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Rating of Developers and Projects

Investment in housing and property is beset by many uncertainties in the prevailing real estate scenario. The investment and transaction decisions in this sector are characterised by uncertainties due to low level of disclosures and information.

The developer is faced with various problems of land acquisition, plotting, provision of infrastructure and thereafter marketing plotted as well as constructed properties. On the other hand, the Government, Town Planning, Authorities, Municipal Corporation and Committees etc. also face numerous problems in facilitating real estate development.

NAREDCO's mission is to improve the confidence level of both investors and consumers by bringing in fair practices through self - regulation and ultimately catalysing the growth of this sector. The National Real Estate Development Council was given the job of instituting a rating system that addresses the concerns of the buyers, developers, government, and its agencies. The Rating mechanism is expected to enhance the comfort levels of the consumers while making investment decisions, and help developers mobilise funds for their projects and also market them effectively. Banks, Financial institutions and other lending institutions are likely to use the ratings as an additional tool to determine interest rates for lending to specific projects. Above all this is expected to promote healthy ethics in the housing sector and facilitate its orderly growth.

Though a number of rating mechanisms are available in the market, their acceptance and universal adherence by developers and consumers is hindering the progress of real estate industry. The rating parameters developed by NAREDCO on the basis of Haryana Model need to be widely discussed and debated all over the country for affecting necessary modifications that allow developers to bring quality products in the market which can qualify for the top most grades.

It is for this reason that concerns of developers, consumers and Government/ Municipal agencies need to be debated to bring about a consensus on the subject of rating developers and their projects.

A unique aspect of NAREDCO rating mechanism is the introduction of real estate industry experts in the process of rating prior to the grading by the rating agencies. It is only when the self regulating role of NAREDCO rating mechanism is implemented in all States and is universally disclosed that a climate would be created for healthy development of real estate industry.

Ministry of Urban Affairs & Employment, Govt. of India had asked NAREDCO to carry out the rating of developers and their projects. Accordingly, Mr. G. V Ramakrishna, President, directed that prior to the actual rating, an exercise be carried out to lay down a prospectus against which the developer would be rated. This prospectus would be based upon the concerns of consumers, developers and Govt. / its agencies.

For this purpose two sub - committees were formed, who were given the task of examining the concerns of consumer, developer, Government and various municipal / local bodies in order to arrive at a prospectus against which the developer would be rated. The concerns based on extensive survey are outlined below:

Major concerns of the developers with regard to the project : -

  • Assembly of land
  • Payment for land purchases.
  • Deposit 30% of the receipts from sales into an ESCROW account to be used in stages for development of the colony.
  • An application to the local bodies for grant of license.
  • Obtaining permission and sanctions of authorities to undertake development. It may take from one to three years to complete the process.
    Timely payments by investors/purchasers of plots/ dwelling units.
  • Timely completion of the project. 8. Making an offer to the public for investment in their project (The minimum points a developer needs to publish in the form of a prospectus).
  • Lack of availability of financing. Access to short term loans for acquisition and on development of on-site infrastructure is limited by the commercial banking institutions.
  • Payment of external development charges for off-site infrastructure such as water, sewerage, surface drainage, roads, and landscaping and community facilities.
  • Progress of external development at Licensees' cost. Provision of `off site' infrastructure such as: development of roads, provision of power, water, sewerage and storm water drainage, garbage collection and disposal, street lighting, maintenance of parks and gardens, sewerage pump houses, maintenance of water supply system.
  • Payment of servicing/administrative cost to the authorities
  • Construction of social infrastructure such as school and medical facilities.
    Maintenance of a colony for a period of 5 years or more.
  • Development of "off-site" infrastructure by the local bodies to co-inside as a pre-requisite for development of colony.
  • Provision of plots/dwelling units for LIG and EWS categories.
    The lack of available off-site trunk infrastructure. Development of transportation links.

Concerns of Consumer

a) Developers track record
b) Ownership of land whether fully owned, agreement to purchase, joint venture, any other.
c) Statement by developers that 30% of the revenue receipts to be put in the ESCROW account. Withdrawal from ESCROW to be limited with construction stages.
d) Location of the project.
e) License to develop the project received from the local bodies by the developer.
f) Timely completion of the project.
g) Type of construction and the construction material to be used.
h) Floor plans
i) Design of the project.
j) Sanction of building plans
k) Parking facilities for vehicles.
l) Electricity, water, drainage, sewerage connections both "off-site" and internal.
m) Off-site infrastructure to be provided by local bodies.
n) The security needs of residents.
o) Provision of social infrastructure by developers linked with stages of habitation. p) Maintenance of colony/property by developers
q) Mechanism for redressal of grievances of the purchaser/investor.
r) Penalty clause on developer for deviating from the terms offered in the prospectus.

The issues on which the committee deliberated to arrive at a prospectus for rating are placed below:

A sample model of development

Against this background, Haryana model of urban development was identified as a role model for arriving at a suitable mechanism to benchmark real estate properties.
At a meeting held on 22nd January 1999, the P C Sen Committee constituted by Ministry of Urban Affairs & Employment arrived at a consensus that Haryana Model involving the private sector in land assembly development and disposal, which is a time tested experiment, be considered for Delhi. To develop singular model of prospectus to be applicable for the country, the guidelines developed by PC Sen committee could well be the benchmark. However, it was recommended that suitable modifications shall be carried by states to conform to the parameters of town planning norms and legislative framework, building bye laws etc.

Haryana Model of Urban Development

Haryana Development and Regulation of Urban Areas Act, 1975 provides for development of urban infrastructure as unde r:

  • Land is owned by the private sector with Government giving license to private sector to develop townships in accordance with an approved master plan. Minimum area required for land assembly is 100 acres of contiguous land for plotted development and in case of group housing, 10 acres.
  • States' Development Authorities provide 'off site' or external development at the licensees' cost through levy of external development charges.
  • Private sector identity is retained in separate townships developed by them where they also provide 'on site' infrastructure similar to the public sector development - thus providing a level playing field for both public & private sectors with the customer having a choice between the two.
  • Social infrastructure is provided by both private sector and public sector.
  • Private sector contributes towards development of linkage through payment of extra development charges for 'off site' infrastructure. These charges are levied on buyers of plots and built properties.
  • Private sector provides social infrastructure in terms of medical, educational as also community facilities. Government reserves the right to resume these sites thus ensuring private sector compliance.
  • Economically weaker sections are provided subsidised housing through cross subsidisation by private section.

Criteria

The NAREDCO model for rating is a comprehensive mechanism covering two parts namely:
a) Developers
b) Projects

Rating of Developers

This is based on a criteria track record, capital employed, manpower, equipment, type of areas, number and value of projects, built- up area, amount of foreign exchange earned etc, as outlined below. NAREDCO rating of developer shall lead to a national pool of certified developers operating both at the national & state levels.

Criteria:

1. Track record of Developers/Builders based on general reputation in the market, including performance relating to items such as -:

  • Quality of construction in conformity with nationally approved standards relating to all fields of construction.
  • Conformity with building bye-laws and regulations.
  • Record of serviced land delivery
    a) On owned land
    b) On others land
  • Provision of on-site infrastructure
    a) On owned land
    b) On others land
  • Conformity with financial regulations and fair trade practices.
  • Nature & extent of litigation against the developer by government/semi-govt/public sector agencies/general public.
  • Conformity with ethics concerning sales and subsequent services.
  • Provision of Community Services : Education, medical, recreation etc.

2. Capital employed by the company and annual turnover for the past five years.
3. Manpower employed.
4. Equipment used either on own or through suppliers/sub-contractors.
5. Type of areas covered during the past 10 years relating to commercial, residential areas, integrated townships, group housing etc.
a) On owned land
b) On others land
6 Number and value of projects in hand (both physical as well as financial) relating to properties
a) On owned land
b) On others land
7 Total built-up area in current project, number of dwelling units, contribution to economically weaker section of the society.
a) On owned land
b) On others land
8 Amount of foreign exchange earned through sale of real estate to NRIs during the last five years.

Rating of Projects

The rating reflects the status on a graded scale indicating developer related risk factors leading to development and transfer the title of the property to the customer / investor. Such a rating shall provide incentives to developers to maintain standards and conform to legal and building norms with consumer / investor getting a fair deal. This shall facilitate the orderly growth of the sector presently characterised by inconsistencies and irregularities.

An indicative criteria adopted by the NAREDCO Committee for project rating is placed below:

1. Land title
Though clear title of the land is a pre-requisite for development of any project that has to be offered, 100% of land ownership by a developer would be an ideal requirement. Since, it will need huge amount of investments to acquire such large acreage, therefore a collaboration agreement with payment made with a 10% payment to the land owner or a development agreement (MOU) between a developer and owner of land would be acceptable.
2. Project Cost
In addition to developer equity for purchase of land, it is essential that he should have substantial resources as a back up for successful completion of the project.
3. Escrow Account
Entire cost recovered from customer should not be utilised in construction, development. A certain percentage (30% in accordance with Haryana Model) should be kept aside as ESCROW account to be utilised towards the project in accordance with progress of construction.
4. Property Offer
No project should be offered till necessary approval/sanctions have been obtained from local authorities or sufficient proof exists that approval/sanction would be forthcoming. NAREDCO shall take up with the Centre and State Governments the speedy approval of plans.
The developer should not advertise or make a public offer of his project until he provides for a portion of total project cost to be put into an escrow account.
5. Commencement of Project
Where construction of projects is based upon customer funding, its commencement should be linked with the developer receiving 33% of total booking in order to ensure that the developer has resources to sustain the construction cost in accordance with market response. This shall prevent the project remaining incomplete due to lack of resources. In case of default, the developer should be required to refund the amount collected from customers with interest. However, this provision will not be applicable to developers having the financial capability to carry out 33% of the construction cost either through own resources or a tie- up, in which case, the fund tie- up shall need to be disclosed.
6. External Development Charges
The developer should deposit with the respective government bodies a portion of entire external development charges, in order to avoid a situation of insufficient funds and subsequent default by developer. The developer should collect the EDC linked with construction stages from customers. However, the public sector agency responsible for provision of infrastructure should be held accountable for keeping pace with the development of the housing project, and liable to penalty on default. NAREDCO can follow-up in case of such default, if mutually acceptable.
7. Property Management
The developer should maintain the property against payments by customers. Property management services have emerged in the country to maintain properties. Hence, property management capability of a project needs to be one of the criteria for rating a project
8. Timely Possession
Timely Possession of the property to the allottee and the penalty in case of a default by a developer in handing over possession in time shall form a part of standard contract. Inclusion of the relevant clause in the contract of a developer should be reflected in the rating.

NAREDCO -CRISIL Rating mechanism
Subsequently, detailed discussions were carried out with a Rating Agency and an M.O U was signed with CRISIL on 28th September 1999 to rate real estate projects in India.
CRISIL - NAREDCO ratings have emerged as a benchmark for developers to showcase their projects and their enterprises, provided they adhere to NAREDCO concerns in the interests of consumers.
The Rating methodology has been developed by CRISIL in consultations with NAREDCO and NHB. CRISIL rating for Real Estate Developers is a measure of their past track record in executing real estate projects and their organizational and financial risk profiles. Developers track record is analyzed with reference to their track record of legal compliance, type of projects undertaken, adherence to construction schedules and market perception about the developer. Organizational & financial risk are assessed on the basis of factors such as extent of structured quality systems, organizational structure, existing financial position, financial flexibility, management evaluation and strategies about taking up and executing real estate projects.
CRISIL rating for a real estate project pertains to a particular project and is not a rating for the company as a whole. To evaluate project risk, CRISIL will focus on the "Legal risk" of the land planned for development and the "construction risk" of the project proposed to be constructed on the land. Only projects with an approved plan and planning permit from the appropriate local authority are considered for a rating.
Rating for real estate projects comprises assessing both developer specific factors (as mentioned above) and projects specific factors. Project specific factors include quality of legal title with respect to property, quality of construction and timeliness of delivery of the proposed unit. Consequently, different projects for the same real estate developer might receive different ratings depending upon degree of risks associated with them.
The rating, translated into a symbol, indicates the current opinion about the project and developer related risk factors, which could affect the ability of the developer to develop and transfer title of the property to the investor.

Rating Symbols
The rating symbols for real estate developer's rating use the letter "DA" indicating Developer's Ability to execute projects, as suggested by his track record. The rating symbols for real estate project's rating use the letter "PA" indicating the Project development Ability of the developer.

Developers Rating
DA1 : Excellent
DA2 : Very Good
DA3 : Good
DA4 : Unsatisfactory
DA5 : Poor

 

Projects Rating
PA1 : Highest ability
PA2 : High ability
PA3 : Adequate Ability
PA4 : Inadequate Ability
PA5 : Inability

 

ICRA-NAREDCO Grading mechanism
ICRA and NAREDCO signed the MOU for the ICRA-NAREDCO Grading of Developers and Projects on 21 March 2001.
Methodology
Developer / Project grading is linked to parameters such as turnover of the developer, size of the projects, completion period, infrastructural facilities, etc under two broad risk categories - business risk and financial risk. The Grading Methodology and criteria has been finalized by ICRA along with NAREDCO jointly
The Grade Assessment Process
The grading process is carried out independently by ICRA analysts and the grade is be determined after deliberations of the grading committee. The whole process is highly interactive and includes inputs from sector experts including the Committee of Experts. ICRA-NAREDCO ensure strict confidentiality of all information collected during the assessment process.

ICRA-NAREDCO grading symbols for Real Estate Developers and their implications are as follows:

Very strong project execution capacity. The prospects of execution of real estate projects as per plan is the best and the ability to transfer ownership as per terms is highest.
Strong project execution capacity. The prospects of execution of real estate projects as per plan and the ability to transfer ownership as per terms are high but not as high as DR1.
Moderate project execution capacity. The prospects of execution of real estate projects as per plan and the ability to transfer ownership as per terms are moderate. Project execution capacity can be affected moderately by changes in the real estate sector prospects.
Inadequate project execution capacity. The prospects of execution of real estate projects as per plan and the ability to transfer ownership as per terms are inadequate. Project execution capacity can be affected severely by changes in real estate sector prospects.
Weak project execution capacity. The prospects of executionof real estate projects as per plan and the ability to transfer ownership as per terms are poor.

ICRA-NAREDCO grading symbols for the Real Estate Project and their implications are as follows:

Very strong project. The prospects of successful implementation of the real estate project and transfer of ownership as per terms are highest. The project risk factors are lowest.
Strong project. The prospects of successful implementation of the real estate project and transfer of ownership as per terms are high. The project risk factors are low
Moderate project. The prospects of successful implementation of the real estate project and transfer of ownership as per terms are moderate. The project risk factors are moderate.
Inadequate project. The prospects of successful implementation of the real estate project and transfer of ownership as per terms are inadequate. The project risk factors are high.
Weak project. The prospects of successful implementation of the real estate project and transfer of ownership as per terms are poor. The project risk factors are highest.

Conclusion
Seventy years ago the western world was dominated by fly-by-night practitioners operating in the climate of distrust and speculation. This however led to widespread degeneration in quality and proliferation of unauthorized construction. Rating mechanism bolstered by self-regulating agencies such as National Association Home Builders (NAHB) in USA had brought about transparency and gave a tremendous boost to the Housing Industry. Similarly, nation wide awareness campaign coupled with creation of a climate for development of authorized and quality construction, through nationwide acceptance of NAREDCO Rating mechanism shall definitely give a boost to the nascent Real Estate Industry in the country.

Abstract

Rating of Developers and their Projects

The issue of a universally accepted rating mechanism has been agitating real estate industry for a long time. Though a number of rating mechanisms are available in the market, their acceptance and universal adherence by developers and consumers is hindering the progress of real estate industry. The rating parameters developed by NAREDCO on the basis of Haryana Model need to be widely discussed and debated all over the country for affecting necessary modifications that allow developers to bring quality products in the market which can qualify for the top most grades.
It is for this reason that concerns of developers, consumers and Government/ Municipal agencies need to be debated to bring about a consensus on the subject of rating developers and their projects.
A unique aspect of NAREDCO rating mechanism is the introduction of real estate industry experts in the process of rating prior to the grading by the rating agencies. It is only when the self regulating role of NAREDCO rating mechanism is implemented in all States and is universally disclosed that a climate would be created for healthy development of real estate industry.
NAREDCO rating mechanism is not restricted to only two rating agencies i.e. CRISIL and ICRA at present. NAREDCO looks forward to interaction with all developers, State Governments and Consumers through its network of State REDCOs that are in the process of formation for creation of a national consensus. We are sanguine that Indian Building Congress will play a pioneering role in creating conditions for development of quality products that can qualify for the highest grades.

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