Everyone wants to purchase their dream house. The demand for residential property is not just limited for own use. A number of people invest in real estate to gain from appreciation in prices. However, despite the comfort most people have with real estate investments, most developers are running high inventory of unsold flats or apartments. Multiple reasons have been attributed for this inventory. Oversupply in the residential market and unaffordable prices are oft cited reasons. To tide over this slowdown, the real estate developers have started to offer innovative schemes to attract buyers/investors. In this post, I will discuss one of such schemes: Assured Return Scheme and discuss its pros and cons.
What Are Assured Return Schemes?
Under these schemes, the builder/real estate developer makes a payment to the buyer/investor for a specific period or till the time possession is given to the buyer. Assured return schemes can be designed in multiple ways but underlying premise is the same. The builder or the real estate developer guarantees income to the investor/buyer for a few years or till the occurrence of a specific event.
Typically, these schemes are offered to customers who are willing to make the full down payment i.e. those customers who are willing to pay complete purchase price upfront.
Let’s consider a scheme where the builder pays the buyer1% per month for a fixed period of 3 years or till such time possession is given to the buyer, whichever is earlier. In this case, for a purchase price of Rs 50 lacs, the builder will pay you Rs 50,000 per month for 3 years or till such time possession is given.
Before you too excited, you need to see why any real estate company will offer such schemes.
Why Will a Builder or a Real Estate Company Offer Schemes?
It is no secret the balance sheet and cash flow position of most real estate companies is severely stressed these days. Since the cost of loan depends heavily on these parameters, these companies are finding it difficult to borrow at an affordable price. On the strength of their balance sheets, it is difficult to get bank loan at less than 16-18% p.a. Through an assured return scheme, builder has accessed cheap finance at 12% p.a. (1% per month). With the stress of their balance sheets and cash flows, this is the cheapest form of finance they can get.
Another reason is slowdown in sales. With such schemes, the developers try to attract investors/buyers to invest in their projects.
What Do These Schemes Hold for Retail Investors?
The payment from builder can take care of your EMI (if you have taken loan) for the initial period of 2-3 years. These days, you will get a home loan between 9.5% to 11% p.a. The builder is paying you 12% p.a. If the builder delivers within 2-3 years, you should be really happy. Your EMI till possession has been taken care of by the builder.
Even if you have made the payment from own funds and do not have any EMI pressure, 12% p.a. fixed returns sounds quite good. If the property appreciates in the interim, your deal has just been sweetened.
You take psychological comfort that you are unlikely to face project delays because the builder is paying out of his pocket and hence has an incentive to complete the project on time. The picture looks quite rosy. Some would say it is too good to be true. No scheme is without caveats. Let’s look at some of the issues with these schemes.
Caveats with Assured Return Schemes
What if the builder does not deliver on time? The builder has promised to make monthly interest payments only for a period of 2-3 years. There is no obligation beyond that period on the part of the builder. So, if the builder does not give you possession in 3 years, there will be no further payments. Project delays of 3-4 years are not uncommon these days. You have already made the full payment. There is little you have on the bargaining table. It is also not uncommon for real estate developers to divert funds from one project to complete another project. If this is the case, it is unlikely your project will get completed on time.
What if the builder defaults on the interest payment? Typically, the builder will give you post dated cheques for 24-36 months, as the case may be. In case the cheque bounces, there is little you can do. You can of course take legal recourse. However, legal option can not only be expensive but also take a long time. The builders are known to have muscle power and legal team to handle and prolong such cases. In such cases, you have to be prepared for prolonged mental harassment.
If you have taken a loan to make full payment, please remember the loan agreement is between you and the bank. The bank does not care if the builder is making you regular payments or not. You have to make regular EMI payments.
The builder may be charging a premium under this plan. It is quite possible that the builder is offering you the deal at a higher price. For example, the builder may be offering you space for Rs 6,000 per sq. feet while the price in the neighborhood is Rs 5,000 per sq. feet. Hence, though the builder has offered you an assured income, he/she is essentially passing on the cost of interest payments on to you through higher prices.
Corporate Fixed Deposits by Real Estate Developers
Another scheme opted by real estate developers to raise cheap money (at low interest rates) is through corporate fixed deposits. These real estate companies offer a return of 12-13% per annum to the retail investors. This sounds attractive to many investors when the bank fixed deposits are offering 7-8% p.a. The high return offered by these companies is a pure marketing gimmick. The actual return is much lower. And the risk is so much higher.
There is no dearth of real estate companies who have defaulted on interest payments of such schemes. Whenever a real estate company faces cash crunch, these deposit holders will be the first ones to face brunt. Banks have their ways of handling such clients. What can an ordinary investor do? Legal recourse is available but the entire process can be long and expensive.
Though this section may appear unrelated, I just want to highlight it is not uncommon for real estate developers to default on payments to retail customers or investors. I am not demonizing real estate companies but most builders are not known to keep promises.
What Should You Do?
This is true for any residential property you plan to purchase or invest in (and not only those projects offering assured returns). Do proper research about the builder and check if the builder has been delivering their projects on time. You also need to check whether other people who opted for such scheme from the builder in the past received their payments on time.
Check the prices in the neighborhood. If the builder is charging a premium under this scheme, you do not gain anything. The scheme essentially becomes a money back scheme where the builder has charged you more to return the money later in form of interest.
Do not rely on builder payments for your EMI payments. You should take only so much loan that the EMI is affordable even if the builder does not make the payment.
If the builder delivers the project on time and makes regular interest payments, then this is indeed a good scheme. The problem is we do not have the gift of hindsight. So, we do not really know if the builder will deliver on the promise. Do not let the scheme play to your emotions. Do proper research to find out if the deal is really sweet.
If you opt for such scheme, you trust a party, which is facing a cash crunch, with cash payments. Something doesn’t sound right, does it?