Housing finance is provided by the Banks & Housing Finance Cos.usually for the following types of properties.
- Ready to move in property.
- Under construction properties.
Present discussion is limited to the financing of under construction properties.
Following are usually the players in a real estate sector project.
- The Home Buyer.( The “Allottee”)
- The Bank, financing the home buyer.( The “Bank”)
- The real estate project developer (The “Developer”)
- The Project Financier for financing the real estate project. ( The “Project Financier”)
Let’s identify the problems being faced by the different players of the real estate project.
1. From the Allottee’s (Home buyer) perspective:-
- Payment of EMI before possession of the flat / property. This problem is quite acute in delayed projects, or in failed projects.
- Recovery of money from the Developer in a failed project.
i). Status of cases under IBC as on 30.06.2020 (Real Estate Companies, as per IBBI Newsletter June,2020)
Average time taken for completion of CIRP, yielding resolution is 423 days. Average time taken for completion of CIRP which yielded orders for liquidation is 312 days. From the above it can be observed that resolution / settlement of cases in the real estate sector is less than 25% of the cases, so far.
ii). Even if resolved or pushed into liquidation, home buyer being unsecured financial creditor, priority of payment to home buyers is subordinate to secured financial creditors (Banks & financial institutions which provided project finance) & employees, in the scheme of things under IBC.
2. From the Bank’s (Financier of Home Buyer / allottee) perspective.:-
- Unsecured financing during the construction period. The money paid by the bank to Developer on behalf of the home buyer remains unsecured till possession & ownership rights of the property are received by the Home Buyer & mortgage of the same is created by the Home Buyer in favour of the Bank.
- Recovery of Bank’s finance to the Allottee in a failed project.
3. From the Developer’s perspective.
- Timely financing of the project during the construction period.
4. From the Project Financier's perspective.
- Excessive /over financing of the project, taking advance from the Allottees besides getting project financing from the project financier.
- Diversion of funds by the Developer.
- Recovery of project finance..
Mechanism of Housing Finance through Smart Contract in nutshell.
1. Prospective borrower / allottee approaches the bank & bank approves / sanctions, in principle the housing finance (Usually 80% of the cost of the proposed property / flat)
2. Prospective borrower / allottee negotiates with the developer & pays upfront 10% of the cost agreed. Developer issues the allotment letter and enters into a registered agreement to sale of the property (obligatory under RERA Act.), specifying therein the date of handing over the possession of the property by the developer to the allottee.
3. Bank on the basis of smart contract (tripartite contract between allottee, developer & bank), issues bank guarantee in favor of the developer on behalf of the allottee, for 90% of the cost (Bank to obtain from allottee / borrower, 10% of the cost of the proposed flat as security / margin for the proposed bank guarantee). The period of bank guarantee to coincide with the date of possession mentioned in the registered agreement.
4. The developer get’s finance to complete the project from the Project Financier against the security of project assets & assignment of bank guarantees obtained from allottees. The assignment of bank guarantees will facilitate obtaining finance on finer terms (competitive rates of interest).
5. On or before the expiry of the bank guarantee / smart contract, the developer approaches the allottee / bank with completion certificate of the project & offers possession of the property and requests for release of the amount of bank guarantee (balance 90% of the cost of property as per smart contract / allotment letter).
6. Bank releases the amount of the bank guarantee to the developer / assignee of the bank guarantee by debit to the housing loan account (80% of the cost of property) & security/margin money account (10% of the cost property) of the borrower / allottee. Thus the developer receives full payment of the agreed cost of property without any delay. Assignment of bank guarantees in favor of the project financier, ensures assured repayment of project finance.
Advantages of Smart Contract.
1. In the above system of financing the prospective borrower / allottee is not under the obligation to pay pre-EMI Interest and / or EMI before possession, with the added bonus of saving of GST. As per rules, GST is not levied, if the cost of the property is paid after the issue of completion certificate of the project. However this benefit will be more or less nullified from bank guarantee charges levied by the bank under smart contract.
2. Allottee’s risk in the failed project is limited to 10% of the cost of the flat, paid by allottee to the developer at the time of booking of the flat. The housing finance through Smart Contract will substantially reduce the problems a home buyer faces in delayed / failed projects. This will go a long way in reducing the quantum of litigation at various forums ( IBC / RERA / Consumer Courts etc.) we are presently seeing in the real estate sector.
3. As the housing finance will be released by the bank at the time of possession of the concerned property / flat, the asset quality of the banks, under housing finance will improve. In the present system of housing finance during the construction period, there is no security for the bank & in the failed projects the banks are left with unsecured NPA accounts. Under smart contracts this situation will never arise. This will be a good source of non fund based business for the bank in the shape of bank guarantees. There will not be any risk for the Bank in the failed project.
4. The developer can raise project finance on the strength of bank guarantees on finer terms and is assured of timely payment by the allottee on completion of the project. This will inculcate discipline among the developers to adhere to the timelines of the project. The developer will also be saved from the hassles of keeping 70% of the allottee’s money in a separate account & paperwork involved in getting the same released from RERA authorities, as per the provisions of RERA Act.
5. As the source of funds for the developer, under the proposed system, are limited to the project financing, the project financier will be able to exercise better control over excessive / over financing of the project and can keep a check on the diversion of funds by the developers. Diversion of funds is the main reason for the majority of the failed real estate projects. Secondly, the project financier will be assured of timely repayment of project finance, with the assignment of bank guarantees with the project financier.
The system of smart contract, in the long run, will create a better environment for all the players in the real estate sector. A win - win situation for all the players of the real estate sector.
Reforms suggested for the Real Estate Sector.
1. Model agreement to sale, as per the RERA rules & regulations, to contain a clause, creating hypothecation charge on the allotted under construction flat / property, so that the home buyer acquires the status of Secured Creditor. This will increase the chances of recovery for the home buyers during insolvency / liquidation proceedings of the developer. Secondly under the provisions of The Companies Act -2013, hypothecation charge is to be registered with ROC. This will prevent the multiple booking of the concerned under construction flat / property. (details of charges created by a company are visible online on the website of the Ministry of Corporate Affairs)
2. Compulsory Credit rating of the developer from two independent Credit Rating Agencies.
3. Introduce License to book under construction flat, which is to be issued by RERA Authorities keeping in view:-
i). Technical & financial strength of the Builder / Developer.
ii). Past track record of the Builder / Developer and its promoters / directors.
All the above suggested reforms can be implemented under the present set of rules & regulations.
Disclaimer: The sole purpose of this blog is to create awareness on the subject and must not be used as a guide for taking or recommending any action or decision. A reader must do his own research and seek professional advice if he intends to take any action or decision in the matters covered in this blog.
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