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9/13/2017 Gmail - India's Big and Messy Real Estate Ponzi Scheme, Just Got Messier


India's Big and Messy Real Estate Ponzi Scheme, Just Got Messier
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Vivek Kaul's Diary <> Mon, Sep 11, 2017 at 7:07 PM

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Publisher's Note: The views mentioned in the article are of the author only.

India's Big and Messy Real Estate Ponzi

Scheme, Just Got Messier
Mon, 11 Sep 2017

Over the last few years, many real estate

companies across the country, particularly in
Delhi and the National Capital Region (NCR),
have taken money from home buyers and not
been able to deliver promised homes on time.

Some of these companies have also taken loans

from banks and defaulted on those loans as well.
Basically, these companies have taken money
from home buyers, they have also taken loans
from banks, and still been unable to deliver the promised homes. In some
cases, real estate companies have already booked sales on homes they are
yet to deliver.

The question is where has this money gone?

I think there are two answers to the question. 1) Promoters of real estate
companies have siphoned off a part of the loans they took on from banks
and the money they took from buyers. 2) This money has been diverted
for other uses, like completing previous projects and buying more land (or
to put it in real estate parlance for building a formidable land bank).

Banks are now looking to recover their bad loans from real estate
companies. And at the same time, the buyers are also hopeful that
someday their dream homes will be delivered to them. 1/6
9/13/2017 Gmail - India's Big and Messy Real Estate Ponzi Scheme, Just Got Messier


Raghuram Rajan Is Worried About

This Too...
Recently, during the launch of his book - We Do What We Do, Dr
Raghura Rajan issued the same warning that we have been talking
about for months...

Here's what he said...

"Remember that we have what we call the population

dividend. A million new people entering the labor force
every month,". "If we don't provide these jobs that are
required, you have a million dissatisfied entrants. And that
could create a lot of social mischief."
Now, make no mistake, what Dr Rajan is so carefully calling "a lot
of social mischief" is something that we believe could be - The
Biggest Socio-Economic Crisis for India.

Imagine millions of young Indians not getting jobs...not having

enough money to put food on their tables...marching on the

The picture is scary.

And to make the matter worse, this is just 1 of the 4 Economic

Emergency Warning Signals that we have identified...and
which are already visible all around us.

So, the question is...Will you keep waiting for the "Economic
Emergency" to become a harsh reality or will you start preparing to
face it today?

Well, you don't need to answer that right away.

First, click here for full details...

There are several interesting issues that crop up here: 2/6
9/13/2017 Gmail - India's Big and Messy Real Estate Ponzi Scheme, Just Got Messier

a) It is now more or less clear that the real estate companies had been
happily running a Ponzi scheme. A Ponzi scheme is basically a financial
scam in which investors are promised very high returns. The money being
invested by the second set of investors is used to pay off the first set. The
money invested by the third set of investors is used to pay off the second
set and so on. A Ponzi scheme runs until the money being invested in the
scheme is greater than the money that is going to redeem the investment
of the early investors. The moment this reverses, the scheme collapses.

The real estate companies essentially followed this model. They announced
a new real estate project and then raised money against it. This money
was then used to buy more land or simply siphoned off. Then a new
project was announced. The money raised against the new project was
used to complete the earlier project. Of course, I am simplifying things a
bit here, but that was the basic modus operandi.

The key in this method of selling homes was the ability to keep launching
new projects. Over the years, as real estate returns fell, the ability of real
estate companies to launch new projects came own drastically. Once this
happened, they couldn't raise enough money to complete their existing
projects. And this led to many buyers being left stranded in a rented home.

b) The inability to deliver on promised homes along with low returns has
put off people from investing in real estate. The falling interest in owning
real estate becomes clear from the savings figures as well. As per the
recently released annual report of the Reserve Bank of India, in 2012-
2013, savings in physical assets made up for 14.4 per cent of the gross
national disposable income (GNDI). By 2015-2016 this had fallen to 10.7
per cent of the GNDI. GNDI is a concept similar to GDP which also takes
remittances from abroad and food aid into account. India's GNDI is around
1.03 times its gross domestic product.

c) A bulk of the buyers had bought homes by taking on home loans from
banks. They are currently paying EMIs against these loans. They are also
paying a rent to live in the homes that they currently do. Given this, they
are monetarily stretched. Further, they are paying an EMI for an asset
which they haven't got as yet and will probably never get in the form they
had originally envisaged.

d) When prospective buyers take a home loan from a bank, the home they
are buying is the collateral or the security against the loan that is taken. In
many cases, the real estate companies have offered these homes against
which home loans had already been taken, as a collateral to the banks,
and taken on more loans. So, the buyers have been taken for a ride here.
Also, the question is how have banks allowed dual financing on the same
asset? 3/6
9/13/2017 Gmail - India's Big and Messy Real Estate Ponzi Scheme, Just Got Messier

It is worth remembering here that many real estate companies which have
defaulted on banks loans and delivering homes, worked on a pay as you
build model. This basically meant that these companies got paid in
instalments from the buyers at every stage of construction.

Hence, the homes were technically owned by the buyer (or to put it more
specifically the bank from which the buyer had taken on a home loan) and
could not have been offered as a collateral, without the consent of the
buyer. Nevertheless, that seems to have happened. This is something that
the banks need to explain. (In case you want to understand dual financing
in even more detail click here and here).

e) So, where does that leave the buyer? Recently, bankruptcy proceedings
have been started against Jaypee Infratech which took money from more
than 30,000 buyers and did not deliver on the promised homes. At the
same time, it has defaulted on bank loans. The Supreme Court has stayed
these proceedings.

The Bankruptcy and Insolvency Code in its current form does not leave
anything for the buyers. The buyers are not on the list of entities that will
be compensated for payment of what is due to them once the company is
liquidated. From the legal point of view this makes sense given that the
money that the buyers had handed over to the real estate companies was
basically an advance and not a loan. But then given that thousands of
families are involved, should only the legal view prevail is a question even
though tricky, worth asking.

Of course, the bureaucrats who wrote the bankruptcy code did not take the
real estate sector and the way it operates, into account. This is something
that the government should hopefully correct for in the days to come.

f) Suggestions are now being made that like the banks, the buyers should
also be ready for a haircut (i.e. be ready to accept a part of the money
they had invested with a real estate company to buy a flat and not the
entire amount). The trouble with this argument is that for the banks, the
bad loans of real estate companies are just a part of their overall bad
loans. For the buyers, the money they invested with real estate companies
was probably the biggest investment they ever made and if they have to
take a haircut on it, they will probably never recover financially from it.

The Supreme Court now needs to decide whether the buyers are financial
creditors or not. This is a tricky question, which I shall elaborate on later in
the days to come.

g) In all this, the real estate promoters seem to be having the last laugh. A
part of the money they borrowed from banks and took from real estate
buyers, has been tunnelled out. It is hardly likely that the bankers will be 4/6
9/13/2017 Gmail - India's Big and Messy Real Estate Ponzi Scheme, Just Got Messier

able to go after their other assets (i.e. the land bank they built by
tunnelling out money) in order to recover their loans. Hence, they have
clearly managed to limit their losses.

In fact, in a fair world, the balance sheets of these real estate companies
would have been subjected to forensic accounting in order to figure out
where did the money go. But the bankruptcy code has no such provision. If
it did that would inevitably delay the resolution process.

And this brings me back to the point that I keep making for all my readers
who forever seem to want solutions to all problems; everything in India
does not have a clear solution.

Of course, now the central government will have to get involved if this
issue has to be sorted at any level. I only hope that they try and arrive at
a private sector solution and the taxpayer money is not used in any form.
Already, a section of the real estate sector is talking about a government
bailout. If the builders in India don't have money, who does?

To conclude, the mess in the real estate sector in India is an excellent

example of what follows when a Ponzi scheme goes bust. And as they like
to say in Hollywood films, you ain't seen nothin' yet. Keep watching.

Comments on this edition of Vivek Kaul's Diary: Post a comment | Read comments

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. He is the author of the Easy Money
trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The
Intrusive State and How It is Hurting Us.

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