One of the biggest reasons for delay in real estate projects is obviously shortage of funds. But how does this shortage of fund arise with you, the homebuyer, paying regular equated monthly instalments to the bank and the bank disbursing a chunk of funds to the company regularly or at a go, depending on whether you have opted for a downpayment or construction-linked plan. This is how: often companies use the funds received from homebuyers to service their debts taken for other purposes, for paying taxes or interest or even to start the construction of another project that is perhaps more in demand.
Says Manoj Goyal, senior vice-president, Raheja Developers, a New Delhi-based firm, “Often developers have to invest almost 40% of the project’s cost on land and approvals from their own share of investments. Banks do not fund the cost of land. After receiving some money from buyers, the developer often withdraw the initial share of funds invested for other purposes.” This may create a problem in future.
By Shyamal Banerjee/Mint
So how do you get around this problem? While things may not be under your control directly, if you ensure that the developer you are booking your flat with has an escrow account dedicated to the project, the problem could be contained.
What’s an escrow account and how does it help?
An escrow account is one in which funds are accumulated for specific disbursements. The disbursements could be regular payouts for construction activity, payment of taxes and interests.
An escrow mechanism is required for timely and proper release of funds without any bureaucratic hurdles.
For an escrow account, the bank and the account holder (in this case, the builder) draw up an agreement and a trustee is appointed for the account. The trustee has well-defined instructions on release of funds, enforcing a charge on assets, managing the covenants and with approval, effecting the remedies against default. The escrow trustee to that effect is a neutral party.
What works here is the fact that the account holder (builder) cannot use the funds parked in this account for a purpose that is not mandated. So if the mandate is that the funds will be used for construction activity, the funds cannot be used for any other purpose. Says Amit Goenka, national director (capital transactions), Knight Frank India, a property consultant firm, “Escrow mechanism is a ring-fenced method of controlling the cash flows, covenants and obligations of the borrower (account holder).”
In case of apartment projects, lending banks usually act as trustees. And for this reason the builder has to take a no-objection certificate from the bank before registering the apartment or any part of the project in the name of the buyer.
Is it mandatory?
Unfortunately, no. There is no regulation that makes it mandatory for developers to have an escrow account for each project in India.
However, the draft Real Estate (development and regulatory) Bill, 2011 has taken notice of the problem. It proposes the use of escrow for customer advances and all third-party liabilities so that proper monitoring and use of proceeds is ensured in real estate projects.
In May last year, the Reserve Bank of India, too, asked banks to put in place an escrow mechanism that can fence their loans to real estate firms and keep a closer tab on the end use of funds. This was primarily to contain case of delayed projects and use of homebuyers’ money for other purposes.
And banks follow this practise. According to the official spokesperson of Axis Bank Ltd, who did not want to be named, “At present, there is no such regulatory stipulation. We try to negotiate opening of escrow account in cases where we apprehend that sale proceeds can be taken out of the project, though it is not mandatory.”
In developed nations such as the US, UK, Australia and Dubai, the model of escrow accounts is already in place for real estate projects.
Do developers in India have escrow accounts? Even as having a escrow account is not mandatory in India, Mint independently found out that most of the firms listed on stock exchanges (national and regional) have a separate escrow account dedicated to individual projects.
Also, companies that receive money from private equity or foreign institutional investors open escrow accounts. Some others in the unorganized segment, too, maintain separate accounts. For example, FIRE Capital, a real estate dedicated fund, has invested in various residential township projects through special purpose vehicles (SPVs). “Each SPV being an independent entity needs a separate escrow account,” says Om Chaudhary, CEO, FIRE Capital and chairman of Astrum Homes, a real estate firm.
What it means for you
This would mean that your developer, in all probability, would deliver the project on time. Besides timely implementation of the project, the move would ensure transparency in fund utilization. “This helps in timely completion of the project as funds are not diverted for any other project/purpose,” says Anil Kumar, joint managing director and CEO, Ansal Properties and Infrastructure Ltd, a New Delhi-based firm having escrow mechanism.
What can you do?
The use of escrow mechanism is a confidential agreement between the lender and the borrower, who could be your developer. However, asking your developer whether he maintains an escrow mechanism is our right. Says a Noida-based developer, who did not want to be named, “One can ask the developer if he wishes to. A firm with a good governance policy will not shy away from discussing the matter and revealing the information.”
On the other hand, bank cannot divulge this information as it is the bank’s responsibility not to reveal details of any borrower. The Axis Bank official spokesperson says, “In a few cases where the builder has agreed to open an escrow account, we try to add a covenant where they are asked to mention this fact on their publicity material, sale letters and agreements. The banks can’t divulge this since it is a bilateral agreement between the builder and the bank.”
If you have already invested in the project, you can still ask your builder. However, if your developer is not maintaining an escrow mechanism, consider your investment to be a risky one.