Not Enough To Build On – Financial Express – 12-Dec-2014

December 23, 2014 - Uncategorized

The government seems to be on an overdrive on regulatory and tax changes related to the real estate sector. With squeezed liquidity, sales of residential units slowing down and foreign capital all but drying up—at least for development projects—there was an urgent need to catalyse investment in the sector, not just for the sake of growth and to meet the unmet demands of housing and commercial space but also to make sure that there aren’t any major loan defaults that would cause stress in the system.

The first of these changes was heralded by the tax provisions related to the Real Estate Investment Trusts (REITs) and with Sebi finalising the regulations. While there was initial euphoria, the devil in the detail on the tax side has not just dampened the enthusiasm but, coupled with a high interest rate regime, has made the economics of this less than attractive at the moment. It seems that unless the tax issues are ironed out in Budget 2015, REITs will remain a mirage.

These announcements were followed by the press release, and more recently, the formal press note, on the changes in the FDI policy related to the construction-development sector. These changes have been on the horizon for several years and, to that extent, credit must go where due. That the new government was able to prioritise the sector and bring about the changes in less than six months of being in power speaks volumes about its commitment.

The intention of the changes is laudable—lowering of the bar on the limitations and conditions, both at the time of the entry and exit of foreign investors. However, one thing that hasn’t changed even with the change in the ruling dispensation is the big slip between the cup and the lip—there are just so many aspects in the new rules that will actually make it harder to attract foreign capital.

On the positive side, the size threshold has been reduced from 50,000 square metres to 20,000 square metres and, for plotted development, there is now no minimum land requirement. This should significantly improve the turnaround time to project completion and, at a time when willingness to take the development risk is low, it is hoped that smaller projects will turn around the fortunes of both developers and investors.

However, the catch here, and to my mind entirely unintended, is the limitation on when the FDI can be made. The new rules stipulate that the minimum capital of $5 million must be invested within six months of the date of all approvals. While this no doubt provides clarity on the meaning of an eligible “greenfield” project, it, in a single stroke, eliminates the projects that have the approvals but have been languishing for years for want of funds. It is critical that this aspect be resolved soon, lest this becomes another example of a well-meaning change that did not actually provide any real benefit.

The other interesting issue is on the lock-in of the foreign investment. It has been the stated policy that FDI in the sector should be sticky and for real development, and not for speculation. The big change is that instead of a period (three years) based lock-in, it is now linked to the completion of the project or the completion of the trunk infrastructure. Well-meaning again, since, if the project is completed, the investor should be able to exit notwithstanding any minimum period test. However, what if the investment is in a large, mixed-use project being developed in phases? Would completion mean the entire project, which could be a prolonged period, or would it mean the completion of each phase? There is also ambiguity on the condition of trunk infrastructure—would this apply only to a plotted development or even to development of a building? Whichever way one looks at it, it appears that the regulation on lock-in has actually become more stringent than it was!

The real silver lining seems to be in the clarification on shopping malls. Inserted at the end of the press note is a statement which clarifies that 100% FDI is permitted under the automatic route for operation and management of shopping malls. There are also relaxations in the case of affordable housing, where it has been specified that the conditions on minimum size and minimum capital will not apply.

Considering what is plaguing the sector, whether it is land acquisition, delayed approvals or high cost of financing, the new policy should have been a manna. However, with REITs having still some distance to cover, and the several open-ended questions that the new policy throws up, the free flow of dollars that the government may be expecting might not crystallise. If the theme of the new government is to improve the ease of doing business in India, this policy, with its many drawbacks, will certainly find it hard to qualify as helping India’s cause.


Financial Express

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