A Game ChangerReal Estate (Regulation and Development) Act

[RERA]Short term pain, but long term gain for the sector

September 2016

From the Desk of CEO - Real Estate Investment and Advisory

It gives us great pleasure to present our maiden quarterly theme-based newsletter.

The team endeavours to create benchmarks in the industry and provide extensive

research-based approach for its newsletter, which shall be useful to all stakeholders.

With the implementation of RERA, we are entering a new phase in the real estate

sector in India.

RERA is definitely a step in the right direction as it aims to bring greater transparency in

the sector. It shall not only help in bridging the trust deficit between customers and

developers, but also enhance financial discipline in the RE industry.

RERA will have far reaching implications on all the stakeholders involved. It is

important that we understand the broad contours and implications of the Act, even as

its implementation is taking shape. Hence, we have chosen RERA as the first theme for

the Center of Excellence newsletter.

We will explore more themes in the future editions of the newsletter and look forward

to your feedback in this regard.

Regards,

Ram Yadav

Pre

face

From the desk of Head- Real Estate, Centre of Excellence

There are moments which mark our life- moments where we realize nothing will be

the same, and time is divided into two parts - before and after. Particularly over last

two decades, the Indian Realty Sector has witnessed several such moments, driven by

market demand, Government regulations like opening of FDI through Press Note 2

(and subsequent relaxations) or REITs, construction and engineering marvels, quality

facilities management, innovative financing structures, mortgages, project ratings,

IPOs of Indian realty companies, the entry of International Property Consultants and

many more.

When we, at team CoE, sat down to pick a theme of our maiden newsletter, we felt

that an event which is likely to have maximum effect on all stakeholders, be it the

developer, the financial institution, the intermediary and above all, the customer, is

the RERA which will be most impactful. The output in the shape of Real(i)ty is brought

to you through extensive research and post discussions with multiple stake holders.

RERA may be the life changing moment in Indian Real Estate, where we could divide

the journey into two parts- before and after!

We thank you and look forward to receiving your feedback.

Yours sincerely,

Puneet Bhatia

TABLE OF CONTENTS

• Background 1

• RERA - Key Highlights 2

• RERA Implications 3

a. End Users 3

b. Developers 4

c. Brokers 5

d. Financial Institutions 6

• Industry Leaderspeak 7

• International Regulations 8

• Summary 9

• References 10

• Team CoE 10

• JAMMU &KASHMIR

• HIMACHALPRADESH

• UTTARAKAND

• PUNJAB

• UTTAR PRADESH

• RAJASTHAN

• GUJARAT

• MAHARASHTRA

GOA •

• KARNATAKA

• ANDHRA

PRADESH

• TAMIL NADU

• KER

ALA

•

HARYANA

• NEW DELHI

• ODISHA

(ORISSA)

•

CH

HATTIS

GAR

H

• MADHYA PRADESH

• BIHAR

•SIKKIM

• ASSAM

•MISORAM

• MANIPUR

• MEGHALAYA

• TRIP

UR

• WEST

BENGAL

JHARKHAND•

•

ARUNACHAL

PRADESH

• NAG

ALA

ND

Demand

• India- burgeoning population of ~1.3 bn

[1]• Acute housing shortage in the range of 20-70 mn units

Employer[3]• 2nd largest employer in country after agriculture

J BSO

Foreign Investments• One of the largest avenues for FDI/FII

YC

Current Scenario

A few reasons for the

trust deficit in the Indian RE sector are

summarized alongside. All of this impacts demand and partly

contributes to rising inventory levels. Thus, regulatory guidelines

like RERA have emerged as the need of the hour, not only to bring

much needed transparency but help home buyers and above all infuse confidence in the sector.

Lack of information on developer or the project

Opaque market with differential pricing

Absence of structured grievance redressal mechanism

Siphoning off of funds by some developers

Slow project progress, delayed possession

Reasons for mistrust

GDP Contribution[2]• Sector contributes ~6% to India's GDP

Major Pitfalls

Bac

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un

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Major Clauses of the Act

RER

A –

Key

Hig

hlig

hts

• Compulsory registration of all residential and commercial projects with land of 500+ sqmt or having 8+ units. RERA will apply to all projects for which completion certificate has not been obtained

• Mandatory disclosure of promoters and project details (past 5 years data). Also, quarterly disclosure of project status

• Agents/Brokers to be mandatorily registered under RERA

• Launch of project only after Commencement Certificate in place; hence, no 'pre-launches'. Not more than 10% collection permitted before sales agreement

• 70% collection to be maintained in a separate account for project purposes. Withdrawal will be allowed to the extent of project completion

• Units to be sold on carpet area basis

• Structural defects within 5 years to be rectified without any charge

• Refund of amount/compensation in case of delay in handing over possession

• Restriction on changing plans without prior approval of 2/3rd allottees

• Punitive provisions, including de-registration of the project and penalties/ imprisonment in case of violation

• Strict legislation against release of misleading advertisements/false statements

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End Users – The biggest gainers

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RERA is stacked in favour of protecting customer rights which were flouted in the sector previously by some developers. This is, unequivocally, bound to change with RERA.

Assurance of timely delivery and quality

• Lower probability of RERA registered projects running into legal hurdles due to title or zoning issues

• Financial discipline on developer - restrictions on fund siphoning

• Punitive measures on developer for delays/not honouring commitments

• Quality assurance - defects within 5 years to be rectified free of cost

Empowerement to tackle unfair practices

• Restrictions on unilateral changes in plans by the developers

• Penalty upto 5% of project cost for non-complinace

• Compensation in cases of delayed possession, with provision for refund if buyer opts out

Pricing

• Pre-launch inventory at sale without mandatory approvals will not be allowed

• Uniformity of pricing as sales on carpet area instead of super built-up area

• In long run, cost saved due to timely completion of projects and standarized activities will benefit the customer

Informed decision making

• Access to track record of developer and project

• Harsh stance on misleading advertisements

• Timley update of project information will avoid ‘information arbitrage’

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Developers - Genuine players to gain, while unorganized operators bound to perish

Increased Customer Focus

• Focus to provide superior customer services throughout the buying process as well after sales service

• Sales agreements to be registered with regulator, empowering buyer

• Punitive measures against delayed project delivery & misleading ads

• Onus of rectification of defects within 5 years of possession is on developer

• Maintainance of 70% of sales collections in project account with certified

Unorganized players will be at losing end

• Increased compliance will tighten noose around their necks

• RERA will curtail practices of using land parcels without or with partial approvals to attract advance bookings

• Increased hestiation among financial institutions to deal with such developers

• Likely to face punitive measures on their multiple incomplete projects stuck at various levels

Higher Disclosure and Compliance Requirements

• Mandatory registration of project with RERA, entailing disclosures of promoter's RE activities

• Detailed disclsoure of project plan, layout, government approvals, land title status, sub contractors leading to higher cost of compliance

• Periodic updation of project progress, sales, inventory and approvals

• Currently, sizeable funding of projects happens through pre-launch sales. With RERA, there will be an end to pre-launch concept and launch only after project is RERA registered

Conscientious developers will gain from RERA

• Already have established systems, processes and management bandwidth to comply with RERA

• No drastic changes required in operations as already adhere to best practices

• Premium pricing on account of reduction in competing 'inventory’

• Attract funding from banks and PEs/FIIs with renewed vigour

• New projects will require high capital cost initially towards land payment and approvals for which developer needs to find equity partner - may see more Jvs

To sum up the impact of RERA on developers, unorganized players will find themselves in peril due to punitive measures on stuck projects and stringent compliance requirements. On the other hand, organized and professional players will leverage their existing processes and capability to not only comply with RERA but also attract more buyers and investors.

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Brokers - Professionalism and Consolidation to follow

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Accountability

• Aggravated customer can file complaint against brokers too, in addition to developers

• Broker as a key stakeholder in RE sector under the ambit of RERA will now have to be more accountable in their dealings

Secondary Market- Unaffected as of now

• RERA covers only new and under construction projects; brokers operating in the secondary market will not be impacted

• In future, further expansion might bring them under RERA

Registration of Brokers with RERA

• Presently, India has a large number of real estate brokers, operating without any regulatory overview

• RERA entails registration of agents and brokers

• States need to formulate processes , systems and guidelines for application and registration of real estate agents

The road ahead with RERA will impact the Broker as key stakeholder in the RE sector. Brokers whose primary livelihood is property dealings and brokerage, and who demonstrate professionalism and accountability along with good training and experience will be able to function and thrive. Also, economies of scale at operational level, sharing of best compliance practices and education will result in consolidation of the brokerage sector.

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Financial institutions - Short-term challenges, but opportunities and benefits in the long-run

Short Term - Challenging

• Enhanced focus in NPAs recognition due to delays in underlying projects against existing loans

• Existing loan portfolio of under-construction projects will throw up challenges. Eg: Mandatory prepayment clauses may face issues due to restriction of keeping 70% collections in project account

Long Term - Benefits

• Availability of quality information will assist better credit assessment

• Funds diversion will reduce, enabling better assessment of project cash flows, thus reducing deviations

• Slippages due to NPA over long term will reduce due to more robust risk underwriting and higher predictability in implementation

Control on project - Double edged sword

• Balance of control shifts towards customers

• Clauses such as revoking of project registration based on allottee complaints and allottees having the first right of refusal on carrying out remaining work, will shift project control

• Such clauses restrict enforceability by lender in case of defaults by a developer

Financing Opportunities- Increase

• End of pre-launch and financial discipline on sales collections would result in more funding opportunities for FIs

• Reduced risk exposure due to additional and stringent compliance

• Capital requirement for Equity/Mezzanine finance shall go up to fund land acquisition

• Cost of Working capital will reduce

With RERA, lendings to projects at initial stages may assume higher equity/mezzanine debt characteristics to protect the financial institution's interests. We may also witness creation of SPVs by FIs to route such transactions, so as to ring fence the larger FI as the promoter of an RE project against possible litigations by allottees.

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Industry Leaderspeak

“We congratulate Edelweiss RE Centre of Excellence for covering a topical subject, the impact of RERA on Real Estate. Real estate regulation is an established practice, tried and tested in most developed countries. Implementation will throw up some challenges in India, and will require some tweaking along the way. There is excitement in the market about RERA, but we also need to put in efforts to improving our dealing with construction permits. We currently stand at 183 out of 189 countries in terms of pace of approvals. It is good that first world regulations are being legislated, but we also need good governance to implement these changes.

Funding requirements for the RE sector will increase on account of:

• The requirement to maintain 70% of the funds collected in project account, to be used strictly for project related expenses

• Not more than 10% collection is permitted without sales agreement “

Mr. Surendra Hiranandani, Founder & MDHouse of Hiranandani

''Congratulations to team Edelweiss RE Centre of Excellence for taking up an apt topic of RERA in their newsletter. RERA is a step in the right direction for the realty sector. It will inculcate discipline in the sector and provide relief to the customers. Developers and Financial institutions are currently gearing up for RERA compliance and gauging the implications of the Act. Developers will have to ensure timely approvals so as to complete projects on time.

Financial institutions' control on projects is likely to reduce on account higher rights accorded to allottees and the rule pertaining to 70% retention of collections in project account. We will witness the creation of more structured lending in the sector. While the quantum of lending in initial stages of a project may increase, the number of projects being funded will reduce. How conflict between RERA and existing SDR and bankruptcy laws is resolved remains to be seen.''

Mr. Sapan Gupta, National Head- Banking & Finance PracticeShardul Amarchand Mangaldas

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International Regulations

Dubai • The Real Estate Regulatory Authority is the Government agency in Dubai set up in 2007. The functions and reasons for set up of this authority in Dubai are very similar to RERA in India.

An online society has been built by the Authority to help in greater coordination between developers, investors, buyers, financial institutions and law firms.

• The reasons for setting up such an authority in Dubai are:

• To provide a strong legal framework to all the participants in the Real Estate space

• To bring in transparency and eliminate property frauds

• To protect the buyers from unfair practices of some developers. The buyers can check if the real estate developer is certified by RERA and possesses a registration number and thereafter make payments via escrow accounts in RERA certified banks

• It helps the industry to develop strategies and regulate activities

• Higher transparency helps in attracting potential investors to Dubai as their confidence will increase

• The functions of this authority are:

• Regulate and set standards for brokerage activities

• Registration of lease contract and rental agreements

• Issue license for Real Estate development professionals

• Formulate processes and documentation related to property

• Provide statistical data about properties to government and the public

• Regulate real estate advertisements in mass media and licensing of real estate exhibitions

Europe • The EU has a mix of countries which are highly regulated and countries which require more regulation.

• Property Services Regulatory Authority is being introduced in some of the countries to bring in more transparency in licensing, regulation and provision of information to the public. In countries like Czech Republic, preparatory work is being done towards more regulation

• In Europe, there exists a Directive on the Recognition of Professional Qualifications which helps individual countries in their regulation. The European Professional Card which is an electronic certificate issued for the recognition of Real Estate professionals has been available from January 2016. This aims at bringing more effectiveness and transparency in the system

• There are some countries which are highly regulated and are moving towards deregulation. Examples include Poland and Portugal where the legislation for removal of the requirement for holding a professional licence by real estate professions has been passed. Further, the European Union is planning on a mutual evaluation between Member States which will require them to evaluate further and justify remaining professional restrictions. Unnecessary restrictions would be scrapped by the respective Member States

UK • UK has a set of Building Regulations developed by the Government which are the minimum standards for design, construction and alterations to every building.

• Also, in the UK self-regulation has been a strong tradition where designated self regulatory bodies appointed by the authorities in effect regulate certain professions taking into account the public interest

US • In the US, building codes are adopted, modified and enforced by local government officials

• Building codes change frequently and vary by state. Most states have adopted the International Code Council series. These codes are updated every 3 years.

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SUMMARY - Short term pain, but long term gain for the sector

While internationally these regulations have been prevalent in most of the countries, we are of the opinion that several developers may struggle on the implementation of RERA in the short term, as existing projects too will be under the ambit of the Act. Also, the number of deals will reduce in the short term, while the quantum of financing requirement will increase. The Act augurs well in the long term, as it will make real estate structurally a stronger industry, with better practices, making it attractive to buyers and investors alike.

Consolidation and professionalisation of

industry

Timely completion of projects- reduction in

finance cost

Higher transparency, attracting more

buyers

Increased investments and

PE Funding

System shortage to tackle elaborate compliance

requirements

Higher litigations against stuck projects

Reduction in number of new launches

Short Term Pain

Long Term Gain

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References

1. [ 1 ]http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:22727486~pagePK: 64257043~piPK:437376~theSitePK:4607,00.html

2. [2] http://www.ey.com/IN/en/Industries/Real-Estate/EY-New-avenues-in-Indias-real-estate-sector

3. [3] http://planningcommission.nic.in/plans/planrel/fiveyr/10th/volume2/v2_ch7_6.pdf

4. European Association of Real Estate Professions Confederation Europeenne de l'Immobilier CEPI-CEI Confederation Europeenne Des Administrateurs de Biens

http://www.b4ubuild.com/links/codes.shtml

5. https://law.resource.org/pub/au/ibr/au.ncc.1.2012.html

6. http://www.poole.gov.uk/planning-and-buildings/building-control/what-are-building-regulations/

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Team CoE

Puneet Bhatia

Anwar Khan T. K. Mahesh Abhinav Jindal Neharika Nawapet Tanaz Tantra

Email: re.coe@edelweissfin.com

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