Good riddance to 80:20 schemes

The NHB directive to HFCs to scrap loan subventions by developers is a good move

Lately, not a week goes by without a development on property-related policies. The latest one was a note from the National Housing Bank (NHB) to housing finance companies (HFCs). The caution was on them lending to finance subvention schemes by developers. The new guideline advises them to not fund such schemes, popularly known as 80:20 plans. This is a good move and quite positive for buyers.

Subvention basics

When the property market was slowing down, developers offered various financing schemes to incentivise buyers. One such was through subventions. A typical subvention scheme may offer buyers to not pay any EMI until the property is handed over. The buyer pays the 20 per cent down payment and takes a loan for the rest. The bank would release payment based on the milestones and the developer pays the EMI until the property is handed over.

It sounds like a win-win situation. It helps a developer — a subvention is really a loan extended by the housing finance company to the developer at a low interest rate. A typical loan for a developer — small or medium — may be at over 15 per cent interest rate. Now, they are getting funds at a bargain rate. At first glance, it may also sound like a good deal for buyers. For example, if there are delays, the buyer is not saddled with EMI payments, plus regular rent for an extended period. Also, the banks would take the responsibility of monitoring construction and release payment with the buyers’ consent.

But there were two problems. One, banks were not able to monitor progress and there have been cases of fund diversion. If there was no progress for the funds released, the risk was borne by the buyer. Two, when a developer defaulted, the onus of paying the EMI was still with the buyer. And any delays in servicing the EMI would affect the credit score of the buyer. It was therefore a good deal only when a developer was able to pay the monthly dues and complete the project. So, subvention carried the risk of a loan being given to a potentially low-credit-quality developer on the terms of a good credit rating of a buyer.

Buying an under-construction property has ceased to be a good idea. But as developers needed the cash from buyers to fund construction, they needed to sell incomplete properties. The lower price, if any, was for the time value of money and the risk taken by the buyer — that it will be completed in reasonable time.

Such schemes were trying to mask the risk and lure buyers with an illusion of gain.

As a buyer, it makes sense to only go for completed properties. For one, there is enough supply of unsold homes — data from property consultant Liases Foras showed that in June 2019 there were an estimated 12.76 lakh of unsold inventory in the top 30 cities. With such a pool, you may have enough choices to select from and there may not be a need to wait for completion.

Two, data from Knight Frank, a real-estate consultant, show that in the past four years, property prices in the top eight cities were mostly below retail inflation growth. So, there is no urgency to book a property early as there may not be any financial return for the risk taken. Also, under-construction properties have a GST of 5 per cent, while completed projects do not fall under GST.

Three, the risk of developer default is certainly higher now than in the past. Data from ANAROCK Property Consultants show that there are 1.74 lakh units in projects that are stalled; these were launched in 2013 or before. Of these, a two-third (over 1.15 lakh units) have already been sold, leaving many buyers already stranded. Also, data from Liases Foras estimate that it will take seven years for builders in the top eight cities to repay the loan they owe banks and NBFCs, given the outstanding dues and rate of sales. Data point to more developer trouble and for buyers to take a risk-averse stance.

Other points

The NHB directive also requires that HFCs to exercise more oversight on the loan disbursement. Housing loans should be strictly linked to the stages of construction and no upfront disbursement should be made in case of incomplete or un-constructed projects. HFCs should have a well-defined mechanism for effective monitoring of the progress of construction and obtaining consent of the borrower(s) prior to release of payments to the builder/developer.

This is also a good step for buyers as there will be a better process from HFCs to monitor progress of construction.

The writer is an independent financial consultant

Published on August 11, 2019

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