In this excerpt from his new book on Indias bad loans mess, author Vivek Kaul discusses the down-in-the-dumps real estate sector and comes up with some troubling conclusions
The unsold inventory in the top eight cities of the country as of June 2019 has risen to 10 lakh units. Builders had taken on loans to build these homes. Unless they are able to sell these, they won't be able to repay them. Pic /AFP
The big question now is, are banks done declaring their bad loans or is there more to come? There are two sectors which are staring at bad loans. These are telecom and real estate. The overall telecom sector has been in a mess since the launch of Reliance Jio, which has dramatically cut both calling and internet rates in order to capture the market. This forced other players in the market to cut rates as well. In the process, their financials came under pressure and have made it difficult for these companies to continue repaying loans. Some companies like the Anil Ambani owned RCom, have even shut down in the process.
Other than increased competition, what has hit the sector is the issue of adjusted gross revenue—in layman's terms this means that a certain proportion of revenues earned by telecom companies needs to be shared with the government's department of telecom. The telecom companies and the government have been disagreeing on the definition of adjusted gross revenue since 2005.
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The companies only wanted revenue from their telecom business to be calculated for this figure, but the government wanted a much wider definition, including non-telecom revenue like sale of assets and interest earned on deposits.
In October 2019, the Supreme Court agreed with the government's definition of adjusted gross revenue and asked the telecom companies to pay the R92,000 crore which they owed to the government. This has pushed the telecom sector further against the wall.
The other big problem looming is in the real estate sector. Over the years, the attention in this sector has been on the builders, who have taken money from prospective buyers and have not delivered the flats. This has basically broken the business model of real estate in India, with prospective buyers no longer ready to finance builders by buying under-construction properties.
But as far as the overall economy goes the bigger problem is the large inventory of unsold homes, which builders have built but are unable to find buyers for. The unsold inventory in the top eight cities of the country as of June 2019 has risen to 10 lakh units. The value of the inventory is R8 lakh crore and equals what builders are likely to sell over four years.
Builders have taken on loans to build these homes. Unless they are able to sell these homes, they won't be able to repay them. In the past, the major part of the funding to builders was provided by banks. Over the last few years, NBFCs (Non-Banking Financial Companies) have provided a greater part of the funding. As of March 2019, the real estate sector had total outstanding loans of around R5.4 lakh crore. The NBFCs accounted for around half of these loans. The total loans to the sector as of March 2015 had stood at around R2.8 lakh crore.
This has more or less doubled over a period of four years, with NBFCs accounting for a greater share of these loans. Of course, these loans had been provided on the premise that the builders will be able to sell their inventory of unsold homes and repay bank loans. But that has become increasingly difficult as buyers have stayed away from buying these unsold homes.
Here is the irony; while the unsold homes of builders continue to grow, so do home loans of banks. As of October 2019, the total outstanding home loans of banks stood at R12.7 lakh crore, having grown by around 19.4 per cent since October 2018. In October 2018, the home loans outstanding had stood at R10.6 lakh crore, having grown by 15.7 per cent.
These are just home loans provided by banks. Over and above this, there are home loans provided by housing finance companies. If home loans are growing that obviously means that people are buying homes. If people are buying homes, it is well worth asking, why the number of unsold homes has not come down? Between 2003 and 2012, investors went overboard while buying real estate. All these homes whichhave been locked up for years are now being sold. This is one possible explanation.
People are buying homes from individuals rather than builders. The builders are not in a mood to cut prices which the investors possibly are.
The main reason why homes are not selling are high prices. Builders could have cut prices and cleared their inventory. But they haven't. The trouble is that any cut in home prices would lower the notional value of the collateral (the unsold homes) against which builders have taken on loans.
This is a problem that is not going to go anywhere soon. Also, as mentioned earlier, there are ten lakh unsold homes with a total value of R8 lakh crore. This basically means that the average price of an unsold home is R80 lakh. Of course, this is in the top eight Indian cities. But even in the top eight Indian cities, how many people can afford to buy a house priced at R80 lakh?
Also, given the high price, this inventory will take more than a few years to clear, assuming no more homes are built. All in all, this is not going to end well.
In fact, this can be concluded by looking at the number of real estate companies under the corporate insolvency resolution process more commonly known as the bankruptcy process. As of September 2018, the total number of companies under the real estate, renting and business activities sector had stood at 209. By September 2019, this had jumped to 500, showing the increased stress in the sector. Banks have direct as well as indirect lending exposure to the sector. The indirect lending has been carried out by lending to NBFCs, which have in turn lent to the real estate sector. In that sense, it is going to be a double whammy for banks as repayment for these loans starts to come up.
Excerpted from Bad Money by Vivek Kaul with permission from HarperCollins India
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