RealTMOR Asset Mgmt LLC and RealTMOR Apartment Mgmt LLP
Purchasing apartments/offices directly from the developer (ready possession or under-construction) is referred to as primary real estate purchase. While purchasing real estate from another entity after the asset has been delivered to a “first buyer” is called secondary/resale purchase. Many people mistakenly feel that purchasing primary real estate is inherently more favorable.
Unquestionably, there are advantages to purchasing primary real estate. In a strictly finance perspective, buying primary real estate indicates one’s future bullishness and locks-in the beneficial price “today”. Additionally, the construction time-frame allows the purchaser to optimize future funding. But, in the current format, primary real estate purchases in Mumbai doesn’t offer those advantages. How does purchasing primary real estate make sense?
- Price: offer price should be discounted to comparable real estate prices in the area. The discount (for a Reputable Developer) should, by rule of thumb, be around 30%.
- Payment schedules: should be structured so that major payments coincide with delivery of the apartment.
- Debt: the buyer should be burdened with minimal debt liabilities during the construction phase.
- Taxes/government charges: should be close to government charges associated with resale properties.
Primary real estate is riskier than resale properties. Returns generated by owning finished properties compensates for “real estate risk” (income stream and price changes). Primary real estate includes additional risks such as construction risk, developer credit risk, financing risk, regulatory risk, legal risk etc. Investors/buyers need to be optimally compensated for the extra risks.
To illustrate, I will describe a deal I recently evaluated. I was offered an under-construction super-luxury condominium on the upper east side of Manhattan. Being a super-luxury property it was priced at a premium to the condominiums in the area (about 15% premium). The developer time-line for construction of the building and delivery of the apartments was 3 years. Historically, NYC real estate has a 15 year (2000-2015) CAGR of 4-6%. Additionally, mortgages in the US (30 year fixed) are priced around 4% p.a. The payment structure was: $1,000 due immediately, 10% due within the quarter and the rest payable upon delivery. If needed, a mortgage could be taken at time of delivery. Analysis demonstrates, discount to current comparables and “most” construction risk remaining with developer. I have seen similar structures for under-construction property purchases in Philippines and UK. Compare this payment structure to the structure that is “considered” NORMAL/STANDARD in Mumbai.
Buying Mumbai’s primary real estate and making substantial payments during the early construction phase results in the buyer taking many unnecessary/uncompensated risks. It entails the buyer taking construction risk. This risk is significant, proven by construction loans being among the most expensive of real estate debt. There is a multitude of reasons why construction could get delayed or shelved even by reputed developers. There could be labor issues, issues with procuring materials, logistics issues and natural calamities which could derail the construction process. The lender and not the buyer should be taking on developer credit risk. Even, the best developers can make bad business decisions or get affected adversely by the business cycle. Thus jeopardizing their business. The buyer will be taking on the financing risk of the developer. Instead of the developer taking an expensive and cumbersome construction loan the buyer takes a mortgage or self-funds the purchase. In addition, there could be environmental concerns, government approval delays, one-sided legal documentation and the possibility of fraud. Most developers in Mumbai do not allow review of the sale agreement until a substantial amount has been paid. Combined this means the buyer is taking on regulatory and legal risk.
All these risks are meant to be managed by the DEVELOPER and the LENDER as these are integral to “their business”. These are NOT risks to be taken by “buyers of real estate” whose goals are to take real estate risk. There is a special class of investors (private equity and real estate funds) that specialize in under-construction project investments (NOT RETAIL INVESTORS!!). By making end-users pre-pay for under-construction property, developers get a “low-cost and low-control funding” source. The developers/banks transfer ALL the risks onto buyers without adequately compensating them. To add insult to injury, in Mumbai, buyers actually pay around 90% of the price around 2 years before possession (upon completion of the bare shell). Once, these funds are received there is no incentive for developers to complete the project in a timely-manner. They have NO SKIN IN THE GAME. That is exactly what happens.
Another interesting anecdote demonstrates the developer mentality in Mumbai. A salesperson of a Mumbai developer was marketing a super-luxury/premium-priced project to me. It was a Rs. 10+cr property and 40% or so of the funds would be paid at the plinth stage. Just the 4-5 year opportunity cost, in India, at 7% p.a. is intimidating. I told the salesperson that this deal was very tough on the buyer. I said that he should either charge his asking “premium” per sqft price or receive funds on possession. He couldn’t do both that’s unfair!! His response to me was emblematic of all that is wrong with the Mumbai primary market, “who do you expect would pay for construction of ‘YOUR HOUSE’, if you pay at possession?”. Actually, the party paying for construction should be the DEVELOPER. The job of the developer includes financing of construction and not just ordering the cement and steel to build a building.
Buying primary real estate in the current structure also attracts an additional government charge. This charge is not levied while transacting resale real estate.
All-in-all buying primary real estate in Mumbai in terms of price and risk in NOT profitable or practical anymore. To all these disadvantages add fraud that happens in the primary real estate market in Mumbai: misleading marketing, delivery delays, non-delivery, delivery of substandard product, non-delivery of items promised. The list goes on and one soon realizes that buying primary real estate in Mumbai is IMPRUDENT!!