20:80 Real Estate Scheme

Every citizen in India is concerned with the rising Real Estate prices. Buying a home is just becoming a dream for a middle class income family. Property rates are shooting up every quarter in this lay off period. As a property buyer we not only pay for the property we planning to own but we also pay for the locality, the facilities around our vicinity, announced projects coming up near us and many more factors add up to our property price. Developers are trying their best to pull out cash from potential customers. Introduction of various property marketing schemes over the years has made many customers pay manifolds than they actually should have. Lets get introduced to a popular scheme that can make you count every single penny you own.  Mid-sized developers are betting their last buck on the 20:80 scheme to beat the slowdown in the real estate business. The scheme, also known as the ‘subvention scheme’, is emerging as a popular marketing tool, as the buyer has to pay only 20 per cent upfront, while the remaining 80 per cent is paid at the time of possession.

Interest subvention schemes are a modified form of financing home loans and have been part of residential real estate over the last few years. Under this scheme, a buyer of an ‘under construction’ piece of property is not required to pay monthly EMIs for a defined time-frame, or until he takes possession. The slowdown in sales has prompted developers to offer investor friendly 20:80 schemes (subvention). Such schemes help the developer to prop up sales without reducing the prices.

Subvention or 20:80 scheme is an innovative financial structuring which involves purchasing of under-construction property directly from the developer with financing from a bank/institution. Under this scheme, the property buyer has to pay only 20% of the cost of the property upfront and the balance payments are to be made in installments only after possession.

The subvention scheme is a variation of the normal home loan scheme, whereby, up to possession of the property, the EMI for the loan is paid by the developer instead of the buyer. For cash-strapped developers, the 20 per cent upfront payment gives them adequate liquidity. And there is pressure to execute the project quickly. The remaining 80 per cent is funded by the bank, which creates a bipartite escrow account that keeps disbursing the funds as the project progresses. Such schemes are popular in the Rs 25-65 lakh segment.

This is how a typical 20:80 scheme works:

• The developer approaches banks/financial institution with the project which he wants to offer under the 20:80 scheme and gets the same approved.

• The developer then bundles this scheme with the property and offers it to potential buyers.

• The buyer purchases the property by paying just 20% of the total cost.

• The buyer gets home loan approved for the balance 80% from the bank.

• A tripartite agreement is made between the buyer, developer and the bank.

• The bank disburses the home loan amount to the developer at agreed intervals on behalf of the buyer.

• The developer pays the EMI on home loan to the bank, instead of the buyer, till possession.

• After the possession, the buyer starts paying EMIs to the bank.
But is it all good when its a real estate deal ?????..... Lets understand. This scheme involves the builder factoring in the cost of pre-emi into their launch price. Say, a builder plans to launch a project at 10,000 p.sqft. They would launch the same at 11,000 p.sqft , with discounts(ranging from 500 psft to 1000 psft) offered to clients who don’t go ahead with the 20:80 scheme. This higher launch rate is basically factoring in the pre-emi that the builder will pay monthly to the bank on behalf of the customer. The bank basically charges a higher rate of interest, say 1.5% higher than the base rate for the scheme towards the customers. Builder can tie up with the bank for a period of 12, 24 or 36 months, depending on the time of possession. The customer has to pay the balance within the term period or possession, whichever is earlier (Most builders reveal this fact at a later stage), likewise the Builder will not get any other payment from the bank until the expiry of the term period or possession whichever is earlier.

In the scenario of delay in possession by the builder, there are basically two options:
1. The customer has the responsibility of paying the pre-emi to the bank until possession, if the term period stated by the builder expires & he has not given possession.

2. The builder makes the customer compulsorily sign an ADF option with the bank if he/she wants to opt for 80/20, thus enabling the builder to get the entire 100% irrespective of the possession of the building.


One of the objectives of this scheme was to facilitate people staying in rented houses to buy under-construction property by taking a home loan. They could move into their own houses once they were ready and start paying EMIs instead of rent.

However, they have become more popular with property investors who would like to take leveraged positions on the property and sale the same on getting the possession.

In the past, investors have made handsome gains using this scheme. For e.g. under this scheme, apartments in Malad West are offered say @10,000 p/sf. A 2 BHK apartment measuring 1,000 sq. ft. would cost one crore for which the buyer will have to pay 20 lakh only and no further payment till possession. The apartment is ready in three years by which time the rate is, say, 15,000 psf. The buyer now sells it for 1.50 crores thereby making a profit 50 lakh on initial investment of 20 lakh. This works out to whopping 2.5 times in three years.

Such schemes have worked well for the investors in the past since the property prices have been on the uptrend. However, if the property prices do not appreciate or start falling, the buyer will either have to exit at loss or hold on to the property and start paying the EMIs. Hence one should be cautious and invest in such a scheme only if one is in position to pay EMI post possession, just in case the market conditions are not conducive for exit.

Nowadays, most developers are using the 20:80 scheme in combination with the ADF (Advance Disbursement Facility). In case of normal home loan, disbursement is made by the bank to the developer in installments linked to construction. In case of ADF, a large part of the loan, say 80% to 90%, is disbursed in advance, ahead of construction. However, banks are very cautious in extending this facility to developers because of the potential for diversion of funds and usually only reputed developers with good track record are able to get this facility.

Another point to be noted is that under the ADF, since the large part of the loan is disbursed upfront, the interest cost during the construction will be higher. Under normal circumstances, this should not impact the buyer since the developer is paying the EMI till possession.

While on the face of it 20:80 scheme looks very attractive, one has to scrutinise the terms in detail and study the fine print to see if there are any hidden costs involved.

The main USP of the 20:80 scheme is that you don’t have to pay any EMI (interest cost) till possession. One needs to see if the developer is bearing this cost in full or passing it on to the buyer by increasing the price of the property. Taking the example referred to earlier if the property rate in Malad West is 10,000 psf and the developer is selling at the same rate under the 20:80 scheme, then it would be beneficial to the buyer. But if is selling at a higher rate say 12,000 psf then he is passing on the interest cost to the buyer. Also if the developer is availing ADF, his interest cost would be higher in which case he should be willing to bear the same.

One of the biggest advantages of the 20:80 scheme is that it puts pressure on developer to complete the project on time since they have to pay EMI till possession. Any delay in completion would result in increased cost for them. Hence this reduces the execution risk to a large extent.

However some developers offer 20:80 schemes under which they agree to pay EMI only for a specified period of time say two years from the date of purchase instead of from the date of possession. In this case, the EMIs would start immediately after two years irrespective of whether the construction is completed or not.


Considering all this, it would be advisable to go for 20:80 scheme wherein the property is being offered at close to prevailing market price and the buyer has to start paying EMIs only after possession.

To conclude, a fair and transparent 20:80 scheme is favourable for all the players involved the property buyer, the property seller (developer) and the property financier (Banks/Institutions).

The property buyer is able to buy the property with limited cash outflow, the developer is able to increase his sales and the bank is able to lend more money thereby increasing its assets and profitability.

CHANGE

GOLDMAN SACHS - GNP PREDICTION 2050

Green Shoe Option - Working Mechanism

In my article 'Green Shoe Option - An IPO's Best Friend" discussed on 22nd November 2012, I introduced you to a price stabilization mechanism and its importance during and IPO. In today's article I will discuss with you on 'How Green Shoe Option Works'

Price Stabilization
This is how a greenshoe option works: 

The underwriter works like a dealer, finding buyers for the shares that their client is offering.
A price for the shares is determined by the sellers (company owners and directors) and the buyers (underwriters and clients). When the price is determined, the shares are ready to be publicly traded. The underwriter has to ensure that these shares do not trade below the offering price. If the underwriter finds there is a possibility of the shares trading below the offering price, they can exercise the greenshoe option.

In order to keep the price under control, the underwriter oversells or shorts up to 15% more shares than initially offered by the company.

For example, if a company decides to publicly sell 1 million shares, the underwriters (or "stabilizers") can exercise their greenshoe option and sell 1.15 million shares. When the shares are priced and can be publicly traded, the underwriters can buy back 15% of the shares. This enables underwriters to stabilize fluctuating share prices by increasing or decreasing the supply of shares according to initial public demand.

If the market price of the share exceeds the offering price that is originally set before trading, the underwriters could not buy back the shares without incurring a loss. This is where the greenshoe option is useful: it allows the underwriters to buy back the shares at the offering price, thus protecting them from the loss.

If a public offering trades below the offering price of the company, it is referred to as a "break issue". This can create the assumption that the stock being offered might be unreliable, which can push investors to either sell the shares they already bought or refrain from buying more. To stabilize share prices in this case, the underwriters exercise their option and buy back the shares at the offering price and return the shares to the lender (issuer).




Such an option which was first used by the company Green Shoe (because of which it was named as Green shoe Option) is used by many companies outside India during their IPO process but is not a big hit in India. Statistics speaks of itself when we read that from 2003 to 2011, 365 IPO's were introduced in India out of which only 18 companies opted for this option which is less than 5% of the total public offerings made till today. Some of the participants in this include the IT giant TCS and Deccan Chronicle Holdings Ltd. in the year 2004, Cairn India Ltd. in 2006, Idea Cellular Ltd. in 2007, Indiabulls Power Ltd. in 2009.

During various researches done on this particular topic, researchers have considered various reasons on why Indian companies may not opt for the price stabilization mechanism, some concerns which sounded valued to me are
1) The issues where GSO is opted may not indicate the correct share prices and it will deprive “Value Investor” from purchasing shares from other investors when the price falls.
2) The legal and regulatory compliances are burdensome, due to this, the issuer companies and merchant bankers are not ready to take additional responsibility.



A survey conducted by The Economic Times said that a typical response was “Unlike in the US, SEBI does not permit merchant bankers to make money in trading. They will have to buy the stock if the price falls below the offer price, but they are not allowed to sell even if the stock value goes up. We are required to stabilise the price around the offer price for which we get a fixed fee”


I believe awareness should be conducted among the companies, underwriters, merchant bankers and investors about the importance and benefits of having GSO included in an IPO process.
SEBI being the regulator of the primary and secondary market may make GSO a mandatory clause in order to benefit the Investors and build their confidence in participating in the Primary market.

DABBA TRADING - NIGHTMARE FOR INVESTORS

We often read about dabba trading, not being permitted by the regulators. Many do not know the mechanics, and also the risk associated with it, till now. A dabba traders office is like any other broker’s office having terminals linked to the stock exchange showing market rates of stocks. However, the difference is that the investor’s trades do not get executed on the stock exchange system but in the dabba operator’s books only. This kind of operation, where trade is kept within the books of the operator is called “dabba” in the popular market terms. A Dabba operator flouts rules and regulations relating to Client Protection, which includes registrations, margins, transaction, execution and settlements. Not only has he evaded the Income tax regulations, which prohibit dealings in cash, but also service tax rules and many other mandatory requirements. If we deeply research into this subject we can understand that a dabba trader do not have the periodical derivative FNO settlement dates being followed. A dabba operator allows the client to carry forward the trade, be it in cash or in derivative segment for a period, not necessarily prescribed by the stock exchange..The settlement cycles are decided by the dabba operator, himself. There is no daily mark to market settlement if the trade is in client’s favour, whereas losses are extracted regularly from the clients.

To describe Dabba trading in lay man words , “You put money to get 100 shares, but the software will register only 10 shares officially in the market, and you will see 100 in your screen, which makes you believe that you really purchased 100 stocks, which is inaccurate”. It is not the investor who makes money, the broker who involves in trading on behalf of an investor makes the money, with 10% of cash put in their pockets illegally and unknown to the investor. Also these brokers don’t deal with successful investors, mostly targets the average and pity ones.

I believe it to be an offence, not much different from smuggling or black marketing. As a result, frequent raids are conducted on dabba trading operators in which their computers and records are seized. Those working in his office are also taken in the custody once they find such activities taking shape. If we run through the media, we can learn that the Gujarat police has conducted several raids in the past and alerted citizens. Media has also played its role in reducing the menace of dabba trading. Some dabba traders hedge their positions in the

market by partly executing the trade in the market, maybe in their own proprietary accounts or some benami names. Dabba traders disappear when the market goes against them, resulting in huge losses for their clients. The brokers who permit such activity in their branches or even sub-broker’s offices are the affected parties. Stock exchanges take

complaints against dabba trading very seriously and enforce strict penalties. Even suspension is levied, if stock exchange inspections confirm the complaint As Sensex jumps, resulting in the spurt in trading activity, dabba traders bounce back in the business. Hence constant vigilance is required.

IBN Live in one of their article revealed that Dabba trading, is still a thriving business in Mumbai, Ahmedabad, Rajkot, Jaipur and Ludhiana long after the SEBI had banned it. They claim that the dark side of this unauthorised stock trade is that it has undergone a technological makeover and paper notebooks have given way to hi-tech software. Available for Rs 2,000 to 8,000 in Mehsana, Gujarat, this software deletes one zero from the number of shares entered for trade. So, if a broker keys in hundred shares, only 10 will get fed into the official exchange terminal. However, the Dabba traders' screen will still show 100 shares. Many a times, it’s hard to understand the state of mind of the investors because some investors, for their profit, trade with these dabba traders knowing their illegal activities only because they facilitate trade with only 10 per cent margin instead of the 25 per cent as in a legal trabsaction in the Future and Option Segment (FNO). That means to buy shares worth Rs 1,000, an investor needs to deposit only Rs 100. However, it's not the investors who make money in this trade, but the brokers, who are quite often not even registered with a stock exchange.

 The clients patronizing such dabba traders may find some short-term benefits here. They do not follow ‘Know Your Client’ norms; fill cumbersome forms, sign long agreements and requirements like PAN card. Margins are bypassed and leveraging is freely available. Unaccounted cash is used for making payments rather than making payment by cheque. There are histories written in blood when Dabba shops close overnight, with traders disappearing from the locality once they see a killing in the market. They go to the extent of employing goons for the recovery of losses. In such a case, neither Stock Exchange Arbitration is available to the investor nor there is any access to customer protection funds which is of up to Rs. 100000.

Nobody has a clue about the dabba market size but it’s functioning on a large scale and it is certainly something which might beat any estimation made during research. However the figures of the Dabba Market turnover for the year 2005 was 5.72 lakh crores which then multiplied near to 24 times to 119.48 lakh crores in the year 2011 and after SEBI’s stringent action and trading policies saw this market shrinking 53.11 lakh crores till July 2012.

CORRUPTION PERCEPTIONS INDEX 2012

TOP TEN COUNTRIES WITH HIGHEST QUALITY OF LIFE

Top Ten Countries with Highest Quality of Life is based on Human Development Index (HDI). Top countries include Norway, Australia and Sweden.

Figures indicate Inequality Adjusted (HDI).

Norway - 0.846
Australia - 0.864
Sweden - 0.824
Netherlands - 0.818
Germany - 0.814
Switzerland - 0.813
Ireland - 0.813
Canada - 0.812
USA - 0.799
South Korea - 0.731