Over the past few months, there have been announcements by various real estate companies that they are debt free or are on a timeline to reduce debt. From DLF to the Hawelia and Omaxe groups and many more have announced that they would reduce debt. Many groups like DLF, Hiranandani, Embassy and RMZ sold corporate assets to consolidators like Brookfield, Blackstone and GIC. This capital has been used to reduce debt. So, is debt the bad boy of real estate finance? Real estate players are lowering or eliminating debt from their books. Industry experts say the capital markets for real estate are still evolving and maturing. Debt management by loanee companies are today being closely monitored by lenders, who too are learning the ropes as capital structures evolve in real estate, says E Jayashree Kurup. Sandeep Runwal, President-Elect NAREDCO, says debt is the usual way for expansion of business. But the amount of debt that built up when companies borrowed left, right and centre was detrimental to the business itself. When sales slowed, there was not enough cash flow to service debt. In business, there always has to be a good balance between debt and equity. Runwal finds his choice of 1:1 debt-equity ratio and fiscal prudence helped the group weather the storm. Pushpak Pusegaonkar, COO, Century Real Estate, believes that “a certain portion of debt is necessary in scaling up the number of projects. The issue is how much do you leverage the asset backing you have and how much further do your cash flows allow you to take it.” He says debt is in two parts - construction finance and land funding. “Those with no existing land banks are pledging the existing cash flows for future opportunity. For those with existing land banks, debt is a medium to manage liquidity.” Mohit Goel, CEO, Omaxe, says that the perception of debt being bad came about 6-7 years ago. Earlier a 1:1 debt-equity ratio or even a 2:1 ratio was considered okay. He says debt is a cyclical thing and companies need to know how to manage it. His mantra is, “Keep debt light during a downturn when receivables are weak and makes debt servicing tough.” Goel says there are four kinds of debt borrowing: 1) Construction financing – This is about 80-85 per cent of total debt. This is the safest as the money is linked to construction and consumer receivables can be used to service the debt. 2) Corporate debt – This is take-out financing, normally secured for purchase of land. This is risky as delayed approvals or the project not performing, can result in an inability to service this debt. 3) Loan against shares – This should be the last resort, where developers pledge their own shares of the company to take debt to service debt payments. This stopped happening 4-5 years ago. 4) Customer advances – These are good so long as the developers do not consider it their own money. It is money paid in good faith to purchase a commodity that developers are entrusted to develop for them. Many developers have used it as their own in the past which explains the problems of the industry in the past few years. Rohan Khatau of CCI Projects says debt is not bad. The only problem he faced in Rivali Park in Mumbai’s Borivali was when the line of credit dried up in the wake of the NBFC crisis. Having used the Swamih funds to complete the project, he also monetised a portion of land and sold 8-acres to the DMart group. This allowed him not only to pay off the Swamih funds but also to reduce the overall debt load of the company. The Reserve Bank of India assigns a risk weightage of 100 per cent to real estate lending. This explains why lenders are averse to lending across the real estate sector. “The lenders were more focussed on their own valuation than in the asset quality they were lending to,” says Runwal. “They often lent to the same asset.” Now with RERA in place and lenders under scrutiny, rarely does formal money go into buying land. Goel of Omaxe agrees. The issue today is not of capital adequacy but of lack of trust. The managers manning the PSU banks have no intent to give loans as they have no targets. So they prefer to conservatively keep the money in low yielding RBI securities, rather than lend to the industry. “Many PSUs are renewing loans given to same loanees rather than checking the merits of projects to back new loanees. Real estate has hard collaterals of secured land.” He believes the mess in the real estate industry is because of poor lending. He names lenders like Piramal, Altico, DHFL and Indiabulls for mindless lending without enough scrutiny. Companies were given loans to buy land, then more for construction till the project was 100 per cent debt financed. Because finance was available so easily, the Real Estate industry bought land that would otherwise not be bought at all. Some lands that were not even contiguous were lent to. They chose not to do that level of scrutiny. Today, developers measure financial closure before projects are launched. Goel says with 40-50 per cent sale of units a project can be completed and debt serviced. Land is bought with the developer’s own money and construction uses consumer money. If that is not adequate, construction financing is sought. Runwal predicts that 20 per cent sales can ensure completion of the project. Rohit Gera of Pune Based Rera Developments says there is a contingency provision for every worst-case scenario. If the project goes through smoothly that becomes the profit. Today institutional finance is available to about 25 developers in the country as compared to about 250 earlier, says Runwal. Goel and Pradeep Aggarwal of Signature Global group maintain that 10-11 per cent interest rate is the best that projects can bear. If there is a crisis, then short-term finance is procured at about 16 per cent. But, as per them, this is not sustainable. This consolidation has created entry barriers to the industry where earlier anybody could set up shop. Also, says Pusegaonkar of Century, “Capital structure is evolving in real estate. From pure equity and debt there are mature products such as Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs). SEBI is doing a good job of allowing the capital market in real estate to evolve. Creating that mechanism is not a challenge. How you grow the pie overall is important and we will see it going forward.” Now lenders are checking all the points at every stage before releasing every tranche of money, says Runwal. In the absence of such knowledge in the banking community, Project Management Consultants are stepping in to do this on their behalf. The success of the Swamih model is the presence and meticulous on-ground checks by project managers on the site. This may well continue to remain the norm with lenders ensuring that the money they gave goes into construction. Rera too has set the benchmark by mandating escrow accounts with money withdrawn to be used for completing that stage of construction. Challenges to debt servicing Materials price rise Pandemic driven lock-down Labour shortage Demand ceases Shift in product demand - eg from apartments to land or affordable homes Checks before lending: 1) Track record of the developer 2) Titles and location of the land 3) Mismatch between sales and construction cycle 4) Understand sale, margins and good buffer 5) Project management expertise either in-house or through consultants 6) Set realistic expectations of 9-12% for IRR E Jayashree Kurup is Director Real Estate & Cities, Wordmeister Editorial Services LLP. She can be reached at jkurup@Asappmedia.com