Real Estate Finance in India

Transcription

1 Real Estate Finance in India Prashant Das Divyanshu Sharma < SAGE M I Business Books Los Angeles London New Delhi Singapore» Washington DC

2 Contents ListofTables List offigures ListofBoxes List of Images List of Abbreviations Foreword by Julian Diaz III Preface Acknowledgments Introduction xvii xviii xx xxii xxiv xxvii xxix xxxi xxxiii 1. Introduction to Real Estate Finance 1 Introduction 1 What Is Real Estate? 4 Land, Improvements, and Bündle of Rights 5 Translating Rights into Money 6 Real Estate Finance 8 Careers in Real Estate 9 Ten Reasons for Real Estate Specialization in India 10 Characteristics of Real Estate Markets 14 The Real Estate Activities Model 17 Node 1: Entrepreneurial Activity 17 Development versus Building versus Construction 19 Node 2: Investing Activity 22 Node 3; Lending Activity 22 Node 4: Governing Activity 23

3 viii REAL ESTATE FINANCE IN INDIA Node 5: Professional Activity 24 Node 6: Consuming Activity 24 Node 7: Successor Entrepreneur Activity 25 A Note on REAM 25 Some Misconceptions about Real Estate 26 Glossary 28 Real Estate Activities Model 29 End-of-Chapter Questions 29 References and Suggested Readings The Value of Time 31 Introduction 31 Scenario I: The Classical Valuation Fallacy 31 The Two Rules of Money 33 Tools for Financial Calculations 34 Getting Acquainted with the Financial Calculator 37 Scenario II: Rental Allowance 38 Compounding 39 Scenario III: The Opportunity Cost 40 Discounting 42 Scenario IV: Saving for the Future 43 Rate of Return 44 Scenario V: Another Look at Saving for the Future 44 Annuities 45 Scenario VI: Future Value of an Annuity 45 Scenario VII: Present Value of an Annuity 48 Scenario VIII: Analyzing Rental Cash Flow 49 Uneven Cash Flows 49 Scenario IX: Deal or No Deal? 49 Net Present Value 50 Internal Rate of Return 52 How to Interpret NPV and IRR 53 Example 1 55 Example 2 59 Modified Internal Rate of Return (MIRR) 61 A Note on Uneven Cash Flow Analysis Measures 64 Glossary 65 End-of-Chapter Questions 65 End-of-Chapter Practice Problems 65 Compounding/Discounting 65

4 Contents ix Annuities 66 Rental Cash Flows 67 Uneven Cash Flows 67 References and Suggested Readings Mortgage Banking in India 69 Fundamentals of Debt Financing 69 Why Debt Financing? 70 Scenario I: Leverage 70 Secured and Unsecured Debt 72 Mortgage Basics 72 A Historical Review 72 Types of Mortgages in India 74 Simple Mortgage 74 Mortgage by Conditional Sale 75 Usufructuary Mortgage 75 Mortgage by Deposit of Title Deeds 75 Mortgage Financing in India 76 Why Is Mortgage Financing Less Populär in India? 76 Mortgage Deed 80 Salient Features of a Mortgage Deed 80 Legal Rights, Foreclosure, and Debt Recovery Tribunals 81 Some Clauses of the Mortgage Deed 82 Who Holds the Title? 85 Mortgage Rates 85 Underwriting Process 86 Evaluation of the Borrower 86 Scenario II: LTV 87 Demographics 88 Credit Appraisal 88 Evaluation of the Collateral 89 Glossary 90 End-of-Chapter Questions 92 End-of-Chapter Practice Problems 93 References and Suggested Readings Fixed Rate Mortgage 95 Introduction 95 Mapping TVM Concepts to Mortgage 96 Mortgage Principal Calculation 97 Scenario I: Mortgage Principal Calculation 98

5 X REAL ESTATE FINANCE IN INDIA Scenario II: Mortgage Payment Calculation 98 Artnual versus Monthly Reducing Balance 100 Amortization Concepts 102 Amortization Schedule 103 Scenario III: Mortgage Balance Calculation 103 Calculating Mortgage Rate Using Spreadsheet' 106 Mortgage Scenarios and Financial Decisions 107 Administrative Fees and Other Charges 107 Effective Borrowing Cost 108 Scenario IV: EBC Calculation 108 Prepayment 109 Scenario V: EBC Calculation in the Case of Prepayment without Penalty 109 Scenario VI: EBC Calculation in the Case of Prepayment Penalty 110 What Is APR? 111 Limitations of APR 112 What Are Your Takeaways from These Scenarios? 112 What Is a Percent Point? 112 Glossary 113 End-of-Chapter Questions 114 End-of-Chapter Practice Problems 114 References and Suggested Readings Altemate Mortgage Types 119 Introduction 119 Scenario I: Loan against a Property 121 The Consumption Functions 122 House-rich but Cash-poor 122 The Utility of Home Buying 124 Scenario II: Reverse Mortgage 125 The Popularity of Home Equity Loans and Reverse Mortgages 126 Floating Rate Mortgage 127 The Tilt Effect 127 Fixed Rate Mortgage versus Constant Payment Mortgage 128 Teaser Rate 128 Caps and Floors 129 Scenario III: Floating Rate Mortgage I Variable Payment 129 Scenario IV: Floating Rate Mortgage I Constant Payment 132

6 Contents xi Issues with Floating Rate Mortgage in India 133 EMI under Construction 134 Loan Schedule for EMI under Construction 136 Scenario V: EMI under Construction-I 136 Scenario VI: EMI under Construction-II 139 Comparing EMI under Construction with Lumpsum Mortgage 141 Glossary 141 End-of-Chapter Questions 142 End-of-Chapter Practice Problems 142 Compounding/Discounting 142 References and Suggested Readings Managing Real Estate Companies 145 Introduction 145 Assets, Liabilities, and Equity 146 Property Owner's Perspective 146 Lender's Perspective 147 Developer/Builder's Perspective 147 The Need for Financial Statements 148 Financial Snapshots of Housing Finance Companies 148 Financial Snapshots of Real Estate Development Companies 148 Balance Sheet 150 Sources of Funds 151 Share Capital 151 Book Value 154 Depreciation 154 Methods to Calculate Depreciation 156 Straight Line Method 156 Written-down Value Method 156 Does Land Depreciate? 159 Amortization 160 Real Estate Brand License: A Case Study 160 Price/Book Ratio 161 Interpreting Price/Book Value Metrie 161 Historical Prices 161 Firm's Age 162 Intangible Assets 163 Variations across Sectors 163 Return on Equity (RoE) Ratio 164 Shareholding Pattern 165

7 Xii REAL ESTATE FINANCE IN INDIA Profit and Loss Account 167 Incomes 168 Expenditures 168 Operating Expenses 170 Financing Expenses 171 Indirect Taxes 171 Excise Duty 172 Service Tax 172 Sales Tax 172 Property Tax 172 Profit 173 Why So Many Profit Measures? 173 Direct Taxes 174 Income Tax 174 Wealth Tax 174 Capital Gains Tax 174 Statement of Cash Flow 175 Glossary 180 End-of-Chapter Questions 181 References and Suggested Readings Interest Rates 183 Introduction 183 Why Study Macroeconomics to Understand Real Estate Finance? 183 Macro versus Microeconomics 184 Debt Markets 185 Who Govems the Interest Rate? 185 Demand for Loanable Funds 185 Case Study: Ahmedabad Municipal Corporation Issues Bonds 186 Supply of Loanable Funds 188 Monetary and Fiscal Policies 188 Fiscal Borrowings 190 Treasury Bills 191 Scenario I 191 Treasury Bonds 192 Reining the Monetary Policy 193 Bank Rate, Repo Rate, and Reverse Repo Rate 193 Cash Reserve Ratio 194

8 Contents xiii Open Market Operations 194 The Relationship between Interest Rate and Bond Price 195 How the Supply of Loanable Funds Affects the Interest Rate 196 The Cycle of Capitalism 197 The Fisher Equation 199 Setting the Context for Real Estate 200 Benchmark Prime Lending Rate 200 Base Rate 201 Loan Hazards 201 Mortgage Modification/Balance Transfer 203 Scenario II: Loan Modification Analysis 204 Synposis 205 The Breakeven Rate 206 Scenario III: A Balance Transfer Analysis 208 Glossary 210 End-of-Chapter Questions 211 End-of-Chapter Practice Problems 212 References and Suggested Readings Property Markets 214 Introduction 214 What Is a Market? 215 Real Estate Markets 215 Quadrant I (Space Markets) 216 Quadrant II (Asset Markets) 218 Quadrant III (Development Markets) 219 Quadrant IV (Supply Adjustment) 219 Space versus Property Markets in India 220 Market Efficiency 221 Product Strata 222 Market Localization 222 Product Heterogeneity 223 Proprietary Transactions 223 Black Money and Untrue Transactions 224 Central Registry of Securitization Assets Reconstruction and Security Interest of India 229 The Pricing Function in Property Markets 229 Residex 231 Other Property Types and Space Markets 232

9 xiv REAL ESTATE FINANCE IN INDIA Some Application of Indices 233 Glossary 241 End-of-Chapter Questions 242 References and Suggested Readings Capital Markets for Indian Real Estate 244 Introduction 244 Capital Markets 245 Debt Markets 246 Rating of Debt Instruments 246 Case Study: Real Estate Ratings 247 Spread Banking 247 Primary Mortgage Markets 248 Securitization 249 Risk Pooling 249 Liquidity 249 Monitoring 249 Conduit Banking 250 Secondary Mortgage Markets 250 Originators and Servicers 250 Issuers 252 The Mortgage-backed Securities 253 Arrangers and Credit Enhancers 254 The Trade-offs of Securitization 254 Equity Markets 256 Private Equity Markets 256 Private Equity Funds 256 Portfolio Management Services 256 Foreign Direct Investment 257 Real Estate Stock Markets 257 The Initial Public Offerings 258 Stock Markets 259 Real Estate Mutual Funds 262 Real Estate Investment Trusts 264 Ownership 265 Assets 265 Income 265 Distribution 265 REITs in India 265 Reform the Primary Markets First 269

10 Contents xv Originators Should Have More Skin in the Game 270 Rethink the Organization of the GSEs 270 Glossary 271 End-of-Chapter Questions 272 References and Suggested Readings Perspectives on Real Estate Sector in India 274 Introduction 274 List of Topics 274 Tracing Land Titles 277 Tracing Litigations 277 Bar on Financing Land 278 Rephasement 278 Collaterals and Third Party Guarantees 278 Stamp Duty on Registration of Mortgage Deeds 278 Hesitancy to Lend by Bank Executives 279 Primitive Sanction Procedures 279 Maturity Mismatch 279 Suggestions 281 The Evolutionary Process 286 The Challenges 286 The Future 288 Real Estate Research and the Role of the Industry 289 Opportunities for Research 290 Need for Education 290 The Future 290 The Scale 291 Benefits of Infrastructure Spending 292 Conclusion 295 Background 295 Involving the Public and Private Sectors 296 Conventional Mortgages versus Innovative Financing 297 Support the Suitable Lenders 298 Shelter for the Urban Poor 301 Home Finance for Informal Settlements 302 Self-construction 303 Finance for Self-construction 304 Lessens for Financial Inclusion 304 Green versus Sustainable Real Estate 307 Limitations of Green Rating Systems 309

11 XVi REAL ESTATE FINANCE IN INDIA Challenges to Green Real Estate 310 How to Overcome the Challenges 310 Green Real Estate Trends in India 311 Conclusion 314 References 314 Answers to End-of-Chapter Problems 316 Index 319 List of Contributors 328 About the Authors 329