Changes needed to support real estate project financing in India

By Ramya Hariharan, Saswata Mitra and Subhro Bhattacharya, HSA Advocates

The Real Estate (Regulation and Develop-ment) Act, 2016, which came into force last year, aims to bring transparency and accountability in the real estate sector. The establishment of a Real Estate Regulatory Authority (RERA), coupled with stringent compliance requirements imposed on developers, has had a positive impact on the sector and helped in improving stakeholder confidence. However, some of the act’s provisions have posed serious challenges to financing of real estate projects.

Ramya Hariharan, HSA Advocates
Ramya Hariharan
HSA Advocates

Given that large real estate projects demand significant capital outlay upfront, developers now have to explore new funding methods for meeting construction costs as opposed to traditional methods of raising funds through “soft-launch” or “pre-launch” schemes. This is because the statute prescribes that all projects have to be registered with their respective state RERA before any offer or advertisement can be published. One of the significant challenges, from a financing perspective, is the provision which stipulates that 70% of the amounts realized for the real estate project from the allottees must be deposited in a separate account to be maintained in a scheduled bank to cover construction and land costs.

Whether cost of financing will form a part of land cost and construction cost has been a subject of debate as the act is silent on this. The Maharashtra RERA has clarified that only interest payable on construction costs is to be added to the total cost of construction, thus implying that 70% of the project revenues cannot be used towards repayment of principal payable in respect of financing of land and construction costs and interest payable towards land costs.

Saswata Mitra HSA Advocates
Saswata Mitra
HSA Advocates

The lack of recourse of the lenders to 70% of the project cash flows makes it difficult for developers to raise project finance. The act also does not clarify if the cash flows remaining after payment of land cost and construction cost can be used for any other purpose. Further, while the act is silent on whether a lien can be created over the separate account maintained for 70% of the cash flows, certain states including Maharashtra have clarified that the account must be a no lien account. This further discourages lending as lenders prefer not to provide finances without alternative collateral in the absence of control over cash flows. The cost of financing of real estate projects has risen as a result of these restrictive conditions, which also apply to existing projects that are awaiting completion certificates.

The act poses challenges not only to security creation but also to enforcement. Assignment by the promoter of a majority of its rights and liabilities under the project to any third party requires prior written approval of the RERA and prior consent of two-third of allottees. Enforcement of a mortgage in case of a default would become an area of serious concern for lenders, as while traditionally they could step in to take control over a project if the borrower defaulted, they will now be at the mercy of the allottees, without whose consent they may not be able to enforce their mortgage. However, it may be argued that enforcement of mortgage is a transfer by way of operation of law, hence the provisions of section 15 regarding prior consent of the RERA and two-thirds of the allottees should not be required.

In this connection, the Maharashtra RERA has clarified via a circular that where a transfer is initiated by a lender, only an intimation would be required to be provided to the RERA and the allottees by the promoter and the creditor. The clarification comes as a huge relief to lenders as they will now not have to obtain the prior consent of the allottees before effecting a transfer of the promoter’s rights and interests in the project. It is expected that other states will provide similar clarification.

Another concern is that a step-in right allowing a lender or investor to take over control of the developer may qualify the lender/investor as a “promoter” and thereby expose it to the obligations and liabilities of the promoter. Lenders may therefore be wary of taking on such obligations, which may affect funding.

To conclude, debt financing of real estate projects will continue to face hurdles until the above-mentioned issues are addressed and sufficient comfort is provided under the act to the lenders in matters relating to servicing of debt and enforcement of security.

Ramya Hariharan is a partner, Saswata Mitra is a senior associate and Subhro Bhattacharya is an associate at HSA Advocates. HSA is a full-service firm with offices in New Delhi, Mumbai, Bengaluru and Kolkata.


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