Gurgaon-based Ravi Lodha, 39, vice-president of UK-based telecom company Leadcomp, was looking for an investment opportunity in real estate. He saw numerous advertisements of 'future', ready-for-sale residential projects coming up in Bhiwadi, a suburb of Delhi.
One project caught Lodha's attention. Being in Bhiwadi, it was close to Gurgaon, where he stayed. The 300 sq. yard plot was precisely what he wanted. The price, at Rs 3,700 per sq. yard, was attractive. The total investment, close to Rs 12 lakh, suited his budget. He would have to pay 25 per cent of the price on booking and another 25 per cent within the next four months. The rest he could pay comfortably over the next two years. Everything seemed right.
So, along with a couple of friends, he decided to visit the site and meet the developers of the project as well as a few others. A representative showed them the plot and, on request, ran them through a bunch of legalese-laden papers. Things seemed to be in order. Even so, Lodha and his investor friends decided to probe further. They found that the developer did not have any legal claim on the land. They also found that the plot was actually 3 km away from the place they were shown. Lodha's plan is now in abeyance.
But, unlike Lodha, many others are parking their funds in similar projects. The phenomenon is being seen mainly in North India, in the suburbs of metros and smaller cities like Gurgaon, Faridabad, Ghaziabad, Kundli, Bahadurgarh, Jaipur, Ludhiana, Jalandhar, Mohali, Roorkee, Rudrapur, Haridwar, Dehradun, Sonepat, Panipat, Karnal, Ambala and Rewari, among other places. The minimum cost of such a project in Gurgaon spread over 10 acres, for instance, is Rs 100 crore (Rs 1 billion).
Although state governments have declared that selling 'pre-launch' projects is illegal, thanks to the real estate boom, the practice has been flourishing for the last two-three years. "It has been banned only to the effect of not being advertised under the 'pre-launch' label," says Delhi-based realtor Shiv Goyal. So, now they are being sold as 'future' projects. "This is happening because of a lack of government legislation," says S.K. Sayal, CEO of Delhi-based real estate company, Alpha G Corp.
The pre-launch game: A pre-launch project is one for which either the entire land has not been acquired (that is, the developer does not have full legal sanction of the title), or clearances (like licences, land conversion and site plan) have not been obtained, or both. Developers are allowed to launch a project only after all clearances, and full ownership of the land have been obtained.
But when a developer cannot raise the entire amount needed to launch the project from internal accruals or equity, he turns to private financiers, investors and end-consumers by 'pre-launching' it. He works on the premise that full legal sanction will come through by the time the project is ready.
Till the land acquisition is completed, the project exists only on paper. The developer pushes sales on the 'buy early, buy cheap' plank. Since he does not have a legal ticket, he keeps prices low enough to tempt home buyers and investors who expect high returns.
Every four to six months, as the approvals trickle in, he keeps hiking the prices. When he gets full legal sanction and is able to deliver at the promised time (usually two to three years), prices double. Usually, by that time, he is able to sell off all the units and is in a position to make a profitable exit. But, what if a project fails?
Gambler's den: It is possible for a professional investor to take such a gamble. But if you are an end-user or an HNI interested in investing in real estate, you are on a risky road. Don't fall prey to speculation. (Developers and brokers often tell investors that prices will rise 30 per cent every quarter.) After all, most individual investors would take a loan, pull money out from other schemes, and live like monks to invest here expecting big returns.
And it may be worth it, till you hear that the project has been shelved, or, worse, scrapped.
Say, you are buying a property worth Rs 30 lakh (Rs 3 million). You can't get a home loan for it, says a banker, as you don't have a clear title and, hence, can't use your property as collateral. He adds that banks might, however, give you a personal loan based on your personal assets and income. If you raise 85 per cent this way, you still have to come up with another Rs 4.5 lakh (Rs 450,000) from elsewhere.
To book the property, you have to pay 15-25 per cent of its price, that is Rs 4.5 lakh-7.5 lakh (750,000). Within the next four to six months, the developers will ask for another 15-25 per cent. The last 50 per cent has to be paid over the next two-three years. So, six months would already be gone by the time you realise that the promises are not being kept and the construction is not happening as promised. By then, you would have sunk in Rs 9-15 lakh (Rs 900,000-1.5 million).
Risk versus reward: Exposing yourself to projects that have no legal sanction makes you financially vulnerable. Your money would be locked in and the property may not appreciate the way you expected it to. The promised infrastructure might not be created. And if the market tanks, you would find it tough to get a buyer willing to pay your asking price.
"The severity of the repercussions of these illegal transactions is not being felt as the real estate market is on a bull run," says Goyal. He warns that once the market slumps, the impact will be so overwhelming that the end-user, or even the professional investors would be unwilling to put money into such projects.
Says an investor, "No bull phase lasts forever and the markets might turn when no one is expecting it to."
The rough exit route. Nilesh Rani, 29, an engineer with an MNC in Noida, bought a 175-sq-yard-plot in Ghaziabad in November 2005 at Rs 6,505 per sq. yard in a pre-launch offer. He wanted to sell it soon afterwards, but has not been able to do so even now. "I am not getting the price I am looking for," he says.
The developer had promised a buyback at Rs 500 per sq. yard more than what Rani paid, but only after the project got full legal sanction. As Rani has surplus funds, he is not as distraught as he may have been otherwise.
If you buy a plot in the pre-launch stage and the project is shelved, the only exit route is to approach consumer forums or courts, unless the developer returns the money.
Even if he does, says Goyal, he would pay 6-12 per cent interest. That is measly considering the financial and emotional distress an investor would have to go through.
So, read the fine print of the sale agreement as it is skewed in favour of the developer. The buyer has little to fall back on if the project goes off track.
Price of temptation: At present, in cities like Meerut and Jaipur, pre-launch projects are being sold in the price band of Rs 2,400-4,500 per sq. yard. In Ambala, it starts at Rs 3,000 per sq. yard. "In Gurgaon, the prices start as high as Rs 6,000 per sq. yard," says a broker specialising in pre-launch projects.
Diligence, diligence: Before investing in any project, you must check the builder's records. "Find out about projects he has delivered in the past, avoid brokers and try to strike the deal directly with the developer," says G P Savlani, resident director of Confederation of Real Estate Developer's Associations of India (Credai), an industry organisation.
Check the title deed and read all the fine print of the brochure and the deal agreement. The riskiest move is buying into a project for which the developer has not acquired the entire land. It would be prudent to check whether home loans are being provided or not. As for lending to the developer, HDFC Bank director Renu Karnad says: "Developers' papers are checked thoroughly and banks lend only (to) 30 per cent of the total cost."
If you are investing in a plot, visit the site and do your own checking with the local residents. If you have already invested in a flat, it would be wise to keep checking on the speed of construction. "What is required is a developer rating so that buyers have some idea about who to turn to, whom to believe," says Sayal of Alpha G Corp.
A reality check: "If pre-launch projects are banned in the true sense, then 50 per cent of the developers will be out of business," says Goyal. Prices will go down 40 per cent if such projects are taken off from the market, he maintains. After all, they are major contributors to the overheating of the property market.
So, if you don't want to be on the speculators' bandwagon, then invest with caution. For, it's just not money, but dreams that are at stake.
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The Modus Operandi
Stage one: A developer announces a project putting in at least 20 per cent of the project cost. Gets 40 per cent financed by private financiers. Another 40 per cent is raised by inviting professional investors. The end-buyers' slot is expected to be negligible and gets adjusted somewhere in between. Some of the legal sanctions are in.
So the developer is dependent on long-standing investors' money and brokers who get non-professional investors.
Stage two: Project is pre-launched and bookings opened at attractive rates. Initial price is decided by gauging the buying capacity of the people of the area and the competitors' prices. It is then escalated periodically. The sanctions are still trickling in.
Stage three: After six to nine months, some investors want to exit. This is the resale phase and construction is likely to be in early stages. The broker becomes more important as he gets the buyers at the higher rate. All clearances are still not in, but the broker convinces the buyer that the project will be delivered when promised.
Stage four: By this time the professional investors who want to play safe would exit. If the project takes off well, everyone is happy. If it is scrapped or shelved, the non-professional investors and end-users are left trapped without the property and no sign of their money.
Even if the investor finally gets possession of the property, albeit much later than the stipulated time, the market may have crashed by then, and he cannot get buyers at the price he wants. For plots, the investor may suffer because the infrastructure could be non-existent. A professional investor could absorb the shock but it is highly distressing for the end-user.
Fixing pre-launch prices: How the rates are set is an interesting arrangement. A developer opened the pre-launch booking in June this year for a project on the Jaipur-Ajmer Highway at Rs 4,100 per sq yard. After booking a pre-decided number of 350 units out of 1,200, the bookings were closed in August. The booking opened again after 20 days but at Rs 4,300 per sq. yard.
In November, the bookings are likely to close, to open again at an expected rate of Rs 4,500 per sq. yard. Corroborates a real estate developer: "This game of jacking up prices is played to give financial comfort to the developer's investors. The developer ensures that his investors exit with a neat profit. A non-professional investor who puts in his money can make the same amount of profit as a professional investor because of prevailing market prices."