that
his income is levered about 70%. A fancy car and a designer lable helps him in
selling at a higher price. This is what I call the Iceland effect, where its
just the money in the economy playing a role and no one knows how to value the
asset. It is speculation and not efficient buying and selling which is driving
the industry. And once speculation takes the charge, its always best for retail
investors or users to stay put till the market corrects.
Also, there is no mechanism to hedge the risks against such
kind of markets in India.
Most of the points mentioned above are common for other sectors reeling under the pressure, however, that does not mean that we will keep bailing out everyone. What steps were taken for the recent airline which almost has shut down (however not so delayed) should be kept in mind and the market should be allowed to take its call. Else, the NPA's will rise and tax payers money will be lost.
Banks however, should consider the risk of losing the money
in one scenario atleast as they are lending to the developers to build and on
the other side financing the borrowers and investors to buy at an inflated
rate. The unsold inventory is piling up
as the investor is not attracted at the returns anymore and the User finds it
too expensive. Hence, It should be left to the markets to decide who shuts the
shops or corrects the price rather than “bail – out” the developers so they can
carry the farce and create another bubble.
Seems all the hard work and reforms (read good reforms) are
being let go off by the government. And I am but forced to draw an analogy with
the recent hit movie by showman of Bollywood “Ek Tha Tiger” and the recent
spate of disappearing tigers in India. The same is the state of reforms which
are disappearing and are being replaced by these “suggestions” by the government.
