In the month of May this year, the President of India approved the ordinance of the IBC act for granting ‘financial creditor’ status to home buyers. This will enable the due representation of home buyers in the Committee of Creditors. In simple words, home buyers who have put their money in under-construction residential projects will now have powers and responsibilities equivalent to that of banks and other lenders, in case the developer becomes insolvent. In this case, the home buyers who were the investors in the real estate project would now become the ‘financial creditors’ of the real estate company.
The year 2016 was the most memorable one for the Indian real estate industry. In March 2016, Real Estate (Regulation and Development) Act was passed and then again in May 2016, IBC (Insolvency and Bankruptcy Code) was legislated. Both incorporated for the best interests of its stakeholders which are debtors & creditors for IBC and home buyers in case of RERA. RERA, the more known of the two acts, looks at providing relief to home buyers and seeks to hold developers or builders responsible in case their projects get delayed. IBC on the other hand was established to facilitate companies to file for bankruptcy and provide relief to debtors and creditors.
Both RERA and IBC protect the home buyers, but in different ways. Hence, it would be interesting to see how the two acts co-exist and which gets priority in case of overlapping clauses.
To understand this relationship, between RERA and IBC, lets take a simple, real life example of a School. Imagine students as real estate developers, class teacher as RERA, parents as home buyers and school principal as IBC (the role allocation is just for the purpose of example, in real life RERA does not function under IBC).
Parents aka home buyers provide the finances to the students or developers for the education i.e. developing a real estate project. Just like a student, the real estate developer has to pass his tests quarterly, by complying to various requirements such as approvals, construction progress etc. Similar to a teacher, RERA will punish the developers in case of not doing the homework i.e. non-compliance of the said requirements. Parents or home buyers can evaluate the progress through the class teacher or RERA.
Consider a situation in which student fails the examination and is unable to fulfill his duties. This case will go to the principal, which is the IBC in real life. It is important to note that in real estate market scenario, RERA will not invoke IBC to resolve the issue, rather home buyers, other creditors or developer himself will have to file for bankruptcy. The principal will call the parents and then the decision of re-admission (new business plan) or leaving the school (liquidation proceeding) will be taken by the parents in a stipulated time.
In actual scenario, the CoC (Committee of Creditors) in which home buyers now have their representation will make the decision regarding the insolvent developer. As mentioned earlier, RERA does not function under IBC. However, in cases where the regulations coincide, IBC being the central authority is expected to precedence over RERA.
To summarize, RERA is a sacrosanct regulation, without who’s consent the developer cannot take his project to the market. Whereas, IBC is contingent and comes into a picture only when a developer is declared insolvent, either by himself or gets invoked by operational or financial creditors.
Now, home buyers have the double scoop of RERA and IBC to protect their interest. But for developers, it is a different ball game all together.
Real estate projects are capital intensive in nature, borrowing funds is a common practice in this sector. Major lenders in the real estate sector are the private & public banks, NBFC (Non Banking Financial Companies), private equity players, etc. The interest rate for these loans are directly linked to the risk of the project. Now, under IBC these lenders will share the status of ‘financial creditors’ with home buyers and hence the recovery amount in case of liquidation will be reduced, as now liquidated value will be divided by more number of people.
Moreover, RERA rules do not allow the ‘pre-sale’ model which was traditionally used by developers to generate liquidity. Also, the restriction on the usage of funds collected from the home buyers, would increase the borrowing component of the developer. This additional risks will either command higher risk premium or less inclination of traditional institutes to provide these loans or advances. Given the situation, the private banks or public banks will opt to reduce their lending to such developers, due to the regulatory capital requirement. While, other financial institutes like NBFC and private equity players may capture a larger market share, owing to these opportunities by incorporating financial innovation and flexibility in lending.
As we know, the number of NPAs (Non-Performing Assets) are increasing in the current dynamic business environment, owing to that all the lending institutes are becoming very cautious and diligent in terms of providing financing to debtors. In real estate market, Grade A developers having a strong balance sheet and relationship with banks or Financial Institutes are less likely to be affected by this. However, Grade B and Grade C developers would be getting loans or advances at a considerable higher interest rate. If the project is not selling as per the anticipated financial planning of the project, chances are that that Grade B and Grade C developers would not be able to complete their projects. These stalled projects would then be taken up by other developers who have credible track-record and are financially stable.
After the company has filed or is being taken for bankruptcy, a resolution plan is decided by the CoC (Committee of Creditors). After, 66% of the creditors give approval to the resolution plan is accepted and implemented. Now, home buyers will also be the members of the CoC they will try to expedite the process of approving the resolution plan. However, if they do not act in a coherent and coordinated manner then the process might take longer than usual, this may happen because different home buyers have different intentions of purchasing a house.
The expected long-term impact of IBC alongside RERA is primarily market consolidation. Market consolidation is a crucial process, every industry needs to go through to sustain its business cycle. Owing to the added transparency under RERA and fast-track proceedings of non-performing companies under IBC, it is expected that more number of foreign investors such as private equity players, pension funds, NBFCs, etc. will be attracted to the Indian real estate.