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The challenges of apartment funding in India

July 28, 2017 / By

Apartment Funding (AF) is a fundraising structure where the investors acquire real estate units at deeply discounted prices. While it appears as a similar structure to bulk buying, unlike the latter, the developer needs to make coupon-linked payments to the investor, which can be customised to suit developer preferences.

While the developer might receive a payable-when-able option, he also agrees for a buyback of the units at predetermined returns if the desired sales rate is not achieved within a predefined duration.

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Why did such a fundraising structure work in the past?

Such deals are win-win situations for both stakeholders. Developers prefer such structures because of two reasons: 1) A quick sale of multiple units supports their financial needs and 2) funds that are raised have no restrictions on usage.

On the other hand, investors get preferred units at deep discounts along with interest, and an option to exit at a predetermined rate. Investors may also get a pledge of shares depending on deal structure, corporate guarantee of SPV hosting said property, and a personal guarantee from the developer.

So the risk is relatively the same as one would encounter in a typical construction finance funding setup, albeit without directly overseeing the project. This lack of control is compensated by much higher returns and is ideally suited for investors who prefer developers with a good track record.

The end of such fundraising structures

Last year, the government of India cleared a Real Estate Regulation and Development Act (RERA). The name itself suggests the purpose of the Act – to regulate the real estate sector where transparency in past has been a big challenge.

One of the major regulation in this act requires developers to deposit 70 per cent of the receipt, through any kind of sale, in an escrow account to be used for project expenses. This money is not available to developers until completion of the project.

With this regulation, developers lose their benefit of receiving upfront funding from apartment funds. While developers receive all the money, they can only use a small portion of it for non-project-related expenditure.

Rising costs following introduction of GST in India

Also, with GST being introduced, the cost of purchase has increased by 6.5-7 per cent for under construction projects. Earlier, the developers were charging VAT + Service Tax which together accounted for approximately 5-5.5 per cent, which increased to 12 per cent post-GST.

The newer greenfield projects will get full input credits which can be passed on to the buyer and offset the additional tax cost. But for under construction projects, since most of the projects are partially based on the old tax regime, only a portion of input credit can be availed which drives costs upwards, making it a much more unattractive scheme.

Since the basic purpose of the structure is defeated, I believe apartment funding and similar structures might fade and be replaced by a new structure much sooner than expected.

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