Will Rera embolden powerful builders?
The Real Estate (Regulation and Development) Act (Rera) was promulgated in May 2016 as a buyer-friendly legislation intended to safeguard the interests of purchasers in dealing with developers. While Rera will no doubt help address the cases of errant builders taking consumers for a ride, how will it affect affordability in the housing market as a whole?
At the crux of Rera are provisions aimed at increasing the accountability of developers, such as compulsory registration of projects (exceeding a size threshold), creation of an escrow account to hold project receivables, mandatory disclosures and heavy fines and penalties on compliance failure. Rera envisages the creation of a Real Estate Regulatory Authority by respective state governments to operate as an industry watchdog enforcing these rules. It also creates an appellate tribunal which will function as an adjudicating platform for speedy redressal of sector-specific disputes.
Several of these steps are positively in the right direction—such as the creation of a state body to collate (much-needed) data on the housing sector, promoting transparency and increasing confidence among buyers. However, in the absence of fundamental structural reforms to improve housing supply, the obligations imposed by Rera could ultimately end up hurting buyers.
Currently, constructing residential housing in Indian cities requires a costly array of clearances from different government authorities at the central, state and local levels. These approvals can take between 12-18 months, in other cases longer, where a single department or official could block a file and stall an entire project. Under these circumstances, developers in many cases are unable to meet the timelines agreed to with the buyers not as a result of their malfeasance, but due to a failure of efficient government coordination. Moreover, the uncertainty about the time schedule for approvals also raises the risk-adjusted costs of capital for project financing. Rera in its present format imposes mandatory obligations on builders to abide by a previously agreed to time schedule, without enforcing these same obligations on governmental agencies responsible for project clearances. The costs of penalties, refunds and interest payments thus borne through hamstrung state capacity by developers will then ultimately be paid by consumers in the form of higher prices, without fundamentally increasing housing supply.
Already, the costs of capital to build residential housing in India are astronomical, in part because the Reserve Bank of India prohibits lending by the formal banking sector for land purchases. As a result, builders rely on alternative means of initial capital, such as cash advances from buyers or private equity at higher rates of interest. The larger, influential builders have an advantage in raising capital but smaller, relatively unknown builders can only borrow at substantially higher rates. Since Rera fails to address the underlying problems of regulatory bottlenecks and access to formal project financing, one likely (unintended) effect of the act could be increasing the market power of the larger builders.
As states are still in the process of formulating the exact frameworks for their respective Rera regulatory authority, it is possible that the rules of the act are not enforced and do not change the status quo significantly. However, one concern is that the states arm the authorities with a powerful weapon to extract greater rents and end up crowding out legitimate builders. It won’t be the first time that well-intentioned efforts by the central government to litigate away a problem have counter-productively made beneficiaries worse off due to state-level implementation challenges. A cautionary example is that of the Right to Education Act which, aimed to improve educational standards across the country, has ultimately ended up being used by several states to close down several low-cost private schools that were providing an essential service in the absence of public schools providing quality education.
If the state Rera authorities significantly increase the costs of regulatory compliance, it may lead to a consolidation in the market. The costs of entry into the sector would also be higher, gifting greater pricing power to the remaining builders, especially in more concentrated geographic markets where land is costlier. This will eventually have an adverse impact on consumers as a resultant decrease in competition can drive up prices and reduce supply even further.
As much as this legislation attempts to make the housing sector more buyer-friendly, Rera still only manages to address the symptoms but not the disease. It needs to be accompanied by more fundamental reforms such as improving land records and titling, reducing relatively unnecessary but costly approvals, reforming rules related to formal financing for housing projects and dismantling regressive land-use constraints and building regulations in cities. Merely mandating developers, for instance, to take on the liability of title representation would only transfer the existing risk of losing land title into higher housing prices for buyers. Although Rera is well-intentioned, the authorities in the respective states need to frame regulations which while encouraging greater transparency and accountability for home-buyers, also push through structural reforms to prevent a further reduction in the supply of affordable housing.
Ohan Shridhar and Kshitij Batra are, respectively, associate and junior fellow at the IDFC Institute.