Tuesday, April 08, 2008

High interest pushes realty to brink

Its high time the bubble pops in Mumbai real estate. The government made few other announcements over the past few days which will impact prices downwards.

1. All flats to be sold on carpet area. The builder can charge for common area but it has to be mentioned in the agreement
2. Increase in FSI for suburbs from 1.0 to 1.3 thats a 30% increase. FSI for SRA TDR's are 2.25 and for Dharavi slum redevelopment it is 4. I think in the city areas it is 2.
3. The premium on the extra FSI has be removed. So the extra .3 which was sold at a premium is now at current rates. This will force TDR's to go below market rates as the premium which existed on the TDR is no valid.

Coupled with the liquidity crisis which the article is taking about, welcome to the bubble pop. You heard it first here :). If you notice carefully the article makes a reference to the word bubble. In the past the writers would always justify the prices repeating cliches like "There is no land in Mumbai", "Prices never fall", "People are migrating to mumbai from all over". All bull crap to justify ad-space spending in their news papers.

MUMBAI: It’s a scary reminder of the exorbitant interest rate of the 1990s’ inter-corporate deposit (ICD) market, where companies borrowed at enormous cost to tide over a cash crunch.

Often, these desperate borrowers ended up losing their businesses to bigger players and loan sharks. In what could be the making of another turmoil, real estate developers, particularly the less creditworthy ones, are today borrowing at as high as 19%-20% from big finance companies to stay afloat.

A week ago, a large property company (which recently withdrew its IPO due to adverse market conditions) was forced to roll over its short-term borrowing from mutual funds, a tell-tale sign of the cash flow strain that some of the realty firms are grappling with.

Since banks have shut their doors, small and medium builders are passing their hat around aggressive non-banking finance companies and MFs who subscribe to the bonds issued by the property firms. The fund houses have quietly rolled over the debt, fearing that the news of default could affect the returns of their schemes and hence, scare away investors.

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Builders who had managed to raise cheap money in the booming IPO market and those who had old land banks created over a period of time at lower rates are in a better shape. But those who had paid a slice of the cost for expensive plots, hoping to make the balance payment with the IPO or private placement money, are stuck.

Small builders who are turned away by MFs and finance companies are borrowing at even higher rates from diamond traders and HNIs. The cost of such money is at an usurious level of 2% a month. Besides, they are mortgaging their properties at 60%-65% of current valuation to raise the money.

“There are three categories of lenders: private NBFC, financial institutions that qualify as NBFCs and a few subsidiaries of foreign banks and securities houses. As long as prices stay high, the party can go on. But it will be impossible for the bubble to sustain for a long time. While pure FDI is coming in for specific projects, structured deals with leveraged foreign funds have come down after the subprime crisis,” said a real estate fund manager.

But the fear is that many companies have already walked into a debt trap with prices beginning to correct in most big property markets except Mumbai. “If the markets do not witness a substantial rise in demand and price in the next six months, these companies will either go bankrupt or be forced to sell out,” said a banker.

Property players also mop up funds by securitising their receivables. If such financing structures bonds (better known as pass through certificates) are sold on the back of the fund flow, they anticipate from property sale. If deals slow down or property prices drop, servicing these bonds becomes difficult.

“However, property prices have to really crash for this to happen. Securitisations are done with margins to cushion the blow,” said a fund manager.

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