Real estate regulator

India’s Real Estate Act shows promise for buyers but success will depend on how states implement it

Real estate is a state subject, so states need to frame their own rules.

The RERA or Real Estate (Regulation and Development) Act came into force on May 1. But regulation of realty will happen by fits and starts with large differences in terms of state-level implementation. Real estate is a state subject. Most state governments derive a significant share of revenues from stamp duty from the registration of sales, and from municipal taxes. The Centre also has a direct stake – in that rentals are supposed to be Tax Deducted at Source from this fiscal year.

The central Act was passed a year ago. States were supposed to get on board within this 12-month period by creating their own rules and setting up their own regulators. But a study by credit rating agency Crisil says:

“Despite continuous monitoring and follow up by the Ministry of Urban Development and Housing, Government of India, only nine states (Andhra Pradesh, Bihar, Gujarat, Kerala, Madhya Pradesh, Maharashtra, Odisha, Rajasthan, and Uttar Pradesh) and six union territories (Andaman and Nicobar Islands, Chandigarh, Dadra and Nagar Haveli, Daman and Diu, Lakshadweep, and National Capital Territory of Delhi) have notified their respective Real Estate (Regulation and Development) Rules, 2017.”

What is more, Crisil claims that many of the state-level rules dilute key aspects of the Act.

A central law

The closest analogy one can find to the situation is in the electricity sector. However, there are differences both in legal status and the ground situation. Electricity has central players and central laws and every state has local powers and local agencies. States have created their own rules in accordance with the Electricity Act, 2003, and its amendments. Each state has a regulatory agency on the lines of the Central Electricity Regulatory Commission.

Similarly the Real Estate Act is a central law and it demands that each state create its own rules and appoint a regulatory agency. But electricity is a near monopoly with few private players and tariff caps set by regulatory commissions. Real estate is run by thousands of private players who charge what they think the market can bear.

Real estate is a source of revenue for states and the single-largest source of corruption. The sector is riddled with corrupt practices. Realtors pay in a mix of black money and white for land and for necessary conversions and clearances. The construction process again involves both black and white costs and the construction industry is a useful vehicle both for laundering (black to white) and for reverse-laundering (white to black).

Very few sales of property are made completely in white either. Primary sales from realtor-buyer have a very large white component. But there is always speed money involved in the registration process. Secondary sales usually have a much larger black component.

The laws are complex everywhere, with complications like land use conversions thrown in. There are also “son of the soil” rules in many states, which make it hard for so-called outsiders to buy. This web of regulations and clearances creates a lot of scope for corruption. Functionaries managing the regulatory processes usually live in a certain style!

Consumer oriented

The sector also has a tendency to go through cyclical booms and busts. Land prices generally trend up but also suffer deep corrections, often lasting years. It is a very opaque market. Realtors often start projects, and leave them unfinished when they run out of cash. Buyers can be left in limbo for years. Realtors are permanently under-capitalised. They raise money to complete projects either by paying very high interest rates, or by pre-selling. Realtors also frequently misuse cash, diverting money paid from one project to another purpose.

Since land prices are variable and subject to sudden sharp changes, the Reserve Bank of India sets a very high bar for real estate-related loans. Lenders are also wary because there can be multiple claims on the same land. For example, a realtor may buy some land and offer it as surety to raise cash. Then he might sell (unfinished) units on that land to sundry buyers. Those buyers also raise money by mortgaging their respective units. The same land is thus mortgaged to two entities. This is fairly common. If the project goes bust, which lender claims?

(Photo credit: HT).
(Photo credit: HT).

The Real Estate Act is supposed to be consumer-oriented and expected to help in cleaning up these malpractices. It is supposed to ensure that funds are not misused or diverted. One of the provisions is that 70% of funds paid for a project must be retained for use in that project. Another provision is that realtors pay interest to buyers if there are overruns in time. Every unit is to be compulsorily registered. Changes in sanctioned plans have to be disclosed and agreed upon by buyers, and structural defects must be remedied. Buyers can also be penalised for late payments. The entire profile of every developer, including the number of outstanding legal disputes, must be posted online. There are penal provisions including jail sentence for violations of this Act.

States dragging their feet?

One key provision is that ongoing and incomplete projects should fall under the Real Estate Act with retrospective effect. The concept of retrospective application is disturbing though there is a rationale for it. There is huge unsold inventory sitting with realtors in completed projects. There are also a lot of incomplete and undelivered projects where buyers have money stuck. It is understandable that the Act tries to tackle those problems. Nevertheless, it is disturbing since retrospective applications of any legislation usually lead to trouble down the line.

If it works on the ground, the Real Estate Act would bring about 83,000 registered builders under its purview. Better regulation and accountability would lead eventually to more investment flows into the sector. So the Act’s focus on transparency and disclosure looks good at first glance.

However, globally speaking, real estate always tends to massively swing. The subprime crisis in the US is a pointer to the fact that real estate busts can happen anywhere and everywhere and bring down rich nations. Ten years after the subprime crisis, the entire world is still suffering the consequences.

The fact that many states have not set up their own Real Estate Act-related rules a year down the line suggests that there is a degree of opposition to transparency.

Many states, including the BJP stronghold of Gujarat, are said to have diluted the legislations pertaining to retrospective effect and also to the mandatory disclosures that developers must make. Some states, like Karnataka, are said to be still debating the central act. Some states copy-pasted the first draft of the Act, which went through changes subsequently that have supposedly not been incorporated.

Implementation will obviously vary in terms of efficiency from state to state. The industry will probably continue to be a haven for black money. But if the Real Estate Act does, at minimum, improve the delivery process and mandate basic quality standards for developers, it is a big win in itself for consumers.

In the broadest terms, complex industries such as real estate cannot be micro-managed in detail by setting up rules. There will always be loopholes and more loopholes within the loopholes. Nevertheless, the Act could improve delivery and customer service norms within the industry. We will have to wait and see what it actually delivers.

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