Anuj Puri, Chairman – ANAROCK Property Consultants
With the implementation of accounting standard – IND AS 115, real estate developers will have to do away with the existing percentage completion method and adopt project completion method.
This is not a mere accounting change as it will have a severe impact on the ways & means in which the real estate developers run business, raise funds, price and sell projects.
Under the percentage completion method (old accounting standard), advance payments received from a home buyer towards an under construction flat were considered as revenue and added to the company’s turnover and net income generated from such projects were treated as profits.
However, under the project completion method (new accounting standard), advance payments received from a home buyer towards an under construction flat will have to be treated as loans and not income from sales. This will bear the following impact:
- Real estate stock prices may witness a significant correction – stock prices are a function of the company’s profitability and leverage. With changes in the accounting standards, the price-to-book value ratio will change and will bear an impact on the current stock prices.
- Large-scale consolidation in the sector as financially incapable and over-leveraged players will find it difficult to survive – only reputed and financially stable developers will be able to continue with the business and so homebuyers can be assured of buying houses in good projects of reputed developers.
- A significant change in the recognition method – leading to a massive revenue and cost reversal in the Q1 2018-19 results of the listed real estate developers, leading to a negative impact on the credit rating which may lead to sovereign/pension funds revisiting their future investment plans. These investors have strict norms under which they invest only in companies which are above a certain threshold of credit rating
- A few ongoing PE/institutional deals may be renegotiated – ongoing deals will be based on the historical and financial projections as per the previous accounting standards. With revisions to the accounting standards, the financial statements will also change. This may impact the developer’s fundraising process/cost and indirectly hamper the prices as well.
Although the change in accounting standard will lead to a severe impact on the ways & means in which the real estate developers operate, it bodes well with the amendment in Insolvency and Bankruptcy Code (IBC) which treats homebuyers as financial creditors.
As a result, the advance payments received from homebuyers will now be aptly reflected as loans on the balance sheets of the real estate developers.