Struggling to raise funds in this sluggish market, real estate developers are coming out with assured buyback/return schemes to attract buyers. While they have been offering assured return schemes on commercial property for years, they have of late started offering similar plans for residential projects too. Fund crunch, it seems, is hitting them hard.
But one should not forget that anything which looks too good to be true probably is too good to be true. Investors, as a rule, must be suspicious about any financial product offering abnormally high returns, that too with a guarantee. Such a product will have always hidden costs. The cost at times may be in form of higher risk. Let's look at how risky these schemes are.
Buyback schemes are similar to assured return offers. Developers assure buyers that they will repurchase the property at a 30-35% higher price, within a stipulated time, generally 18-36 months from the completion of the project. "After selling a real estate asset such as an apartment or an office, the developer offers to buy it within a time frame at an assured rate of return. It is a good way to raise capital in a slow market," says Joy Sanyal, national director, Strategic Development, JLL India, a real estate consultancy.
By doing this, the developer is trying to show confidence that the price will rise by a certain level in the future. If it does not, the buyer can sell the asset back to the developer. This gives the buyer assurance that he is investing in a project that will be profitable. "Investors find such schemes lucrative because of the assured return. Considering the cyclical nature of the real estate industry, the scheme protects investors from the vagaries of the market," says Anshuman Magazine, chairman & MD, CBRE South Asia Pvt Ltd, a real estate consultancy.
"Some developers combine buyback and assured return features. For instance, a developer promises to buy back the property at a premium of 30-35% and also give an annual return of 12% a year for three years. The overall return comes to 60-66%," says Rajan Ahuja, director, Realty Verticals, a real estate advisory firm.
But investors should read between the lines and don't go by just the promised returns.
Here, we look at things that may make such schemes less attractive than they seem.
No regulator for real estate:
The lack of a real estate sector regulator means it is difficult for investors to take action against developers for wrongdoing. "Lack of regulation often allows developers to get away with failed schemes, which sometimes remain only on paper, putting end-users' money at stake. If regulated on the basis of the development company's record, plus other aspects such as financials, such schemes can be a good tool for both developers and investors," says Magazine of CBRE.
No guarantee that the money will be used for the same project:
It is not mandatory for developers to create escrow accounts for individual projects. An escrow account is the easiest way to ensure that the money raised for a project is not used for any other project. But there is no law which forces developers to do so. The buyer has very few options if the developer doesn't use the money for the project for which he has been paid.
Don't fall for guaranteed gains, stake can be high:
Usually, under these schemes, developers ask buyers to pay 80-90% money upfront. This means a huge part of your house-buying budget is locked-in till the project is complete. So, the risk if the developer defaults is very high. Project delay may also lower returns. That's why the buyer should link payments with stages of construction.
These schemes are offered by developers whose main aim is to address cash-flow issues and enable sales, says Magazine. "Some new entrants offer unreasonable returns, which can neither be guaranteed nor paid. Only those who follow real estate market trends or have reasonable experience of real estate investing should subscribe to such schemes," he says.
WHAT SHOULD THE BUYER DO?
Look at the property's intrinsic value:
The buyer should evaluate on his own or with help from an expert whether the value of the property can rise as much as the builder is projecting. Will the property be worth the promised price? If not, he should doubt the developer's motive. The investor should find out about factors that can lead to a rise in the price of the property such as planned infrastructure in the area. Prices generally go up in a short span if the area is likely to be connected by metro rail or highway, or an industrial area is coming up nearby.
Check the record of the developer:
Consider the track record, financial health and reputation of the developer. Check whether the developer has defaulted in the past. And, of course, whether he has been completing projects on time or not."Even if the builder is trustworthy, the lock-in period may become a problem if you face a financial crunch and need to sell the property. This is because the developer may be the only person who can buy it from you, and he may do so at the same price at which he has sold it to you" says Vineet Kumar Singh, business head, 99acres.com.
Read the fine print:
The buyer should check the fine print for hidden costs. "The investor should look into the agreement with the builder, which should be watertight, and cover his risks in case the developer does not have liquidity to pay at the required time. The buyback interest rate should be applicable on the entire amount paid by the buyer to the builder when he or she purchased the apartment and not just the base cost. The investor should also examine the post-tax returns," says Sanyal of JLL India.
Most experts we talked to suggested caution. "The assured buyback basically converts the house into a financial product. These schemes can be very dangerous and sometimes almost in line with the Community Investment Schemes, which are illegal and on which Sebi has cracked down heavily" Says Sanjay Sharma, managing director, Quebrex, a Gurgaonbased real estate & consultancy & brokerage.
So, buyers should not be lured by the returns alone. Their first aim should be to protect the principal. "If the scheme is designed well and offers a realistic rate of return, it can be good for both the investor and the developer" says Magazine.