Distressed real estate – invest or avoid?

By,Shobhit Agarwal, MD & CEO – ANAROCK Capital

The aftershocks of multiple disruptive policy reforms and structural changes continue to ripple through the Indian real estate sector. While its visible transformation from unorganized to organized and opacity to transparency are indubitably positive, we cannot help but count the fatalities of this process.

Many real estate developers are finding it extremely difficult, if not impossible, to realign their businesses to the new norms. It’s not just a question of compliance, but also the fact that the new real estate development norms call for massive capital infusions.

The practice of raising interest-free monies via pre-launches now more or less a thing of the past, interest rates are hardening and the banking sector is not especially well-disposed towards lending to developers. Simultaneously, investors who had depended on heavy cash components for their resale properties have been left in dire straits by demonetization and the concerted drive towards financial transparency.

Many developers need to sell their hung-over inventory in a hurry – either to raise funds for new projects or so that they can cash out and leave the business. Likewise, many investors or other property owners are also desperate to exit their holdings. And as is usually the case, one man’s loss is inevitably another’s potential gain. The current state of the market certainly presents a window of opportunity for smart property buyers who can make the most of it.

Today, there are plenty of distressed properties available on the Indian real estate market. The opportunities include retail and office assets, hotels, individual residential units and even entire housing projects. With proper due diligence and the appropriate capitalization, one can actually strike a gold mine.

However, one still needs to know what one is doing, and also follow some very necessary precautions before entering into a distressed property deal.

Is this the right time to buy distressed properties?

With rising population in urban areas (more than 10 million people migrate to Indian cities and towns every year, and India’s urban population likely to surpass 800 million by 2050), there is a significant inherent demand for homes, offices, malls and other real estate asset classes.

In the current market conditions, many distressed assets are available at attractive valuations and it may not be a bad idea to seal a deal. However, one should not do this without a clear plan of action on how to utilize or monetize the acquired asset.

Aspects to investigate before acquiring a distressed property:
Reasons for the distress sale – It is extremely important to identify the reason for why a property has become distressed, to assess if they involve policy changes (which may affect the new owner as well), financial troubles or wrong intent. The latter is the most difficult to identify and tackle, and so must be investigated with utmost care.
Existing debt – A distressed property buyer must do a thorough check on the existing debt which the new buyer will assume. In addition to the overall quantum, one must segregate such debt into short-term and long-term, and also understand if the debt is backed by any security or otherwise.
Physical condition – However attractive the valuation may appear, the physical condition of the asset to be purchased plays a key role in its inherent value to the new owner. Regardless of whether the buyer plans to refurbish and release/sell and/or demolish and rebuild the property, this check is important to assess the cost implications.
Law adherence – A prospective buyer of a distressed property must ensure that the asset is developed as per the stipulated regulations, including FSI permissions, statutory approvals, fire safety norms, and many more. If there is even a faint hint of a violation, the buyer must understand the risks and have a plan towards mitigating them.
Litigation check – The buyer should check for litigations that embrace the distressed asset. It should be commercially viable to own the property despite the existing litigations, and the buyer should have the knowledge, means and a plan to overcome such issues.
Title clarity – A clean title is a must for the hassle-free future transactions or development of the purchased asset.
Lease contracts – If a buyer is acquiring a pre-leased asset, it is imperative to check the lease contracts and their expiry dates so that they can be factored into future financial projections.
Conclusion

The momentary pause and panic in the real estate sector of a country whose GDP likely to reach $5 trillion by 2025 can certainly be viewed as an opportunity by large global investors who are looking to enter into or expand in India. However, such players are not gamblers and will always ensure that they have the benefit of an experienced India-based consultancy to identify opportunities as well as their accompanying risks and required mitigation plans.

Individual investors, on the other hand, bear the onus of due diligence while acquiring distressed assets. It should be clear that a well-meditated play in distressed property can reap rich benefits, while an inadequately researched acquisition can result in a severe financial setback and even legal complications.