Challenges in real estate financing post RERA

Though RERA has been extolled as a landmark reform for the real estate sector, it does not override other Acts which continue to exist.

Nov 21, 2017
Rajesh Narain Gupta 
Managing Partner SNG & Partners

The roll-out of the Real Estate (Regulation and Development) Act, 2016 (RERA) has been heralded as the most comprehensive reform measure for the real estate sector since independence. With developers sourcing funds from non-institutional sources, and several issues arising in this sector compromising the interest of the consumers on multiple fronts, policy-makers were prompted to formulate RERA with a view to induce accountability and transparency for an industry that has been highly opaque and capital intensive in its functioning.

Till date, commercial lenders have been extending funds to real estate players against security interest. The money, which was collected by the developer as project funding, was under the charge of the lenders. However, the key provision of RERA mandates that no charge or lien can be imposed on 70% of the amount, which is collected from a prospective homebuyer towards sale of property. The amount will have to be deposited in an account to be maintained in a scheduled bank. The funds deposited can be specifically utilized to cover cost of land and construction cost for the specified project for which it is intended and will not be diverted to cover the expenditure of other projects of the developer. The procedure is easier said than done as banks would largely be concerned with how this bifurcation of accounts will take place and how the mechanism is put into place. Since 70% of the funds will be held in a separate no lien account, the funds will not be directly accessible to lenders.

Lenders including banks now will need to work carefully on their cash flow component and the same will have to be carefully incorporated by lenders in their lending and security documents. Lenders also remain concerned about the implications and are working towards revising the format of the lending and security documents to ensure that appropriate representations are obtained from developers and promoters. Lenders are also taking care to ensure that loan and security documents are tightened wherever necessary to ensure that rules and regulations are complied with from a RERA perspective.  Upon the completion of the project, the excess money left in the no lien account, after the funds have been utilized for project completion will belong to the developer. Hence, lenders have exhorted that they be allowed to create and enforce the charge on such account once the project is completed as envisaged under the Act. This provision is largely within an ambiguous zone and is being dealt on contractual basis with existing rules being largely silent on the aspect. 

A key point to be noted here is withdrawing money from the no lien account will be in tandem with the completion of the work on a specific project. Sanctioning of the withdrawal from this account is subject to the builder obtaining three certificates from an architect, an engineer and a chartered accountant, with an audit of the withdrawals to be undertaken every six months. In spite of these regulations, if there are allegations of wrongdoings or malpractice against a developer or he is subjected to legal action as regards the 70% funds held in the no lien account, banks may be dragged into litigation as a necessary party or as witnesses (though Banks cannot be made liable for any such wrongdoing).

Though RERA has been extolled as a landmark reform for the real estate sector, it does not override other Acts which continue to exist.

The provisions of RERA have been formulated to exist in addition to the provisions contained in other Acts. To protect the interest of the Consumers the Act provides that a builder / developer cannot transfer his interest in the project without taking the permission in writing from 2/3rd of the allottees and also the RERA authority. A serious issue to consider here is that where a Lender takes recourse under SARFAESI for the sale/transfer of a project to a new developer/builder, would the Lender be required to obtain the consent of the RERA authority and 2/3rd of the buyers/allottees who have invested in the project. This aspect of the Act has been touted as a key area of concern by lenders and with rules being silent, it offers no visible solace to the lending community. It has been argued that logically under SARFAESI, this requirement does not hold any validity as the sale under SARFAESI is also being executed as per the provisions of an applicable statute. However, with a view to forestalling the smooth execution of security interest created in favour of the Lender, the builder/developer may try to turn this into a contentious issue.   

With the real estate sector becoming RERA compliant and developers bracing themselves to face the challenges of an overarching regulatory regime, the need to evolve an industry-friendly financial model assumes paramount significance. RERA has the potential to vastly improve the efficacies of the Indian real estate sector and root out fiscal indiscipline in an industry vastly known for its use of unaccounted funds. Developers are rejigging their systems and processes to ensure greater financial discipline, which conforms to RERA compliance requirements. A check and balance mechanism and monitoring of real estate projects along every stage of the project execution cycle by the RERA authority with the implementation of a due diligence system has made it easy for lending institutions to invest in realty projects.

The implementation of RERA is a market-friendly, consumer-centric initiative, which would bring about a paradigm change in the manner in which the country’s real estate sector operates. Aiming to provide an organizational framework to a largely unorganized industry, RERA has the power to kick-start the investment cycle in the real estate sector by making funds largely available to developers through ushering in a transparent lending process. This also indicates that fly by night operators are likely to vanish as this sector becomes organized. Consolidation of real estate sector and elimination of small builders who thrived in the unregulated market are imminent consequences.

RERA has been hailed as the proverbial panacea for the real estate sector in the country whose potential has not been fully leveraged. If implemented in its true letter and spirit and if all the stakeholders in the real estate supply chain contribute to its effective execution in a united manner, it has the potential to place the country’s realty industry on a higher growth trajectory and progress path. Removing the anomalies in allocating funds for construction projects and enabling a steady credit pipeline to the industry so that realty projects are not stalled for want of funds would make RERA a much-needed catalyst for the transformation of the real estate sector. 

It is critical that all safeguards and proactive steps are taken to ensure that concerns of lenders are put to rest so that this sector does not suffer financial constraints.