A black spot on real estate

The scourge of black money has gripped real estate and buyers too are involved,knowingly,in generating it much against one’s will.

Written by Anshumali Ruparel | Published:June 23, 2012 3:37 am

The recently released ‘White Paper on Black Money’ by the Union government says that real estate is the highest contributor to the total black money being generated in the country. This ‘black money rolling’ percentage within the sector is much higher at around 30 per cent depending on the parties involved and the kind of transaction. It has become a vicious cycle and the hapless buyer is the ultimate victim.

“Real estate is plagued with black money and this has led to an unequal playing field among buyers and is tilted against the salaried class,” says Pravin Malkani,managing director of Patel Realty,a Mumbai-based firm.

THE NEW GOLD RUSH

The reason is simple: super-normal profits. If one compares the appreciation in the rates of shares,gold and real estate in the last decade,then real estate has on an average yielded almost 300 per cent appreciation of investment across all major markets in the country.

Very high demand against very low supply coupled with attractive interest rates for home loans in the beginning of the last decade boosted high appreciation. In addition,lack of stringent laws and a regulator for the sector,made it a haven for parking unaccounted money. Real estate had two benefits: high profits in a short span of time and an easy route to laundering black money.

The initial entrants invested black money generated from other businesses. Some stayed on to become developers and many others entered the fray as investors and promoters.

A significant source of black money in the sector comes from investors. They could be businessmen,politicians,mafia lords,NRIs and in some cases even celebrities. These ‘investors’ bankroll developers even before the project takes off,thereby giving the developer sufficient funds with which to launch the project.

There is a difference though,between these investors and financiers. The latter finance a project on the basis of an agreement with the developer. Investors,on the other hand,do not have a registered document,but an understanding on paper for the arrangement of the funds. Financiers charge a fixed interest rate while investors take a proportion of the profits from the developers. This arrangement could be for the short- or the long term.

When an investor exits in the short-term,returns have a higher cash component while in the case of a long-term exit,the returns could be paid both via cash and cheque. This is one way of converting black money into white,and the cash component is invested again in other projects and the cycle goes on.

Investors usually decide at what price they would exit. Until the prices touch that threshold,the developer is unable to sell his share of the apartments/units at a lower price. Since investors bring in the funds at the initial stages,the developer seeks to protect their interests. This is one of the reasons why developers do not reduce prices despite low sales. It is a phenomenon that is being witnessed in all major cities — thousands of flats are not occupied,developers say that they belong to investors whose identity is not revealed and prices do not fall.

THE GRAVY TRAIN

The developer who gets this black money has to pass it on,mainly in four directions. First,he has to pay the landlord from whom he buys the plot or the structure. Secondly,the contractors,suppliers,professionals and retainers working with him. These two categories are basically trying to evade taxes on their earnings and so demand some cash from the developer.

Then come two categories of claimants who ask for cash as they are not entitled to any legitimate payments. One are the local politicians,mafia etc of the area where the project is being executed. Two,government officials who allegedly demand payments for approvals and sanctions. A developer has to arrange for cash to make the payments so that the project would take off.

In order to shield the source of black money,many developers avail of loans from banks for their projects. Interest payments can be managed with the high appreciation of the property upon completion.

The legitimate funds are used to pay the legitimate portion of the payments due to contractors,suppliers,the landlord etc. The remaining black portion is paid from the investor-provided funds.

ENTER THE BUYER

The cash generated by the processes we visited may not be enough as the project progresses. This is where developers get another cash cow: the home buyer.

Barring some exceptions,usually few and far between,the practice across the country is that the buyer makes the payment for the property in two forms: cheque and cash. There are two ways in which this cash is demanded from the buyer.

Let us suppose a buyer buys a flat of 800 sq ft at Rs 20,000 per sq ft. It would cost Rs 1.6 crore. The developer may ask for a portion to be paid through cheque and the remaining in cash. The agreement will reflect 800 sq ft area and the amount paid via cheque. The cash component is black money poured into the system.

Then there is the second malpractice resorted to by developers. They would show extra space as the part of the flat and will demand payment for this space in cash.

For example,the buyer has bought a flat of say 800 sq ft carpet at the price of Rs 15,000 per sq ft. The developer then adds 400 sq ft in the form of ‘dry area’,garden,flower beds etc. The buyer has to pay for 1,200 sq ft at the same rate leading to a total of Rs 1.8 crore.

The extra space added is called loading and the total area paid for is called ‘super built up’ or ‘saleable’ area.

The agreement the buyer enters into,would show only 800 sq ft of carpet area. The buyer has paid for extra area that is not part of the liveable space within the flat.

However,when the buyer tries to resell the flat,he can only charge for 800 sq ft as the agreement says so. Let us say the rates have appreciated to Rs 20,000 per sq ft. For his carpet area,the buyer would net Rs 1.6 crore,booking a loss of Rs 20 lakh despite the appreciation.

Ideally the buyer in this case should get a profit of Rs 5,000 per sq ft for 1,200 sq ft totalling to Rs 60 lakh. He cannot spread this amount across the stated area of 800 sq ft as the rate then would jump to Rs 7,500 sq ft to make the sale rate Rs 27,500 a sq ft. It would attract high stamp duty and taxes,eating into a significant chunk of the gain.

Enter black money again. In order to make a profit,the buyer would be tempted to ask for cash payment for the unregistered 400 sq ft.

Although the developer seems to be at the centre of black money in real estate,the home buyers are also to be blamed for abetting it. He may call it helplessness but he too surely tarnished by the guilt of evading taxes and encouraging corruption in the sector.

Developers agree that black money and corruption are interrelated and both must be curbed,if not eradicated. Most developers Express Estates spoke to in Mumbai,refused comment. There are some developers who are making efforts at being transparent. “It is difficult until India remains a cash-driven economy. It is only when the smallest transaction is mandated to be electronic,can we see some progress. My company does not engage in the practice of involving black money in any of our transactions,” says Malkani.

Lalit Kumar Jain,the national President of the Confederation of Real Estate Developers Association of India (CREDAI) said that several bottlenecks at the central and state levels are responsible for the scourge of black money.

“We are victims of the system,not beneficiaries. We curse every person who exploits us to give us a legitimate permission,which we deserve instantly and without any illegitimate demand,” says Jain and has appealed to the government to create one-window system for approvals and sanctions to curb corruption. “We too hate the system that labels us as crooks,cheats and breeders of black money,” adds Jain.

One can only hope that a regulator is set up for the sector and wish that it be effective in curbing black money and giving the buyer his due.

anshumali.ruparel@expressindia.com

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