Sort by :
Filter by :
- The corruption trickles down
Sure, builders are victims of this anarchic system. But they also exploit this anarchic system while transacting with buyers, who neither know the rules well nor have the wherewithal to immerse themselves in such details. An example is the illegal sale of parking spaces. Another example is underreporting the sale price of a property. Because of the high tax rates-stamp duty of 5-14 %, longterm capital gains tax of 20%-both buyers and sellers tend to under-report the transaction value of a property and transact the differential in cash.
"The increasing spread of home loans and corporatisation of big real estate companies has reduced such transactions in original purchases," says Ananthanarayanan. "But in resale, a cash component of 20% remains the norm," adds Sachithanandan. Such transactions put cash in the coffers of builders, which the promoters use to buy favours or generate more cash for themselves.
"The expense side is a rich source for money laundering," says the regional MD of a consultancy quoted earlier. He says builders purchase many small items from the unorganised sector-for example, steel rods and sand-in cash. So, for example, a builder will show. 100 cash paid towards buying material. But as per an agreement with the supplier, only. 90 worth of material is delivered; the builder siphons off the remaining. 10, thus escaping tax. "Many realty firms indulge in 'creative accounting', which inflates sales and profits," says Jamil Khatri, executive director with KPMG, an audit and advisory firm
Builders have even violated loan terms. With real estate emerging as an investment, builders exploit bank finance. They buy land, advertise a scheme and collect 20% of the booking amount from buyers. But instead of beginning construction, they use the loan to buy another plot for a new project. Banks are not allowed to fund land acquisition, but money is fungible.
A slowdown in loans can snap this chain. The credit crisis of 2008-09 threatened this chain. But PSU banks were coaxed by their political masters to provide loan support to builders on the pretext that defaults could put the economy under stress. Even as the BSE Real Estate Index tumbled 80%, real estate prices fell just 15%. Thanks to the generosity of bankers, and the interest of politicians, builders have consistently defied a basic principle of economics : prices should fall if supply exceeds demand.
In 2010, the number of unsold flats in the Mumbai Metropolitan Region (Mumbai, Thane and Navi Mumbai) stood at 28 times normal monthly sales, according to research outfit Liases Foras. Yet, in the past year, house prices in the region are up 36%. "That's because Indian builders can access alternate finance channels," says Kaushal of BNP Paribas. It's an intricate chain of corruption, controlled by the rich and the powerful. And the losers in this cosy, connected web of relationships are honest, powerless buyers like Paromita Banerjee.
Accounting Conditions Apply
Even in how it does it accounting, sharp practices are endemic to the sector, which is partly the reason why the stock market perpetually discounts its stated value. As these five examples show, one just can't take a builder's word at face value.
PERCENTAGE COMPLETION METHOD
When a builder recognises revenues is divorced from when it delivers a property to a buyer. Most builders follow the 'percentage completion method'. This lets builders recognise revenues from a project on an ongoing basis, based on how much work they have done on it. Say, if in a financial year, a residential building is 40% complete, the builder can recognise 40% of the revenues. The next year, it is 70% complete; the builder recognises 30% that year. And so on. Since this method does not differentiate between finished projects and work in progress, it does not incentivise builders to deliver on commitments.
In developed markets, the rule is to recognise revenues only on delivery. It could have become the rule in India too, but builders lobbied successfully against it earlier this year when the government was drawing up its plan to align with International Financial Reporting Standards (IFRS)-a global accounting framework. Builders were "pretty organised", says a member of the committee overseeing this convergence. "They marshalled key accounting professionals to present their point of view."
And they had it their way: the percentage completion method stays. The current rule has the rider that builders can recognise partial revenues only from sold properties. "One on three companies add revenues from unsold flats too," says Jamal Khatri, executive director, KPMG. In 2009-10, DLF had an innocuous item in its balance sheet: unbilled receivables, worth Rs 1,443 crore. The interpretation: these properties are unsold but their revenues accounted for. DLF did not respond to queries on this practice.
UNDERSTATING CURRENT EXPENSES
There are expenses specific to a project. Then, there are indirect expenses, spread over many projects. For example, sales and marketing expenses, or headoffice expenses. Builders often bundle these into the project cost. It helps builders in two ways. One, they have to provide lower expenditure in the current year, which increases their profits. Two, the project is written over several years and it gets a tax cover too. By deferring expenses, it will account for lower expenses than incurred.
This is a money-laundering trick. Builders show fictitious payments to labour. This is easily done because labourers are mostly paid in cash. Cash is sid out, which can be used to oil the corruption chain, or spent or deployed elsewhere.
DEBT STRUCTURED AS EQUITY
In March 2009, a foreign developer invested $50 million each for an equity stake in two real estate subsidiaries of its Indian joint venture. The foreign company is assured a 'minimum guaranteed return' of 10% a year, which is compounded and is payable at the end of five years; 15% if the JV fails to bring in two more investors in six months, with invetsments of at least $5 million each. Is this debt or equity?
The question acquires significance since foreign debt is not allowed in real estate companies and the accounting of such a transaction inflates profits of the Indian firm. At the time of investment, the Indian company books a profit equivalent to the difference between its cost of investment and the price paid by the investor. But if the buyback arrangement is effected, on exit, the same transaction is treated as redemption of debt.
Continued in next post .....CommentQuote0Flag
- UNDERREPORTING DEBT
Another opaque practice is that of floating a special purpose vehicle to acquire land. A person close to the builder's promoters will float a company with a small capital of, say, Rs 5 lakh to acquire land. To avoid land prices from going up, this company's name will be such that it doesn't establish its connection with the builder. The builder lends money to the company. Say, the cost of acquiring the land isRs 100 crore. The builder transfers Rs 20 crore and the rest is borrowed from banks, with a corporate guarantee from the builder.
"As of now, the debt in the books of land-buying company is not reflected in the builder's balance sheet, leading to underreporting of debt," says Khatri. Such practices mask the quantum of debt being carried by a real estate firm. At a later stage, the loan is converted into equity.CommentQuote0Flag
- ET articles :) :)CommentQuote0Flag
- Originally Posted by kingmanishET articles :) :)
True, when did I say it is my article :D.CommentQuote0Flag