By Munir Kulavoor | 20th Apr 2016 | Integrafinserve.in
In the past year or two, sales of real estate companies have either declined or remained flat. Lenders have also remained cautious and have reduced exposure considerably, leaving only one option for the developer and that is to raise funds from the consumer either through Pre-Launch of new projects or offering discounts or offering to pay PREMI / Interest till possession. Those with land bank were able to improve liquidity under the guise of the Pre-Launch. The ones who were desperate reduced the price for limited number of units at different points in time. And others at higher stage of construction sought to raise money through customer home loan disbursements, took the interest subvention route.
Let us look at the working of PREMI subvention schemes. Ideally if the deadlines are met this scheme works out to be a win-win-win situation for the Bank, Borrower & Builder/Developer. Banks are able to acquire bulk business; Developer is able to quickly raise funds at Home Loan rates (~10%) compared to commercial rates (~17%); Client gets to book a property without having to block liquidity plus interest holiday till possession.
Bank approaches a developer, usually category A/reputed only, to offer subvention scheme for an under construction project (generally >30% stage). The important factors to determine the scheme are:
Subvention Period: This usually is between 12 to 24 months & in rare cases may even be stretched to 36 months. It normally ends at the date of possession or fit-out. During this period the developer undertakes to bear the interest cost (obviously passed on to customer).
Interest Rate in Subvention Period: This is usually fixed (at prevailing home loan rate) for the tenor for ease of calculation and to enable the the Bank recover the interest amount at Net Present Value (NPV) from the disbursement or demand due amount. Some lenders have differentiated rates for Salaried & Self Employed individuals.
Discounted Rate: To arrive at the NPV a discounted rate is agreed between the developer & Bank. The discount rate allows for the time value of money and uncertainty of future cash flows; the greater the uncertainty of future cash flows, the higher the discount rate.
Table For Illustration:
|Project||Unit Type||Exposure Limit under Subvention||Subvention Period||ROI fixed for Subvention period*||Discounted Rate||Min Customer contribution.
|Max Funding by BANK
|Building ABC||Apartment||50 Units
Exposure: 100 Cr.
|Till 31st Mar 2018 (24M)||For Salaried – 9.45%
For SENP – minimum 9.65% and above depending on profile of the customer
|8.0%||25%||75% of COP as per underwriting team of BANK|
Proportion of Funding: According to the example given below for loan of Rs.100 lacs, say the stage of construction is 81% (demand due), the customer has to pay 10% & Bank shall disburse 71% immediately. Before possession the customer pays the remaining 15% as per the payment schedule and at possession the Bank shall disburse the balance 4%.
Subvention payment schedule (Cost of property)
|Banks Contribution||Customers Contribution|
|Remaining Own Contribution (OCR) of Customer||15%|
Documentation: The Developer and Bank enter into a Memorandum of Understanding (MOU) where they agree on the modus operandi and the above mentioned terms. A Tripartite Agreement (TPA) is signed by each Customer, Banker & Developer again agreeing on the above terms, legally binding each party.
Subvention is therefore a well meant innovation in providing solution to the funding scenario prevailing in the market. The same principles are used to create different variations (like 20:80 scheme, 10:70:15:5 scheme,etc.) in the product offering to attract the consumer.
The risks associated with this offering from the consumers’ perspective is a topic of discussion better kept for another day.
I encourage readers to post their experiences or bankers who may have different ideas or solutions on this problem of funding in real estate industry.