FOREIGN DEBT STILL SEEPING INTO REALTY

Foreign debt, banned in real estate, is finding its way into property firms as bankers and lawyers help builders cobble together new deals to raise money. Even though foreign loans—better known as external commercial borrowings—are not permitted in construction, property firms have spotted a mechanism where the debt can be provided by foreign institutional investors (FIIs) registered with Sebi. No rules are broken and the deals, involving a three-way transaction, come across as normal private placements in the corporate bond market. The process begins with a real estate company placing nonconvertible debentures (NCDs) with a local entity, such as a nonbanking finance company (NBFC). The next step involves listing the debt security, soon after which an FII steps in. Once the NCD is listed on a stock exchange, the NBFC offloads the paper to a foreign fund. Since FIIs cannot invest in unlisted debt, the NBFC warehouses the NCD till the paper is listed and then recovers the money by selling the debentures to a foreign fund. The two transactions are part of a back-to-back deal struck between the firm issuing the NCD, the local NBFC and the FII. At least four developers—three from Mumbai and one from Bangalore—have risen over Rs 1,000 cr in the past few months through this route. “It does not directly violate the Press Note on foreign investment in property, and such FII investment is within the overall corporate bond ceiling applicable to foreign funds... but it’s against the spirit of the regulation,” admitted a senior banker who has advised one such NCD issue. Indeed, a few foreign banks have made presentations to property firms on the convenience of such fund-raising which has become more attractive since the government plugged a loophole on the foreign direct investment (FDI) regulations in the real estate sector.

Courtesy:- ET dt:- 04-Mar-2010

INVESTORS SPARED OF SPECIFIC NORMS

In the past few years, FDI worth billions of dollars came in as overseas investors subscribed to equity and quasi-equity products — often with put options — sold by real estate firms which were starved of bank finance. But a chunk of this inflow was based on an interpretation that the three-year lock-in on the FDI applied only to the ‘original’ amount brought in and not the full quantum of FDI in a project. Many investors took advantage of this: an offshore fund which decided to put in, say, $25 million split the inflow, by first bringing in $5 million, the minimum amount, and then bringing in the balance $20 million subsequently. The understanding was that the lock-in applied only to $5 million and not $25 million. This flexibility in interpretation disappeared after the government clarified last year that the full amount, irrespective of whether the money comes in tranches, would be locked in for three years. The move, which came as a jolt to several foreign investors, paved the way for the more recent NCD route that’s catching on among local developers. “There are advantages. First, there is no lock-in because the FII can sell the NCD as and when it wants. Second, the debt is secured against mortgage of assets, pledge of shares, etc. Third, unlike FDI, here the foreign investor can fund even those projects which are not FDI-compliant,” said a lawyer familiar with such debt-raising. For a project to receive foreign equity or FDI, it should not have less than 50,000 square meters of built-up area, among other things. “These conditions don’t come in the way when a foreign fund buys NCDs,” he said. Interestingly, such NCDs have also been issued by a leading NBFC which, like property firms, are restricted from tapping the ECB market. According to a real estate fund manager, some foreign investors reluctant to increase their equity exposure post the downturn, prefer secured debts with a decent interest return. Sebi’s listing regulations extend to debentures that have been privately-placed; and, the NCDs can be listed even if the real estate company or a project specific special purpose vehicle floated by it is a private firm or an unlisted public entity.

Courtesy:- ET dt:- 04-Mar-2010

CONSTRUCTION SERVICES TAX TO RAISE COST OF APARTMENTS

The Budget proposals have thrown up a dampener for the housing industry. Construction services have now been brought under the ambit of the service tax in an unexpected move that would raise cost of apartments that are still under construction. As per the Budget proposal, the finance ministry has suggested that construction would be deemed to be a taxable service if the building or complex is still under construction and approval from the concerned regulatory authority — which in most cases is the resident municipal authority — hasn’t yet been granted. The levy would cover all construction of complex service or commercial or industrial construction services, the Finance Bill suggested. The service tax levy would be 10.3% and would also apply to additional services such as those offering preferential locations for flats in multi-storey buildings where flats in each floor are priced at a premium due to their location. This too has been described as a service and hence taxable, according to the proposal which was tabled in Parliament on Friday by finance minister Pranab Mukherjee. The premium is typically levied on categories such as flats or apartments that are above a certain floor rise or have other high value locations such as being in front of a garden or a sea or any other preferred locality. “The proposal is to tax construction if the entire payment for the flat is made before completion of construction,” said consulting firm RSM Astute executive director K H Viswanathan. “This would increase the cost of the apartment and may discourage potential buyers.” The service tax would be 10% on 33% of the price of the apartment, while on the remaining 67%, tax won’t be levied. Till now, for all apartments under construction, customers paid in instalments based on plinth level construction and also on the progress in building activity. Banks too lent money to the customers according to the requirement of the builder. Now most developers would ask customers to pay the entire value of the building if they sought to lock in at a certain value. This would mean paying the entire sum before the construction. Typically, in cities such as Mumbai, where there is a pressure on space and hence apartments and flats are much sought after, customers booking for flats in an under-construction building, is very common. “The service tax and excise duty hike on cement would increase the overall cost of apartment by about 10%,” said Dharmesh Jain, managing director of Nirmal Lifestyles, a Mumbai-based developer. “It’s a negative step and we are considering to meet the finance minister to plead for a relook on this measure,” he added. But there are other positive measures that the Budget proposes such as allowing pending projects to be completed within a period of 5 years instead of 4 years, for claiming deduction of profits, as one time interim relief. There is also a suggestion that the commercial area included in a housing project would now be 3% of the aggregate built-up area of the housing project or 5,000 sq. ft, whichever is higher, compared to the existing limit of 2% and 2,000 sq.ft. respectively. This would help developers and real estate companies to make their projects more viable.

Courtesy:- ET dt:- 01-march-2010

PNB SHUTTERS LOANS AGAINST PROPERTY

Other Public Sector Banks Such As Bank of India, Bank of Baroda & Indian Overseas Bank Go Slow On Mortgage Loans Banks have started taking proactive measures to prevent defaults in their real estate portfolio by cutting exposure to loans against property. State lender Punjab National Bank (PNB) has taken a lead and has stopped giving such loans while Bank of India, Bank of Baroda and Indian Overseas Bank have decided to go slow on such loans. While banks have always been cautious and selective on real estate loans, this is the first time a bank has taken a decision to avoid this business. Banks' real estate exposure includes loan against property, and loans to builders. Although home loans are a part of real estate exposure most of them constitute priority sector loans and are not a part of bank's exposure to sensitive sector.

Loan against property

popularly known as mortgage loans — is mostly availed by small businessmen and trader community. Officials from PNB say the decision was taken a few days ago. Other banks have been going slow on such loans for the past few months, although they have not completely stopped it.

Bankers point out that this section of borrowers is typically the one which does not have a balance sheet culture. This makes it difficult for lenders to foreclose a property. "Most traders do not disclose their cash flows to banks nor do they draw balance sheet. Traders avail loans based on property pledged with banks. In case of defaults, banks are unable to gauge the cash flow position," said a senior official from PNB, justifying the stand taken by the bank.

Senior officials from Bank of India and Union Bank of India pointed out that they are encouraging loans where the trader is willing to avail a business loan with property as security. But for a business loan, they need to draw balance sheet. "We are discouraging loan against property by refusing to provide overdraft facility and charging higher margins," they added. Other banks are discouraging such loans by valuing the property at distress level or by valuing the property at the price it was purchased.

Resistance towards such loans is also because real estate loans attract higher capital requirement than other loans. "Besides, if we have to take real estate exposure on our books we would prefer giving loans to builders where we can charge higher interest rates rather than to loan against property to traders," said senior officials. At present, most builders avail loan at interest rates much higher than benchmark lending rates, while loan against property is usually pegged at PLR or slightly higher. PSU banks' PLR stands between 13.75% and 14% while private and foreign banks have pegged it at 16-18%.

In the last two years, banks have been going slow on loans to builders as on several occasions the Reserve Bank of India and finance ministry had expressed concern over these loans. To discourage banks from aggressive lending to builders, RBI had stipulated a higher risk weightage of 150 basis points on loans given to them. This is much higher than 50-75 basis points risk weightage on top-rated borrowers and retail loans

Courtesy: - ET dtd: - 25th Sep. 2008