Buying a House – Tips and Paperwork

Rishab asked a few questions a couple of weeks ago regarding buying property and I will try my best to answer these as well as I can. I guess what I can safely say is to take as much advise as possible from friends, family, bankers, financial planners (if you have access to them) and of course, the internet. It is a great proud feeling to buy your pad (if buying for the first time) and it also involves us emotionally. Like hunting for jobs, this experience should be enjoyed and not feared or seen as a chore. We don’t hunt for jobs or houses every day, do we? Here are a few words of advise that I can suggest from my limited set of experiences so far. Caveat emptor.

1. Pre-Owned or Ready only – I would recommend that you purchase a house that is near complete or second hand only. There is too much economic uncertainty and too much of leverage on the books of real estate companies in India to share project risk with the developers. We have one life and most of us get one chance to pick up a house – we should be as risk averse as possible. With land prices in urban India being bid up higher and higher, property developers have to borrow to buy. If the interest rates rise in the future it will make the going quite though for the real estate companies. That is the reason why the business model of Godrej Properties (GPL) is so cool – they mostly lease property from owners, develop it and share the profits. And that’s one of the reasons why I consider my investment in Godrej Industries Ltd (part owner of GPL) to be a part of my core holdings. Inner core.

2. Documents to look for

The following documents are usually sought for when buying a second hand property:

– Agreement of sale between the builder and the first owners and all the subsequent agreements of sale thereupon.

– Papers that uniquely qualify a clear title to the land. Also known as the Conveyance Deed.

– Registration certificate of the housing society. It usually takes 1 – 2 years after posession is granted by the builder for society formation.

– No objection certificate from the society to transfer the flat in the prospective buyers’ name.

– Copy of share certificate of the society. Once the society formation is complete, it issues share certificates to its members. You should take a look at this.

– A draft agreement of purchase (between you and the seller)

– Copies of municipal tax paid by the society. This may be tough to get but you should try.

– Occupation certificate granted by the municipal corporation to the builder.

– No objection certificate from the society to mortgage the flat in the favour of the bank, along with a letter stating the lien (this is in case you want to avail a housing loan)

– Income tax clearance of the seller (for registration purposes only). Check that.

There are other sets of documents that would be required if A) buying a resale flat if the society is not formed or B) if you are buying a new flat from a builder. Let me know and I shall email these to you. It is prudent to ask for/be aware of these documents. Indeed some housing finance institutions may not ask for all of these (more on that later) and the builder/society might spin tales as to why some of these documents are really not required – if that happens just walk out of that meeting. When I was looking around for my first house, a particular builder just did not want to part with the architectural plans and other documents of a second hand, unlived flat that I had liked. Luckily for me, I did not have a penny on me (only a promise of future income) and therefore I did not have any option but to look to a bank for finance. Since the bank would not advance the loan if the architectural drawings were not made available I had called it quits.

3. Finance – I am really in no position to opine on which housing finance company you should take your loan from. This decision is not as straight forward as taking out term insurance – in that case you should simply head to the insurer that offers you the lowest premium. Most properties are on the ‘pre-approved’ list of many financers – which means that they have already completed most of the paperwork required. Buying property in such buildings from these banks reduces the risk of landing up with an unclear title as well as easing up the paper work. Public sector banks in India generally offer the most competitive rates but dealing with them may not be a smooth affair. They don’t give a rats ass whether you give them your business or not. On the other hand, private sector banks put stiff sales targets on their sales people and you really do not want an over zealous sales turk to finance what turns out to be a sand castle to you! Finally, interest rates may very well rise in the near future. Inflation is too big a monster for the Reserve Bank of India (RBI) not to do anything to the current rates. However, most banks offer only a 3 year fixed when they refer to fixed rates. I daresay that if someone is to buy a house next year, he/she should pick a floating rate – but it really depends on your view of the interest rates. 

4. CIBIL Credit Report – You should apply and procure your credit report from Credit Information Bureau India Limited (CIBIL). This is available for a nominal processing charge and is one of the things that banks look for when deciding on the grant of the loan. There are known instances where people have found errors in their CIBIL credit reports and while the RBI prescribes a time limit of 45 days for compliants to get resolved, you do not want to be running around clearing the errors in your credit report. Purchase opportunities do not last forever. In fact you should procure and check your credit report regardless of whether you intend to take a loan or not. Beware, if you are blacklisted or your credit score is very low, the chances are extremely high that your loan application will get bluntly rejected without a proper explanation. The onus will be on you to investigate and clear your name. Even if this is your first mortgage application, the fact that you might have had credit cards to your name – some of them you don’t even know if you own – will reflect in this report. Just get that report – home loan or not. My gut is that the public sector banks will be quite partisan to the credit report. At least the private banks might be inclined to help you work your way towards clearing your record (if tainted) since there are sales targets to meet.

4. Other considerations – Some other points that you might want to keep in mind (readers, please add on to this list if you can. I will keep adding as and when I get new insights):

– While the useful life of buildings is usually considered to be 70 – 80 years, do not buy a property that has had more than 2 past owners or is more than 15 years old. Maintenance expenses spike up around this point in the life of a building.

– Do not pay more than 1% as processing fees.

– Best to get a term insurance cover from the same institution to cover the quantum and tenure of the loan. Use this option to squeeze a better rate from the bank. Reveal this card only during the latter stage of rate negotiation.

– One trick that many want to play is to play one bank against another when trying to drive a bargain for the best rate. I don’t feel it’s worth it – India is a growing economy. The mortgage to GDP ratio for rapidly urbanising India is a paltry 7% which is way, way behind the developed economies (60% – 70%). So, banks are not under too much pressure to run after you.

– If the seller of the house also has a mortgage, it’s advisable for you to take your loan from the same institution.  The process gets simplified. Unless of course some other instituion is offering you a much lower rate.

– Bargain with the seller like your life depended on it. In some ways, it does. At least your financial life does. Rehearse your speech and plan your tactics, even if it means you appear like a penny pinching moron.

– If you are married, buy property in joint name. Makes things easy later on.

– Try to see the locality during the peak of the monsoon season. You’ll get an idea of water logging, seepage etc.

– refer to my other post on Buying Property for some more ideas.

Obama Speak

The US President is going around asking his fellow countrymen to produce more graduates and compete with the likes of India and China. These are good points to raise but then when this is accompanied by curbs on granting visas it begins to sound like rhetoric. All under the guise of protecting US borders! The border security bill will hike visa fees to $2,000 per applicant for companies that have fewer than 50% of its workforce as US citizens. Thats a cool $200 million bill for Indian software companies that rely heavily on “body shopping”. The standard line of the Indian industry has been a lament on the lack of the totalisation pact between the two countries. India has to contribute towards social security for the workers that it sends to the US – and if they return back to India, there is no possibility of a refund. I would welcome to hear something from Dr. Manmohan Singh on the issue. He is his usual quiet self.

While India remains preoccupied with flash floods, Kashmir, honour killings and the Commonwealth Games tamasha, China picked up the gauntlet and responded well by making outsourcing completely tax free if delivered from 21 cities. The Chinese have made no bones about the fact that they want to end India’s dominance in the sector. Should India not make a counter move to steal some foundries away from China?

India’s earlier responses sound quite pathetic to me. If the US politicians are ushering their wards back to school and hoping and helping their middle class to retain their sources of income, whats wrong with it? Cribbing about it and making it sound as if some grave injustice is being done against it is mooching. How would India feel if people across its eastern border arrived in hordes and stole away jobs? Some factions cannot even tolerate intra country movement of labour.

The rhetoric in the US however is also missing its mark. Senator Charles Schumer has called Infosys a chop shop. Its easy for the sound bytes to morph into an India/China hate undercurrent (if one does not exist already). Lou Dobbs, a popular media anchor, for instance has written a book on outsourcing and devotes much of his website to the phenomenon and how the American middle class is being killed. Is it? Don’t think so. Maybe going through a very tough phase. An important counterpoint to note is the indirect benefit that this can yield to the US.

It would be good for the US to note that the Indian middle class is gravitating towards more and more consumerism. People are seeing their incomes rise and are swiping their credit cards, buying second houses, ipods, etc. gleefully. This is allowing banks like BoA, Citibank etc to set up their shops in India. While such benefits selectively accrue to the Dells, Microsofts and BoAs of the world, the American middle class can certainly benefit. President Obama should also consider exhorting his masses to match imports (of services from China and India) with American exports to these countries. The oriental appetite for consuming intelligently designed goods and services in the occident will only grow. Americans would do well to understand one basic trait of most Indian middle classes – they are afraid to take risks. Innovation is rarely seen. While hordes of software junkies pound away at maintenance and basic software jobs, there is hardly any technological breakthroughs that emerge from this populous nation. The US has always thrived by managing risk and employing innovation which have set up a very strong financial acceptance to see capital freely flowing to fund ventures that are risky. Indians generally take the easy way out – outsourcing is one of them.

But these shifts and changes, as significant as they can be, happen slowly and the threat of the current American middle class losing its plot somewhere is indeed very real. And such Obama speak will found many takers and therefore votes. Whether the White House politicians actually act in earnest to plug the leak (which in my opinion they should not blindly do) is a different matter. Donations from many top industry groups may be funding the election expenses of these law makers.

In my opinion, its futile for the US (as a nation and culture) to fight outsourcing. Its perfectly logical and sane for the US society to agitate and therefore equally logical for the politicians to flog this sentiment for election victories. The US should focus on earning export dollars (USD should depreciate as years roll by) by tapping into the growing prosperity in China and India. India and China, on the other hand, should open up their economies further, slicing and selling off non-strategic assets to the highest bidders and generating more wealth in the process. Its a great lifetime to spend in the Indian and Chinese capital markets of today.

License to Bank

The Finance Minister during his Budget speech for the year 2010-’11 had promised new issuances of banking licenses to private sector players and Non Banking Financial Companies (NBFCs). Which really seems to have lighted up hopes and share tickers in anticipation of the grant. It could very well be a grand party, but the RBI promptly stepped in on the back of this announcement (post the Budget ’11 speech and the subsequent soundbytes) declaring that all the norms of due diligence would be strictly adhered to and that a few more screws would be tightened. We all now await the screws. I have a feeling that the apex bank may not be too keen to dole out banking licenses to corporate houses and might toy with upping the net worth criteria (currently Rs. 300 crores). The policy announcement regarding these eligibility norms are now awaited – expected shortly.

I think such prudence is called for, whatever be its reason. The Indian banking sector has come out relatively unscatched from the global banking turmoil partly because of the fact that it’s still small in size in comparision and closed (to the outside world of free capital flows). Seeking a widening of base by inducting new players into the fold seems to be the right thing to do at this point, but will more of the same spread the roots? One of the most important functions that banks serve is to lower the cost of capital available for economic activity. They can do this since they have access to low cost funds – the interest that banks need to pay on current accounts and savings accounts (CASA) is lower that what an institution would have to bear if it were to raise the money from other sources. This therefore lowers the hurdle rate that the economic deployment of such funds should earn.  That explains, in part, what has got the NBFCs and the private financial institutions all excited. But apart from that there are other parameters which also might get considered by the RBI – those of geographical coverage and reach into the poorer sections of the society. I later pick on two institutions (towards the end of the post) which I feel are good candidates, each covering one of these two objectives with one of them also being a prime trading call from my perspective today.

But some history first: RBI seems not to be too inclined towards this policy and looks like it has had to toe the line cast by the Finance Ministry. The last time that this was done was in the early ’90s. In fact, no new Indian bank  has been set up since the advent of liberalisation in 1993. Some of the NBFCs that were allowed to get converted into banks were Yes Bank, Kotak Mahindra Finance Limited and 20th Century Finance. While Kotak diversified into full service banking services, 20th Century Finance became Centurion Bank and was eventually taken over by a bunch of private equity investors only to finally land in the lap of HDFC Bank. HDFC Bank itself started life in the early ’90s and along with Axis Bank (formerly UTI Bank) has become a very successful private Indian bank. Then there was the case of UBS that had to wait for nearly 3 years before getting its banking license from the RBI. The matter had to do with disclosure norms and UBS being a Swiss Bank (perceived to be stolidly protecting of its customers’ interests and assets) may not have been too comfortable disclosing certain information about its customers, including Hasan Ali Khan, the Pune based stud farm owner. Standard Chartered Bank was not allowed to sell off its Mutual Funds business to the UBS Securities. SEBI had barred UBS Securities from issuing offshore derivative instruments for one year.  Was this a tactic to delay, we know not, but for sure what comes out is that the Indian banking scene is tempting enough for global players, burnt from the sub-prime arson, to ignore. Recently, the Credit Suisse group received the green signal to start core banking activities. In December of last year, the RBI finally accorded its assent to convert the Orissa State Cooperative Bank into a full fledged bank. It had to wait for 43 years till it became eligible to sit on the high table. Interestly, of the 31 state co-operative banks, only 15 have managed to secure banking lincenses. The deadline for them expires in 2012.

Given that backdrop, lets look at the names published in the media regarding the current hopefuls: Reliance Capital, Bajaj Auto Finance, Mahindra & Mahindra Finance, L&T Finance, IFCI, Indiabulls, Religare, Aditya Birla Financial Services, SKS Microfinance et al. The CEO and MD of IDFC has ruled out his company from applying. The news certainly seems to have set the shares of some of these companies on fire – with a promise of more to come.

There are two companies that I want to mention. First being SKS Microfinance, which has submitted its (draft?) Red Herring Prospectus (RHP) for its IPO that is soon due. I guess it should also be keen to apply for banking license. While I don’t know what happens in such cases – i.e. when the objects of business change drastically enough to warrant a re-look at the financials, prospects etc, then does the RHP have to be pulled back and re-submitted? While there may be an ethical debate regarding SKS Microfinance and the threat of defaults on micro-lending activity might be higher, the logic that such companies can reach the poorer sections of the society and introduce banking to them is impeccable. The fact that N.R. Narayana Murthy’s Venture Capital (VC) fund Catamaran Investment Pvt. Ltd. may also dip its toe will definitely make people eye the IPO.  Is the Bangladesh based Grameen Bank a full fledged commercial bank? Need to check, but to borrow a line from my previous “Hot Pani Puri” post: Micro sized sales units sold at low prices but in large numbers is the essence of India. But I do not apply for IPOs so no show there for me.

The second company being IFCI. It has been playing quite a tango with the Government so far and seems to be a prime candidate for receiving a banking license this time around – solely for that reason alone. The Government had wanted to divest its stake in IFCI and had made an announcement in early 2007 but the front running joint bid from Sterlite Industries & Morgan Stanley got stopped in its tracks since the Government would not come clean on what it proposed to do regarding the conversion of institutional debt (that IFCI held on its books). If this was to be converted to equity, then it would obvisouly be less attractive to the winning party. So the party was called off. The Finance Minister (Chidambaram) must have smarted privately and had promised to make amends in the future. Given that the banking licenses are now to be handed out, interest in IFCI has peaked and the stock has moved up well. IFCI had earlier made an attempt to make itself into a bank, but that earlier attempt had failed. All others (ICICI, UTI, IDBI, HDFC) went ahead while IFCI was left out. But It looks likely to pass muster this time. What will happen if it becomes a bank? Its cost of capital will come down improving its profitability and new avenues of business will open up. It would be fair to compare it with the valuation ratios of other banks and expect the market to crank up its valuation of IFCI to match these levels.

For the year that ended Mar, 2010, the equity base is Rs. 738 crores and its net worth is Rs. 3,152 crores. Given the face value of Rs 10 per share this gives a book value of (3,152/73.8) = Rs. 42.7 per share. The Current Market Price (CMP) is Rs. 56.75 (before opening bell on 5th July, 2010) giving us a P/BV ratio of 1.32. The PAT for the previous financial year was around Rs 671 crores giving us an earning of 671/73.8 = Rs. 8.55 per share. This implies a trailing 12 month price to earnings multiple of (56.75/8.55) = 6.64. Lets compare that to the number that other banks are reporting:

Incidentally, the reason I’ve highlighted Karur Vysya Bank in red is because that was a trading call I’d entered into at Rs. 475 on 27May’10. Translates to a 25% return in 39 calendar days. The reason I’m digressing is because I am now faced with a decision on whether to hold or sell. Which will be the subject of one of my future posts. When to buy is not the important thing, when to sell is the most critical piece. What do you think? Should I take the money and run?

Now, coming back to IFCI, its logical to expect the share to jump up to a 10x earnings multiple if it becomes a bank and increase its P/BV ratio by 50% to bring it somewhere in the middle of the table. Therefore, lets watch it up to Rs 70 per share giving a return of 23% or so (hopefully). I’m getting in given the above logic, however will be ready with an appropriate stop loss should something spook the banking license party.

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