Escrow accounts in Real estate

A week back, a journalist with a leading business newspaper in India, connected with me on the subject. Knowing the sensitivity of the subject, I realized that many a sources the newspaper would tap would not be honest & direct. I requested the journalist to send me a brief questionnaire on the story line so that I could share my opinion on the Operations, justifications and handicaps around the subject.

I thought it prudent to share my opinion, and encourage debate, irrespective of the story which might get featured in the business newspaper. This is how it went. (my answers are in red, against the questions from the business paper.

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Hi Sir,

I am writing a story on the significance of having escrow accounts for a real estate project.

Please share your views on the following:

1. Do you think the realty developers should have an escrow account for their projects (especially residential) ? In the best interest of the consumers, each developer should have a project specific escrow account, to ensure that the payments made by the buyers against their specific property is utilized towards the development of the said project. However, since the operation of the account is solely undertaken by the developer, there are no checks & balances on the pay-outs. For e.g.: The developer can pay the bills incurred for the project “A” from the escrow account of project “B”, since the payouts are towards vendors, contractors and suppliers, who might be common.

The consumers invest into projects with an escrow account since they feel confident that they are funding their own acquisition, and their purchase / investment would not be slowed down by the overall financial condition / Wrong investment strategy of the developer in multiple projects, elsewhere.

2. If a developer does have an escrow account can a customer rest assured about the timely completion of the project, such that the funds will not siphoned off for construction of other projects or for purchasing land? – Not always. Currently, the announcement of the Escrow account is only a confidence building tool to communicate to the buyers that the payments made against a certain project is not being diverted. However, the reality defies the promise. The buyer(s) have no direct access to the operation of the account, and have absolutely no say, control or even information about the flow of funds. Contrarily, in a group housing society, the society members can seek information about the details of receipts & expenditure, and can raise objections / views on the same. Many developers did communicate the escrow accounts almost a couple of years back, and the ground realities do not really point to the restrictive use of funds in the said accounts. (The projects are not moving at the same pace as it should have).

Escrow accounts are not the solution to the problems anticipated in many projects. The consumers should be wary of developers who have announced a large number of projects, and do not have the wherewithal to complete them. There is no current mechanism to govern the cash flow of the accounts, since the management teams, suppliers, contractors, vendors, employees etc. of multiple teams remain the same, and that the buyer has no window of periodic interaction / review of his own funds.

2. With a large number of developers announcing less-than-Rs 20 lakh houses, is it legally possible for them to siphon off the funds collected from the customers to other project of theirs? I cannot comment on the legal possibilities. Operationally, it is possible to pay-out vendors of project “A” from the collections of project “B”. The management team operating either accounts remain the same. As for the many “low cost housing projects” under announcement, I would watch it with a lot of scepticism. There are two things I would microscopically view amongst the developers announcing such projects – “INTENT & ABILITY”. Had they had the right combination of both, the earlier projects would not have been stuck, and new projects cannot be used as a ‘bail-out’ or avenue for collection of funds.

Low income or low cost housing Projects which are stand alone, and would not be burdened by earlier projects are the ones which I would bank & invest in. The consumers have to ensure that they don’t get carried away by the million dollar announcement of “Budget homes” from the larger developers, but depend on credible, cash positive local developers who can complete the projects in the shortest possible time. Also, consumers better invest in smaller projects, rather than large projects, since the chances of problems are always larger bigger projects.

3. The realty sector got into the current crisis after a majority of the developers diverted large chunks of money into building land banks; how do you see the present hysteria over building “affordable” houses by the same set of builders. The land banks which many developers announced were not always valued at the announced value. Many a developers did not really have the physical possession of what they announced. Many investors were the first ones targeted by the developers to get them a start in projects, and then the end users used to filter in. Currently, the investors or speculators are staying away from the “affordable housing” as their investment would not grow at the same pace as it would have on a mid-high end housing. Hence, the lack of start up capital. End users as such are awaiting competition to hot up in the segment for better deals, as well as to assuage themselves of their continual cash flow status over the next few years, before committing themselves to pay for an asset.

I view many a recent announcements with scepticism and am not convinced about the “Intent & ability” of the promoters in completing and handing over the housing units to buyers. If you analyze, the markets flocked to the private developers since the govt. Agencies like DDA, HUDA etc. weren’t producing enough, OR, delivering on time, in spite of the payments being made on time. The time delays by the private developers, on account of their own management follies are not really building the consumer confidence, in spite of the big ticker announcements. I would still bank on smaller projects, which operate on a strict delivery schedule and don’t carry a debt burden. On a smaller project, the buyer can easily track the progress of the project on a periodic basis, to assess on the proper utilization of the funds.

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