The new middlemen in realty

Written by Sandeep Singh

Updated: March 29, 2014 3:08:24 am

Given the fading demand, they are finding themselves at a loose end, which is the time to go for that bargain deal.

Faced with a rise in unsold inventory and with working capital hard to come by, real estate developers have over the last few years leaned heavily on a class of investors to generate sales and bring in that much-needed cash flow. These investors, called ‘underwriters’, typically buy a large proportion of the upcoming inventory to be sold directly to buyers.

Even as they have come in as saviours for the real estate market, industry observers say that underwriters are currently holding around 40 per cent of the unsold inventory in Delhi-NCR. Underwriters usually sell their holdings at a discount to the developer’s price, but experts say that buyers should be careful in dealing with them as there have been cases of false promises being made in order to make the deal look attractive, and such promises have not been honoured by the developer.

Underwriting in real estate has become a very lucrative business and this segment is populated by large brokers who have the marketing arm to generate sales. Developers too have turned to this business, which has the potential to deliver good returns.

Several industry insiders that The Indian Express spoke to have identified Investor’s Clinic, Raj Nandini Estate, Favista Real Estate as some of the major players in this business.

Business Model

The business model is quite simple: buy in bulk and sell few at a time. Typically, an underwriter books around 30-40 per cent of the inventory that is to be built, at a discount that could range between 10-20 per cent. The catch here is that the developer will not grant any discount to a buyer for a certain period.

For example, if the builder has priced the project at Rs 3,000 per sq ft, the underwriter books around 30 per cent of the upcoming development in the project at say Rs 2,500 per sq ft with a condition that the developer will not sell the remaining inventory at less than Rs 3,000 for the next six months or one year.

The underwriter would sell his holdings at a slight discount to the developer’s price say between Rs 2,900-Rs 2,950 per sq ft. Most underwriters have successful brokerage arms as well, which ensures good marketing for these projects.

After the six month to one year period (negotiated with the developer), the underwriter transfers his unsold inventory back to the developer, and takes back his booking amount. On the portion that is sold, the underwriter makes margins of anywhere between 10-20 per cent.

One such underwriter said that the picture is not as rosy as it seems, for the margins are dictated by what turn the market is taking. “While underwriters make money in a rising market at a time when the demand is high, they may see their business die in a slow market as they may not be able to sell the inventory purchased from the developer and thereby get stuck with their investment,” the head of the company said declining to be identified.

How do homebuyers benefit?

Industry experts agree that when it comes to getting a good deal on pricing, underwriters should be the first port of call. In fact, most of the marketing done through newspapers and radio spots is done by them.

But given the current state of downturn in the market, the underwriters who purchased at higher prices are looking for ways to offload them and cut their losses, and experts say this is the time a buyer can get a good deal from them.

“Underwriters currently are stuck with their investments as the demand was very slow in the market and in a bid to exit from those investments they are offering good discounts to the customers. It may be a good time for hard bargain to buy property from them,” said Samir Chopra, founder chairman, Re/Max India, a brokerage firm.

In case buyers are not dealing directly with developers, they should check whether the party they are dealing with is a broker or an underwriter. With underwriters, there is always a potential to bag a higher discount, as they are in a position to give one.

While that may seem like a good move, buyers too should exercise caution while negotiating their deal.

“There are cases where underwriters make false promises to buyers about facilities (free parking, free club membership etc) or give a credit note for a discount to be given by the developer at a later date. The developer may not have promised these. It may be better for the buyers to deal directly with the developer,” said Abhay Kumar, CMD of Griha Pravesh Buildteck.

Regulatory gaps

The key question, however, is what explains the rise of this investor class in the realty sector? The fact that their presence is littered around the Delhi-NCR market points to regulatory gaps that have unwittingly aided their business. For example, Maharashtra as seen no underwriters. This is because the state’s laws call for compulsory registration of the property in case 20 per cent of the price is paid.

“Once registration is done, and stamp duty paid, the transfer of property to another buyer becomes complicated, and in this case, the margin for the underwriting business goes for a toss, which is why they have not flourished in the Mumbai market,” said Kumar. This is not so in Delhi-NCR, where registration is done and stamp duty paid only at the time of possession.

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