The Real Estate (Regulation and Development) Act, 2016 came into existence after almost eight years of deliberations, largely fuelled by concerns over unscrupulous practices of developers such as delaying projects, demanding unscheduled or unaccounted for payments without actually delivering the product, misrepresentations and so on.

To this end, the Act has several provisions such as (1) the obligation of placing 70 per cent of all receipts received under a project in an escrow account to be used exclusively for the project it was obtained for; (2) restriction on the maximum amount that can be sought as down payment for a project that is yet to commence construction, (3) restriction on advertisements and notice for sale of any project prior to its approval by the competent authority, and (4) penal provisions for delay in delivering the saleable property to the purchaser.

While these are welcome moves, a key question that arises is the matter of cost of compliance – and its effect on smaller developers working in areas where property markets do not behave in the same manner as larger cities. Recent times have shown an emerging class of developers, who - by choice - do not operate in larger cities, but in smaller towns that are likely to generate a good amount of economic activity in the future, and where there may not be serious developmental pressure on land. Such developers may not have the financial or other resource wherewithal of large developers required to comply to all the provisions of the law, but have established practices that do not broadly violate common consumer concerns such as timely and quality delivery of real estate products.

Let us say that such a small developer (with projects not over a couple of acres), M/s XYZ, who is otherwise reputed for doing several small but good quality projects in smaller towns and with timely delivery – has two projects positioned in two different locations – A & B. Location A has a reasonable level of development activity and a good number of competing real estate projects coming up within the same space and at the same time, while location B is being planned for some major economic activity within the next six to ten years, but isn’t showing much activity at present. The two projects may be called A1 and B1 for convenience; project A1 is supposed to be delivered in two years, while project B1 can be delivered in five years’ time – during which external development of services such as water power, roads etc. would happen near the site of project B1. Since project A1 is competing with a good number of similar developments in the same area, M/s XYZ decides to lure customers to project A1 by waiving off all requirements of any payment until possession.

However, since M/s XYZ needs operating capital, they have to arrange for monies from somewhere. The firm can seek, at a rather high cost, debt from a financial institution, the cost of which is back loaded into the final cost of the units under project A1, making the product more expensive and accordingly losing competitiveness. Alternatively, the firm can advertise project B1, which they have to deliver in five years anyways, and divert a portion of the advance proceeds to meet the operating expenses of project A1 as an interest free internal transfer. Project A1 completes on time and purchasers get possession of the units; some of the proceeds are restored to the operating costs of project B1, which can resume its normal course of development – and still give delivery within the stipulated time of five years.

Now – this should not have been a problem, since M/s XYZ has a very reasonable reputation in the market, and purchasers of products under project B1 would be well aware that they are booking a product that would be available only in five years’ time, since the area is underdeveloped at present but carries promise of development in the future. However, in the eyes of law, M/s XYZ would have violated several provisions thereof with respect to project B1. For one, M/s XYZ would most certainly have violated the provision that makes 70 per cent of all proceeds from one project to be retained in an escrow account that would have to be used in the same project. Secondly, M/s XYZ would also violate the provisions that restricts soliciting or advertising projects before approval of the competent authority – which would not be forthcoming since NOCs would not be available from agencies which are yet to set up a presence in the area. Quite possibly, M/s XYZ will also be guilty of having sought more than the prescribed amount that can be charged as upfront payment for a real estate product prior to delivery.

The problem is more pronounced if project B1 is actually plotted development, i.e. where the developer’s obligation is to provide a serviced plot of land to the purchaser – and the bulk of the investment is into roads, power lines, water supply, sewer lines, drainage, parks and horticulture – most of which is also dependent on upstream availability of trunk infrastructure which is yet to be laid out.

As a small developer, M/s XYZ would not possibly have the luxury of a large amount of cash reserves, and in all probability, also have arranged for high cost finances to arrange for monies to buy the land for project B1 – making the prospects of availing debt for short term operating expenses difficult. In such a case, the above example would appear to indicate that the provisions of the law require M/s XYZ to have sufficient liquidity to operate in compliance. This in turn raises the question – are the provisions of the law fair to smaller developers working in smaller cities and economies? The above example certainly doesn’t seem to indicate as much.

Is such a situation avoidable? Probably, if clauses such as the requirement of 70 per cent of project proceeds being kept in an escrow were not there in the first place. One can appreciate that the reason to have a provision like this in the first place is to prevent developers from diverting monies between projects, which has been known to cause delays in completion and delivery of projects for which such monies were sourced. However, at the end of the day, shouldn’t the developer be held accountable for the result alone and not how he achieves it?

If a developer, at the time of booking of a real estate product, has maintained a pre-specified schedule of payment and a definite date for delivery of the product –should it really matter as to whether this is achieved by keeping 70 per cent of receipts in an escrow account or by any other method, as long as there are strict penal provisions for delays that are not caused by any external factor, or by the purchaser? Likewise, the amount payable as advance is also not something that should be determined by law, but by specific instance of projects – as long as there are suitable and enforceable provisions that levy interest or warrant refund of the principal amount in case of non-delivery of the real estate product by the date agreed between the developer and purchaser.

It would appear that in a bid to ensure that the interests of purchasers and consumers of real estate are protected, the law may have inadvertently engaged in overreach – applying the same standards and benchmarks to all forms of promoters – irrespective of size and type, and imposing conditions that could be questioned on account of whether they qualify as ‘reasonable restriction’ in the first place. A cooperative (group housing or house building), for instance – which is described as a promoter as per the law – would ordinarily not have to advertise sale of houses – it would actually advertise memberships instead, which would be like a surrogate advertisements for a housing product – even without having land in possession in the first place. A possible fallout of this one-size-fits-all could be that of smaller developers entering into agreements with landowners to split the land into smaller parcels to remain outside of the purview of the law, or worse, target areas that are not statutorily ‘urban’, such as census towns or outgrowths which are not classified as ‘urban areas’ as per the provisions of the law.

There is a need to revisit certain sections of the law to understand their impact on different kinds of developers and if possible – remove such provisions that are not ends to means by themselves; while according more powers to the Authority and tribunal to set forth standards and deliberate upon cases of dispute, in effect, removing grounds for dispute without disturbing natural market propensities. The purpose of regulation is as much to develop a sector through innovation and diversification of products and services, as much as it is to prevent distortions and abuse. As it is, there is apprehension in certain quarters as to a potential reduction in supply on account of greater compliance needs and efforts, which has the potential to distort the market again.

That being said, the law in itself still remains a commendable effort – and such anomalies can (and should) be expected in the first instance. However, anticipating them provides the opportunity for corrective measures – more so at this time when States are still firming up rules and regulations to the law.

This article first appeared in ET Realty

Sachin Sandhir is the Global Managing Director-Emerging Business, RICS