Indian Property Market Faces Major Issues

Speculation that accounting practices in the Indian real estate sector are suspect is running high at the moment, causing many (myself included) to wonder just how far the sector is going to crash and how many frauds are going to come to light. Senior board members of no less than six top real estate companies have resigned unexpectedly in the past few months, in much the same way rats leave a sinking ship.

Directors and senior executives of previously well-respected firms such as Omaxe, Puravankara Projects, Kolte Patil, Akruti City, Parsvnath, BPTP and Ansal Properties have resigned. On Friday, there were rumours that DLF CFO Ramesh Sanka had also resigned, pulling the stock down in early trades. Mr. Sanka later denied he had resigned.

Normally, it is not a noteworthy event when a company’s chief financial officer sells his ESOPs, or the executive director of a company resigns. But this is happening in one particular market - real estate. Though officially, ‘personal reasons’ have been cited as the cause in most resignations, industry officials said the current level of corporate governance in the real estate sector is an important reason for exits. Audit experts say accounting practices employed by most Indian developers have caused concern among professionals.

The focus on corporate governance has gained traction in Indian corporate circles after the recent developments at Satyam Computer Services after one of India’s largest corporate frauds came to light with the apprent involvement of PricewaterhouseCoopers. Early last week, the executive director of Omaxe, Vipin Aggarwal resigned.  “It’s time to move on in life and there wasn’t much happening in the sector,” said Mr Aggarwal. Early this year, Omaxe CEO and director (corporate strategy and finance) Arvind Parakh, quit and rejoined his previous company, Jindal Steel.

Brijender Ahuja, an advisor of corporate strategy at Omaxe, has also resigned. Ansal Properties, another Delhi-based company, saw three different chief financial officers within six months. Parsvnath Developers CFO Ravi Pani, too, had quit the company six months ago, while the CFO of BPTP, another Delhi-based real estate company, had tendered his resignation a few months ago. Pune-based developer, Kolte Patil, saw an exodus from its high-profile management team while Noshir D Talati, director of Puravankara Projects, a Bangalore-based real estate firm also tendered his resignation recently.

“Corporate governance issue has always been traditionally attached to the Indian real estate sector and domestic institutions kept real estate away from their investment portfolios,” said Amber Maheshwari, director DTZ, an international property consultancy. “After FDI was allowed in real estate, developers have been trying to be more transparent and started to consider corporate governance as a serious issue. However, many firms are still following highly unethical practices,” he added.

Currently, real estate firms are facing an acute cash shortage, with sales drying up debts mounting. “Balance sheets of real estate firms are in a bad shape. In many cases, sales are almost equal to receivables, meaning that sales being shown by real estate companies actually have no meaning, as these are only on paper. No cash is being received by the company,” said a top executive at a Delhi-based realty company who also  resigned recently. In some cases, sales are being made to friendly brokers, who don’t need to pay more than 5%, so even if sales figure look good, in real terms, it doesn’t help the company.

Singapore-based real estate consultancy firm KimEng In its recent report, said the accounting practice of capitalizing 60% of interest cost on land bank and unfinished projects is misleading and has lead to both inflated earnings and higher book value. The capitalized interest charges are so significant that had developers taken these charges onto the profit and loss account, the actual results would have been far worse.

Most Indian property companies are privately held, with equity stakes controlled by family members. Till recently, they had followed the ‘friends and relatives’ culture in their business operations, but the new wave of foreign funds in India’s fast-booming real estate sector has forced them to become more transparent and professional. Despite payment plans that are favourable to developers, many are now operating on negative cash flows. Instead of using customer advances on construction, developers utilised the funds collected for other purposes, including launching other projects, building a land bank and investing in unrelated business, the KimEng report said.