Housing finance scam will probably induce correction in the real estate market

CBI investigations into the multi-crore loan scam, which has led to the arrests of senior managers of LIC Housing Finance Ltd. and several public sector banks, is sending tremors across the real estate sector. As more secrets of this financial scam are unearthed, experts fear that the scandal could lead to a 10-15 per cent correction in the market.
The major source of worry is that these officials have been accused of giving loans to companies in return for monetary benefits from a city based financial services company, Money Matters, believed to be associated with top real estate firms.
Experts fear that the scam could lead to a cash-flow problem, leading to delays in execution of projects. Banks will become cautious in lending, and increase rates of interest.
The situation is likely to get even more precarious as the need for debt is still looming large. The dependence of developers on private equity funds and public markets will increase, but the stock market is not likely to be supportive either. With investors looking for a way out of projects, dependence on cash flows accruing out of actual end-user sales will increase.
This could compel developers to offer “soft discounts” to buyers in the form of reducing floor rise charge or additional parking space, translating in reduction of costs of about 10%. While the buyer is in a profitable position, this could also impact execution of projects. CBI’s revelations have stunned buyers but insiders say most of the malpractices exposed now have been going on for a while.
Some builders are known to obtain credit from banks at an interest rate as low as 11 per cent, even though the cost of borrowing project finance from a lending institution is usually between 13-18 per cent. Experts say intermediaries hired by companies have been arranging for loans at such low interest rates by applying for them under General Purpose Corporate Loans.
While on paper the companies say they will use the loan to retire supplier’s debt or growth purposes, in reality the money is used to buy additional FSI, repay private equity obligation and pay off interest of private lenders charging as high as 25 per cent interest.
Moreover, there’s another malpractice of inflated valuation of land that has come to light in this case. The problem as it stands is that the price of a property is determined on the basis of how much a developer quotes for it can be sold at any price, even if actual transactions happen at a much lower rate. Since many loans are sanctioned against mortgage of land, in reality it is still higher than the actual value of the land, thereby benefiting the builder.