The biggest challenge with real estate funding is banks are prohibited from funding land. Land is actually inventory for Real Estate Developers. In all other businesses other than real estate the inventory funding happens from Bank facilities which are in the nature of cash credit, overdraft or other working capital products like LCs, BGs or Bill discounting. However real estate developers do not have access to any such facilities.
Real Estate development involves substantial approvals and delay in getting any of the approvals can result in significant delay in project timelines. Financial institutions while evaluating a real estate proposal need to underwrite these risks.
Further real estate development projects are prone to title deficiencies. There is no full proof method to evaluate title of particular land parcel. The methods of evaluating title that are used by advocates reduce the deficiencies and possibilities of further litigations. Title is one more risk that financial institutions need to underwrite.
Real estate as a sector is highly cyclical in nature and gets affected by the vagaries of economy. The industry is highly capital intensive and any dip in demand can have significant impact on the development of the project and its eventual closure.
Solution:
Real Estate funding in India happens in two stages:
Stage 1 – Land funding. This is a high risk product for financial institutions and hence they charge a premium for the risk they are underwriting.
Stage 2 – Construction funding. This is a bread and butter product for financial institutions that do real estate funding. This stage comes when the Land is procured, RERA registration is done, plans are approved and all the necessary approvals like Traffic NOC, Aviation NOC, Environment NOC, etc are in place. This is a less risky product and hence is priced lower than the Stage 1 funding.
There are few financial institutions which do real estate funding at land stage. However there are many financial institutions that do construction funding. The only thing the developers need to bear in mind is that they need to be organized, have their approvals in place and approach right financial institution to ensure financial closure. Hiring a decent consultant for arranging funds helps who will advice on the nature of funding, financial institution to be approached and the mode of funding.
New modes of real estate financing are also evolving like private equity, mezzanine funding and joint development projects. Each means of financing has its own pros and cons and needs to be evaluated keeping in mind the size of the project, the IRR, area in which the project is undertaken and the risk appetite of the developer.