Improving housing market practices via banks

In his open letter to RBI Governor , V. Raghunathan (CEO, GMR Varalakshmi Foundation) starts like this:

Dear Dr Reddy, have you ever read—I mean really read— the contracts builders hand out to ordinary homebuyers to sign for a transaction worth lakhs and even crores?

People would know what is to follow next. He goes on to say the contract leaves the home buyers without any help whatsoever. He is completely at the mercy of the builder as the contract is lopsided. The builder charges a huge penalty if the buyer misses an installment on the due date but hardly any penalties are there if the builder misses his completion stages.

While the buyer will have to pay a penal interest of 18% per annum for a delay of even 15 days on his instalments to the builder, the builder has no such obligation for delaying the completion of the work by any length.

Then he points there is no say to enforce quality of construction promised. It all depends on the builder. All sellers say it is high quality stuff at time of sale but we all know how false these claims are. Other products don’t matter as much as a house. In a house most people put their lifetime savings (or are entitled to pay the bank for near life time) and there is no recourse. In Navi Mumbai for instance, whichever property you buy, it starts leaking in the first rain itself and you can’t do anything except spend more to fix it. 

The author then asks RBI Governor to use banking system to impose some standards in this industry:

Often, the agreements with the builder are linked to the loan contracts, so that the loan disbursals go directly to the builder. So it should be possible for banks providing the housing loan to require all payments from buyers to the builders to be made through an escrow account. The bank could also hold a limited power of attorney from the homebuyer (borrower) to ensure that the builders have met their obligations and once so satisfied, clears the escrow.

I must say it is a good thought. The practices in housing markets in India (particularly in metropolitan cities , where we have multi-storey apartment system) are so bad, that any help would be great. The Builder-Broker nexus is too strong and you feel duped all the time, but can’t do anything. Whether you take a house on rent or buy it ( See the economics of house-hunting in Mumbai), there are such huge transaction costs that you always feel burdened.

For instance, in Mumbai you have something called a “super built up” area which is roughly about 35%-40% of area. So, if the builder quotes 1000 sq ft area what you get is 600-650 sq ft area but you pay for the entire 1000 sq. ft. Super-built up includes area of terrace, balcony, parking, garden etc. and as this also involved development costs. the buyers have to pay for it collectively. But why 35-40% from all the buyers??  This was earlier called built up which was 15-20% but now has been extended to 35-40%. And worst of all, this has now been included for all flats. Even the old properties are selling at superbuilt up areas.  

Apart from this, Banks can also be very usefully used to do some rating of the builders. As of now, Banks just approve certain builders but there is no rating. You really do not know which builder is a good one. As a result, the apartment prices are near similar and depend on the area, not the quality of the builder. Some builders have developed a brand equity but they are very few in number.

The author also points to a problem which provides some food for thought for beh eco guys: 

And the most unfortunate thing is that most buyers do not (and others cannot) even read what they are signing on, thinking the process to be a mere formality.

This is also a big problem. The form is a mixture of legal and financial lingo and very few people have the speciality to understand both. The forms should be made simpler and shorter. But again this is a less of a problem than solving the above issues.

Housing is big problem in places like Mumbai and it is a very basic issue. If banks can help, it is most welcome. Moreover, research and debates are advocating that Central Banks need to look at asset prices (discussed here) and asking banks to monitor developments in housing markets might just be a good idea.

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