The recent bloodbath in the real estate sector has started taking a toll. Almost all large developers are now facing a severe cash crunch and finding it difficult to complete their ongoing projects. In fact, the situation is so bad that most of them have reported a 50-70% cash shortfall. Industry sources told SundayET that the liquidity crunch has forced many developers to pick up cash from the unorganised market at interest rates as high as 35% to 50% annually. The lending rate of banks is between 18% and 20%.
As a result of the crash crunch many developers have started going slow or even stopped construction of projects which are either in their initial stages of development or which would not affect their bottomline in the near future. While most developers that SundayET spoke to, agreed with the problem at hand, none of them were ready to be quoted on how it had affected them.
What’s more, bankers say they may now get more cautious towards lending to real estate developers. “Real estate companies have many projects at hand and the sales have been constantly dwindling. Analysing these sentiments, any financial institution will be cautious. Remember, during monsoons, housing sales come down and banks may have to consider increasing interest rates further in future,” says HDFC Bank chairman Deepak Parekh. State Bank of India (SBI) is no different. It is also contemplating similar measures. “We are not sure for how long the current volatility will exist in the realty market. Also, banks need to maintain their reach among their clients. However, it is possible that all banks may sanction loans to only those developers with whom they have had a long relationship,” says a top SBI official.
Industry experts feel the only avenue available for raising capital in the current situation is at the project SPV level and by way of private equity or similar sources, which is generally the most expensive method of raising capital and has limitations on the over all extent of financing that is required. “Concerns about liquidity will continue to plague the market since debt will not be easily available. Real estate players had traditionally raised money from debt funds via corporate deposits and commercial paper. However, debt funds are currently not eager for more exposure in real estate and are continuously rolling over the debt advanced to these players. The primary source for institutional funding will, therefore, now be private equity,” says JLLM chairman & country head Anuj Puri.
It was only a matter of time before the worldwide squeeze in liquidity affected Indian real estate and this news should not come as a surprise to anybody. While the implications of a liquidity squeeze are no doubt bad for developers, private equity investors who have already taken stakes at an SPV level are also likely to be hit badly. High cost of leverage & delayed cash flows have a severe impact on IRRs. Consider the scenarios below
Even without accounting for any escalation in costs/drop in prices due to softness in the market, returns to the private equity investor drop by more than half due to an increase in the cost of leverage and a 6-month delay. Of course, if even if you add a very conservative input cost escalation (we have seen higher numbers), there is a further drop in realized returns. Not a very pretty sight for anybody who went in thinking this was easy money. The developers are in a slightly better position because a) Their investment in the SPV was likely in the form of land bought at a lower price b) They get paid a variety of fees (construction, project management etc.) and are able to recoup a part of their investment regardless of how little the private equity investor makes.If the conclusion drawn up in the ET (of private equity being the primary source of institutional funding) needs to hold, expect to see private equity investors demand a very high return on investments going forward. In turn, this does not bode well for Indian developers who not too long ago were in the driver's seat and could choose between investors. The altered landscape is already weighing on the equity markets, though it is not clear to what extent it has been priced in.
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