Alternate funding for developers

Due to the ongoing crisis, the real estate sector has seen a 60% fall in the demand for properties. Banks are quite reluctant to lend loans to firms even for ongoing projects. Hence, developers are looking at alternative instruments of funding such as lease discounting for completing ongoing projects, especially the commercial ones.

Under a lease or rent discounting agreement, banks lend to developers for new projects against rents they directly realize for completed projects, which also is mortgaged with the bank. Thus, banks are assured of guaranteed cash flows and also have physical assets in case of defaults. Lease discounting is a much safer mode of lending, as the entire loan amount is covered through the rent agreement, and the banks are cushioned against defaults. The risk averse banks are more willing to lend under this arrangement as it is safe. Also, the rate of interest charged by banks for loan against rent, generally for a tenure of five-six years, is generally 1-2 per cent lower than the benchmark lending rate.

But the question remains how many banks are willing to lend to developers? Most of the bankers say that they have limited headroom for real estate sector and have already exhausted the stipulated limit for real estate lending.

Problems with the real estate firms

If you are a developer, I am sure you are a worried man! Things are not at all rosy for the industry, which was a darling of foreign and domestic investors for the last few years. So what went wrong with the sector? why has it started loosing it shine? I believe there are many a factors hurting the developers and all at the same time. I will discuss few of them here.

1. Liquidity crunch
Real estate firms have depended hugely on foreign investors to raise capital to fund their expansion plans. Now the crumbling financial sector has forced investors to either pull out of the ventures or stop lending to firms (Rumor is Lehman Brothers has over $1 Billion of investments in Indian real estate sector!!). This has put a brake on the expansion plan of the developers. Additionally, RBI has strict lending conditions for Indian banks for real estate sector. With the stock market showing signs of southward movement across the global, developers plan to raise capital by IPO or issuing additional stocks has now no taker.

2. High interest rates
RBI's aggressive policy to control inflation over the last six months or so has led to higher interest rates in the market. Interest rates on home loans have shot up from 7.5% in 2005 to 14% in mid-2008. Residential properties buyers are shying away from borrowing loans because EMI has shot by tremendously. Thus, demand for residential properties has come down significantly. This is hurting developers who are left with lot of invesntory and stuck with ongoing projects. Moreover, borrowing rates for developers have shot up as well. Indian banks are putting a yield spread of over 400bp on real estate firms' bonds.

3. Global slowdown
There is a constant fear that US and EU might slip into recession due to the ongoing financial crisis. This will seriously hurt India's flagship Outsourcing industry. Given the fact that IT/ITES firms consume around 75% of all commercial properties in India, any slowdown in this industry will seriously hurt developers. Real estate firms have lauanched numerous projects (some eof them are under ccoinstruction).

All these will have a spiral effect on Indian economy. Global slowdown and higher interests mean lower growth for IT industry, exports sector, automobile industry, banking system etc. This may lead to lesser hiring in the coming months or years or layoffs to cut costs. All these will lead to negative sentiment in the market and among consumers; thus, lowering the demand for properties or in general on most of goods and services. I believe demand for properties in FY'09 would be 30-40% lower than that of in FY'08.