How to Navigate Funding Challenges in Real Estate

Real estate is a highly capital intensive sector and  requires big capital  to set up  business and  drive growth. Capital in India is available at a high cost and that too only for construction and home finance and not for land purchase which makes  the business unviable. In the light of this, the big question is how to meet the funding challenges to run the business smoothly.

After twenty five years of deep diving into the  industry, my take is not new or different from what we had read during  school time about the survival of the fittest. Even today what we need to learn is how to get into the category of being labelled as ‘fittest’. Over the last two decades, we saw a large number of small  time contractors become big  and the more ambitious ones grew to become developers and later big developers.

The early years of 2000 were bountiful years for the industry and the developers made huge fortunes. Home loan was introduced by the banks and the white collared employees from the  IT Industry, banking & finance, FMCG could easily leverage their salary slips and buy homes. One had to pay just 15 % of the property cost upfront and the remaining  amount was funded by the bank. The supply was low and the demand was high, leading to big time appreciation in prices which turned real estate into an investment asset and not just a product to  fulfill the basic need of a shelter.

Not only the end users and investors saw this as an opportunity but  even entrepreneurs found real estate as a money spinner business .People who did not have any experience of construction also entered into this business  by virtue of using their  surplus money for buying land. Some traded in land and others started construction to make extra money by value addition. There was prosperity for all stake holders viz developers, investors, end users and also for the financers.Strong cash flows allowed the developers to tie up new land parcels for growth. The Excel sheets presented a super rosy picture and the industry steered like a brakeless vehicle .

It was a flourishing environment but it brought with it many folies. The true picture of financial health of the company was never known for the reason that real estate is work in process and mostly the assumptions are made hypothetically- FSI cost plus  construction cost  plus finance cost  equals to  total production cost . The selling price minus total production cost equals to profit. This is how calculations were done. No contingencies were ever accounted for. There was no cash flow management mechanism. The establishment costs and operational costs went out of control. The cost escalation was not provisioned. The real estate business was largely run in a conventional mode. Since the sale velocity was high for reasons listed above, the collection was far more than what was required for construction and operational management, hence everything looked just rosy. The developers who were able to market and sell aggressively, had surplus  funds to take out  from one project and  deploy the same to buy land for another.

And then came the  Dooms Day. Recession set in  and sales velocity got reduced. This impacted cash flows badly. The financial institutions also tightened their grip and hence the developers faced a double whammy – slow sales and tight liquidity. The projects started getting delayed and the consumer started getting nervous. The customers also faced the heat as on one side they were not getting possession and on the other hand they were made to pay rent and EMI.

Developers started defaulting especially the ones who had secured large debt at a high cost .The confidence of the customer was shattered. The local /regional developers faced a tough time trying to manage their customers and  brand value . And then, the national level developers took this as a responsibility and also as an opportunity to expand their footprint  into regional markets and enhance their market share

Prominent builders like Tata, Godrej, DLF, Prestige took advantage of the emerging opportunity and expanded their inventory across the country. These mega  brands which over the decades had built a loyal customer base, found traction and customer willingly paid premium in buying branded real estate, rather than purchasing from local or regional developers.

Moreover these big branded  companies easily raised capital from banks, NBFCs, alternate investment funds  and through FDI at very cheap rates, compared to regional local players. And as fund raising was difficult and expensive for mall/medium size local regional players, it made their business unviable.

Why do the funds discriminate when lending to one versus the other? Won’t this create a monopolistic situation? Developers must understand the way the funds operate and on what parameters the funds deploy capital. The funds primarily look at the criteras involving the delivery record of the  developer,  size of the organization and the quantum of work in hand and delivered,size  of the debt and the plan to  pay it off, brand value and  execution capability, strength of sales team to generate  the required velocity of sale for ensuring healthy  cash flow for the operation and  execution of the project, corporate governance and adherence to compliances,land records, consultants on board and     transparency in the system.

The national developers clearly pass all the above criterias and hence are able to raise funds from domestic financial institutions as well as international funds at cheap rates ,making them competitive with  sizeable profit . The regional / local players even with good track record ,find it  tough to raise funds in first place and even if they  manage, they get at a high rate of interest, thereby defeating the core idea of doing the business.

I have a set of simple recommendations for all those real estate developers who are here for a long haul and wish to do this business in a way that is motivating enough.

Create a listed parent or holding company under  which the business will be done.Be compliant and also make sure that you have a process-driven system which will ensure timely (quarterly) posting of results in public domain for the funds, government agencies,  public to evaluate your performance and have confidence to invest in your company. Create a skilled man power pool. And since an organization is nothing but the sum total of people who work there,create a solid organization structure.The future of the industry is bright for all those who believe in process driven organization rather than  an owner driven company.