Real Estate Builder Scam

Abandoned Real Estate projects: Understanding the Builder Fraud

How a generation of home buyers were systemically defrauded in broad daylight. Do the consumers stand a chance when the entire system was designed to con them? Has anything really changed in Indian real estate sector today?

Do these pictures below seem familiar to you? 

Go to the outskirts of any major city in India, (take Noida & Gurgaon, around Delhi), you see miles & miles of semi-built structures that are unfinished & probably dead. Are you still paying EMIs for these?

Let's try to understand how the home buyers were conned in a structural manner by the builders, the banks, the regulators & the government . It qualifies as a nationwide organized fraud & yet, very few understand the depth of it. This post may ruffle some feathers but the cause is worthy enough.

Real estate housing is the bedrock of any developed nation's economy. Afterall, home is the most expensive asset one would buy in a lifetime. No wonder you need a home loan. Most developed economies have a well-structured & organized market that forms the backbone of the economy. Almost 65% of all consumer lending in #US goes to mortgages. There are strong laws that govern the entire eco-system of builders, brokers, banks, property owners & a regulatory system that ensures fairness for everyone . Avg US person has almost 80% of his wealth locked in their homes. A responsible nation can't risk any harm to this engine of growth. Even China rode the real estate train to develop into a middle income nation.

How did India go about this? We created a system that was designed to finance the extremely poor credit builder & rob the consumer of his lifetime earnings with no recourse to justice. What could have been the spearhead of our economy is now just a miniscule part of our development story. Meanwhile, most of the middle class still dreams of better homes that appear only on glossy papers, mostly. Some of you may say that things are changing. Well, they always are but at the core, has anything really changed?

How did the "fraud" begin ?

Let's start with some context here. These unfinished structures that you see started at different times, but surprisingly, they all supposedly faced "financial trouble" right after the "basic structure" was built. Why don't we see many buildings that stop in-between, say after foundation work or after few floors? No, we don't. It's precisely when the "full structure" is complete that the construction work stops. Ever wondered why ?

The answer lies in a structural fraud (Chose a better work if you like) played together by the builders, banks, state governments & financial regulators. The root of the issue was the innovation called "construction linked plan". The builders sell you the flat while assuring that money is payable only when construction progresses. You assume that is a fair plan & builder's interest are tied to completing the project with speed. Right?

Looks fair deal for all ? But this is exactly where the catch is!

What was the "fraud" here ?

The payment plan is designed in a manner that you would have to pay 90% of the apartment price upon "laying of the top floor of the building". However that is not how the expenses of the project flow. By the time, the structure is complete, the builder usually has spent appx. 40% of the project cost. The rest 60% of the money is needed later in the finishing work - electrical wiring, plumbing, flooring, paints, lifts / elevators, external work, parking, basements, provisions for water, sewage, power, etc. Even government approvals and fees come later. Also account for his profit margins of 20% as part of this.

With 90% of the project revenue collected, the builder is sitting on appx. 50% of excess cash (90% - 40%). His profits are in already but the costs are yet to flow out. And all that he is left to "earn" from you is mere 10% of revenues. Why would he spend another 60% money just to recover 10% from you? He stops work right here!

You thought that there is a timeline to deliver the project. But wait, what if he misses the deadline of delivery? There must be some penalty, right? Check the agreement - ah well……… keep searching!

So if developer delayed the project, there was no penalty due on his part (or may be a meager 1% interest penalty). But if you delay his payment, interest is charged @ 12% to 18%. Ever heard of one-sided agreements? Which business would not seize this opportunity to "borrow" free money & that too without interest?

In retrospect, it appears that this exactly was the plan all along. But why didn't the banks stop it? Wasn't it their money at stake? Well…..not really.

How & why did the banks encourage it ?

The "supporting actor" award in this scheme must go to the banks & NBFCs. Most banks don't finance the builders at all. They are also averse on financing the builders for construction, except for some at exorbitant rates. But never mind, consumers can always borrow home loan at 10% & "pay" the builder. So essentially, the consumer is "financing the builder" in the name of "construction linked plan". All this, when the same builder can't raise any penny of debt in credit markets because he has no credit rating at all. Beat that!

Did I tell you the best part? This money was interest free for the builder. So a developer, to whom no bank lends money, can actually get "easy finance from the buyers" at 0% interest, while the borrowers pay the EMI with interest!

What about the banking regulator? Didn't they see this?

Didn't #RBI see this rot by design when home loans were stuffing bank balance sheets? Does it take a genius to figure out that the RBI could have set this right just by a regulatory intervention at right time? The regulator could have asked banks not to support the construction linked plan where 90% money is out to builder in early stages? It could have tried to modify the payment schedule of the project cost to balance the cashflow with expenses. But RBI chose to sit aside, while the banks & builders continued to fleece customers. May be because it was not a risk to bank balance sheets. As long as the banks get paid by the borrower who carries the loan on their credit report, RBI is fine. Let the consumer chase the builder. And take the loss if necessary. Afterall, consumer will take the gain too when property appreciates. What about the rules of the game set by the regulator? But there is more to this story later.

You would think that the judiciary would help in cases where the builder abandons the project. On the contrary, they couldn't care less about any of this. In one instance at Noida, the judges intervened "Suo-motto" to take cognizance of the "air pollution" & some "bird sanctuary" in Noida & ordered to stop construction. The builder is more than happy to follow court orders. He was anyways not trying to construct anymore. More interest free money for him. Meanwhile the poor buyer pays EMIs. No wonder these justices are called "My lord".

Where did the money go ?

Estimates by Amitabh Kant committee indicate that appx 412,000 units worth Rs 4 lac crore ($50 Billion) are stalled / long delayed. Other estimates are for $65 BN for appx. 6 lac incomplete units. Imagine the scale here. This is 10% of central govt revenues & 1.2% of the GDP. Consider this – a noted developer like DLF has annual sales of below $1 BN. You get the scale of the issue now.

So where did the money go? Well we can only speculate, with reasonable accuracy. Democracy is an expensive way to run governments. State governments have been enjoying the party with builders because of this perfectly "legal" way to pull credit money from the banking system.  So the affluent middle class was financing (in black ) the political system too, alongside the govt. taxes (in white). Middle class was sold on the idea that "property appreciates forever". Builders diverted money to political system to get favors on land & permits. Everybody wins, except the buyer.

Additionally, the builder used this surplus 50% "free cash flow" to buy new land parcels, to launch more projects & collect even more surplus interest free money. The land prices were "appreciating forever" with money being pulled out of the banking system on your credit reports. By the builder who would never get credit on their own books. And you thought we don't have innovative companies?

Sadly, the "middle class" consumers will continue to pay their monthly installment to banks, while their money has been siphoned off by the builders, political system, govt taxes & the banks. Add to that a sizeable amount of speed money lost to corruption in approvals.

Is there a recourse for the buyer?

The only possible recourse was to take the loss & surrender the property to the bank. But the banks are smart enough for that. If you think you can get away by defaulting on the bank loan & surrender the abandoned property, you are just a novice here. This one is too well planned right till the end. I'll explain.

In the developed markets, you can surrender your collateral property to the bank and walk out debt free. US home buyers did that in 2008 after the sub-prime lending crisis & the banks took the haircut /losses. That is why the banks had to be bailed out by the government.

But not in #India. Here, you owe the full money back with interest, regardless of your collateral value. Bank agreements have a "special clause" where they can auction your mortgaged property (at washaway prices) & still make you liable for the balance loan amount. I'll explain with an example.

Assume you have a home loan of Rs 50 lac for a property that is unfinished & stuck. Now, if you "surrender" your collateral property to the bank, they can "auction" your property for Rs 10 lac & still come back to your door for rest of the Rs 40 lac you owe. Wow! So what is the point of collateral? The bank carries no risk here. No wonder they "approved" the projects with speed.

And you thought only the builders had one sided agreements? Now banks too? Everybody in this system is good here. Except the home buyer. So the banks have no skin in the game if credit goes bad. You as buyer will owe the money for all execution risks. Looks like this was well thought out by everyone. This kind of official extortion is unthinkable in organized markets. We have heard of people robbing the banks. Ever heard to banks robbing people? This is how it looks like.

Someone tell me how is this right in a large democratic society. When a housing project goes wrong, who is responsible? It is not the bank that approved the project as collateral, it is not the state govt. that monitored the builder, it is not the municipal bodies that charged taxes, it is not the financial regulator & it most certainly is not the judiciary. It's just you, the buyer who bought the flat on debt & assumed that the system will work for you. Only you pay the price for everyone.

This may be the reason why #RBI was not worried about bank defaults? With right to full payments from your income, the banks were safe all thru. Well played!

Does RERA change anything ?

They say a con never changes its character. It just changes it's colors. Enter #RERA. The RERA seeks to address vital issues of fair agreements, limiting cash leakages by builders, timely delivery & speedy adjudication of disputes. How much of it is working? You tell me.

We have escrow accounts now that should keep customer funds pocketed in one place. But builder can always expense faster & siphon off the money. The heart of the delays come from one sided builder buyer agreements. "Standard builder buyer agreement" is still missing. Each state can have different agreement. Every builder can still have its own version. There is still a fine print that works for builders. Recall supreme court request in Jan 2022, Justice Chandrachur said, "We are very keen on this. Instead of leaving it to all the individual states, we want the Centre to formulate a uniform builder-buyer agreement, which shall be applicable in all the States". Keen on this since 2022 ? Judiciary has its own pace & priorities.

A law is only as strong as its enforcement. RERA orders have no enforcement power. Even if you win interest penalty for delayed completion, you can take that victory certificate where you want to. But the builder is not going to pay anything. The recovery process is with state govt authorities & the police. Plus an advocate to initiate a contempt case. And the police have no authority still as the cases can be appealed further. Try fighting the legal battle to get decision from regulators. Then move to Appellate Tribunal, then the High Court & finally Supreme Court. Can you hold legal battles for 25 years or would you rather take the apartment on builder's terms? It's not a choice really.

In absence of land reforms, state govts are unwilling to let go of the power to change land use. Meanwhile, buyers pay an enormously high prices for the lack of urban planning & limited supply. Aside of the demand supply gap pushing prices, almost 40% of the property cost in India is composed of taxes. Examine GST rates – Cement- 28%, Steel- 18%, Plywood/ finishings- 28%, Pluming materials, electricals- 18%, GST on flat purchase- 5% & finally Registration cost- 5% - 7% of property price.

If it feels like your story too, you're not alone. The real estate sector could have been the leading source of economic development & a wealth creator for the citizens. If only. 

You lost your home. 

The nation lost an opportunity