In our previous article, we had covered the potential of investing in early-stage real estate projects.
In this one, we’ll cover the various risks involved in investing at this stage of a project’s life-cycle and how you can avoid them.
Risks are related to three categories: developer, micro-market, and macroeconomy. In Part 1 of this article, we’ll cover issues related to the first one.
We’ve all heard of unscrupulous developers who are infamous for delayed timelines, shoddy construction work, and worse. But the ‘shady’ developer is a symptom of a larger problem - i.e., a customer base that is unable to do its homework on the developer at the time of investing in a project.
There is an element of greed involved occasionally, but more often than not it’s a case of investors missing red flags about the developer’s reputation, or not adjusting for it. Here’s how you can check for major red flags:
1. Financial Solvency
Builders facing temporary (or in some cases, permanent) cash flow issues isn’t uncommon. While the RERA Act solves this to some extent, you can still carry out your own diligence to minimize these risks.
For starters, analyze the developer’s balance sheet. Many larger developers like Tata, L&T, etc., have detailed, audited data about their financial health - often at a project level. The most important metrics you want to look out for are current assets and current liabilities.
Many established developers also borrow institutional capital from private equity funds, etc. For example, you can refer to CRISIL Ratings of major developers here. Ensure that the developer has not been downgraded recently.
2. Regulatory Issues
Land and environment-related litigation is one of the most common reasons for projects being delayed in India. Land records in India are often disputed, which leads to aggrieved parties using the court.
Additionally, environmental laws are complex and sometimes contradictory, which means environmental regulations tend to be subjective and oftentimes selectively enforced.
With respect to land ownership issues, the chances of disputes coming up are less if the land was purchased from a private limited firm or a trust. You can find this out by combining survey number data from RERA and other sources.
Regarding environmental issues, a potential investor can check for a few things before construction begins. Firstly, has the developer acquired building plan approval from the BBMP (in case of Bengaluru, for example) and other relevant authorities?
Secondly, has the developer deviated from the approved building plan in the past? If so, there’s a high chance they’ll do it again.
3. Construction Quality
This is difficult to gauge before construction has begun. While the RERA Act does mandate that developers have to rectify any quality-related complaints within 30 days, it is best to do your due diligence by reading reviews of the developer’s previous projects vis-a-vis other comparable projects in that area.
Also, compare what the developer is offering compared to the best developers in the market. For example, every project mentions the details of the interiors (fitting type, flooring, quality, etc.) in its brochure. You can compare this to those of luxury projects in the same area.
4. Project-Related Infrastructure
Your investment in an under-development project isn’t just for the unit - it’s for the amenities that come along with it. Several times, developers delay constructing the clubhouse and other amenities promised until all the phases of the project are completed.
To account for this, understand in detail from the developer about the timeline for all the amenities included in the complete project.
Also, understand how many amenities promised by the developer are actually in their hands. For example, several developers in Bengaluru had misled customers regarding a Cauvery water connection for their projects, leading to long litigation battles.
Conclusion
To summarize, it is important to do your due diligence and account for any potential delay in possession, or anything else that might not be up to your expectations.
Nearly 95% of delayed construction projects in India are residential ones, so the risk of a project being delayed by anything from 6 to 24 months is a genuine one and should be accounted for when you are calculating your potential returns.
In parts 2 and 3 of this series, we’ll cover risk factors related to the micro-market and the macroeconomy respectively.
As you’ve noticed, understanding the nuances of a project and deep-diving into a developer’s history isn’t easy. That’s where TruEstate comes in. We provide free in-depth research and recommendations about high-potential projects for real estate investors. Sign up today!
