Prelaunch schemes by Indian residential developers may soon vanish

December 2, 2013 / By

Pre-sales of residential units is a widely followed practice universally. However, in India, developers go a step further, offering units for sale at a prelaunch stage. During prelaunch, developers offer investors an opportunity to purchase residential units ahead of even procuring all necessary approvals. At times, land title due diligence or product-mix (retail, residential, commercial) considerations may still be underway. During prelaunch, developers apprise an inner circle of brokers/investors that a property not officially launched in the market is available for sale. While one imagines the news spreads through word-of-mouth or email, recently we have seen prelaunch announcements made on public hoardings and in newspapers.

For developers, prelaunch provides funds, which could be used for part-payment of land (or to acquire another piece of land) or meeting approvals related costs (which in India are usually higher). Also, developers benefit through test-marketing a project before spending time, effort and resources on approvals, due diligence and construction. Developers expect to sell 15-20% of units during prelaunch. For investors, prelaunch provides an upper hand in terms of apartment choice as well as price discount. Market observation suggests prelaunch investors could earn a discount of about 15% over the base price at the start of construction. In recent years, investors enjoyed healthy returns by holding from pre-launch until completion (usually 3-4 years) considering that over the past four years, the price of residential units pan-India increased by over 50% on average. The risk involved is related to approval delays, product-mix changes or project cancellation at worst.

In June 2013, India’s Group of Ministers (the Union Cabinet) approved the Real Estate Regulatory Bill, which prohibits residential unit sales by developers before obtaining all approvals. Though still not approved by the parliament, the Bill has aroused debate about the viability of developers’ current business practices and the Bill’s likely impact on land cost and housing affordability. It is pertinent to mention that the Indian central bank prohibits funding for land purchases to avoid land hoarding, and prelaunch was an alternative funding mechanism for developers. Thus, in its current form, would the Bill create funding constraints for Indian developers?

Let’s look at China as a comparison. The practice of prelaunch does not exist in China and banks are prohibited from making loans for the purchase of land use rights. However, capital markets in China are highly liquid and developers have many sources of funding including the corporate bond market onshore and in Hong Kong, project-level equity joint ventures with domestic or foreign funds and institutions, as well as lending from trusts and other non-bank financial intermediaries. In China, the government is typically responsible for land acquisition, rehabilitation and resettlement, while developers purchase land from government with clear title. Since the land title is clear, developers can mortgage their land to acquire additional funds for construction work. In India, however, developers are responsible for land acquisition and rehabilitation, causing delays, manipulations and litigations.

Prelaunch leads to information asymmetry and, thus, should be abolished. Simultaneously, there is a need to provide practical solutions to the genuine funding needs of developers. Either the bank funding channel needs to open-up, or a better market environment must prevail to attract more private investors.

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