Shobhit Agarwal, MD & CEO - ANAROCK Capital
We often hear of banks auctioning off seized distressed properties, and how such properties can be lucrative investments as they come at very attractive prices. Studying the market of distressed properties is not very easy, but there are some areas of predictability. The 'supply' of distressed properties is usually closely linked to the prevailing economic situation. Severe market setbacks or stock market crashes can result in an unusually large infusion of distressed properties in the market.
In a normal or vibrant economic situation, the availability of such assets is much lower. Less than 8% of Indians who have borrowed from a bank to acquire a residential property will default on their home loans unless there are exceptional circumstances involved.
How do properties become distressed and go to the auction block?
A homeowner is considered to be in default when he or she is behind on the agreed-upon EMIs for three consecutive months or more. When a home loan is in default, banks do not seize the assets of the borrowers immediately. They send a notice to the borrower highlighting the missed EMI repayments, and that they will take strict action if the situation is not remedied.
Banks do understand the various reasons why a borrower may have defaulted on EMI payments, which include financial crisis, serious health setback, loss of job, a family crisis, etc. These are facts of life, and banks do not make themselves unapproachable to defaulting borrowers who state such reasons. Once the buyer has explained the reasons or they are otherwise evident to the bank, an offer to restructure the EMI and extend the tenure of the loan is made.
A borrower may ask for a grace period on the basis of a good repayment record for loan repayments and that interest rates have increased beyond affordability. The borrower can ask the bank to refinance the loan, resulting in reduced EMIs over and increased tenure period. The defaulting borrower may offer to liquidate other assets such as fixed deposits, insurance policies or mutual fund investments in order to repay the debt. He or she may even sell the property themselves to pay back the amount instead of letting the bank take over and auction it.
If these measures help the borrower to catch up on the outstanding EMIs, the property will not come up for auction. Auctions happen only in extreme cases - and even then, the borrower may not incur a total loss. If the property is sold within three years of its purchase, the borrower is entitled to a profit on the sale after the bank has recovered its dues. If three years have elapsed since the property's acquisition, the owner is still entitled to tax exemption benefits.
If the borrower is still unable to pay back the principal amount and interest on a home loan after 90 days, the bank will classify a home loan as a Non-Performing Asset (NPA) and will seek to recover the complete home loan amount. To do so, they will seize the borrower's assets and/or the mortgaged property. They are authorized to do this under the SARFAESI (Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests) Act to protect their interests.
Even at this stage, the banks may not go as far as auctioning off the property, preferring to resolve the borrower's issues by further easing the repayment process and burden for the borrower. Only when all these measures fail will the bank proceed with selling the property.
The Process of Property Auctions
At this stage, the bank will take the defaulting borrower's property into its possession and seek to dispose of it under the guiding factors of the SARFAESI Act. The process begins when a borrower's home loan account is classified as a 'chronic' NPA - one where no other form of resolution is possible. The bank will issue the borrower a 60-day notice, which is technically a reminder to the defaulter stating the issue and the factors that have led them to this point in full detail.
If the defaulter does not respond during this notice period, the bank proceeds with the auction of the property. Even in this period, the borrower has the option of resolving the issue or raising an objection to the notice. For instance, the bank will specify the property's fair value and the borrower can object if the property is perceived to be undervalued or if he or she has an alternative to pay off the pending dues to the bank.
The banks must then serve a fresh 30-day notice period to auction the property, and the subsequent notice will include all the relevant details of the sale. Finally, the property is auctioned and the outstanding amount is recovered.
The process of bank-auctioning itself is, however, quite cumbersome and lengthy. The bank will first advertise the upcoming property auction on a given date, assimilate the various offers and then determine the final buyer. The process can get prolonged even further if the buyer intends to acquire the property via a loan, either from the same or a different bank or financial institution. Also, all intending buyers need to be fully vetted and the final transfer of ownership is subject to a NOC by the pertinent housing society.
Are distressed property auctions a good investment bet?
It is true that properties on sale via bank auctions can be bought at prices which are significantly lower than the prevailing market rates in that particular area and for that particular property size and type. However, it should also be borne in mind that the base price for a property on auction is a function of the outstanding loan amount in question. In other words, the longer the current owner has been servicing the home loan, the lower will be the base price of the property. If the current owner is only a few EMI cycles short of complete repayment, he or she will seek to restructure the loan on the property instead of allowing it to be auctioned off.
Getting to know of such opportunities is not hard. The public will be informed quite efficiently when an auction for single or multiple seized properties is to take place, as the bank will advertise the fact along with all pertinent details online and in leading dailies. Distressed properties and their scheduled auctioning will also be mentioned in a bank’s annual report under the category of bad debts. Interested buyers may also turn to trusted property consultants who will apprise them of distressed assets on the market, and what the expected price range will be.
The primary potential advantage to buying a distressed property being auctioned by a bank is obviously the possibility of getting an asset at a potentially lower price than the prevailing market rates for such a property in that particular location. Another plus could be the potential for securing a property in a prime location. Also noteworthy is the reduced burden of due diligence since the auctioning bank will already have established that the property is legally sound in all aspects. Notably, the property would come up for auction only after the previous owner has exhausted all available avenues to stay the proceedings, and no longer has any legal recourse.
There are some potential challenges to investing in properties being auctioned by banks. In the first place, there is no single database of such properties to consult. Secondly, it is impossible to anticipate what the highest bid for any given property will be, so there is no assurance of acquiring a particular property one is interested in.
In any case, buyers need to be very familiar with the exact process involved before, during and after buying a distressed property. The process of buying distressed property on auction is only complete when it has met with the expectations of both the auctioning bank as well as the property's previous owner. If it hasn’t, there could be legal problems even after the property is legally purchased by its new owner. Also, the buyer must have a complete understanding of the ownership history of such a property and needs to ask for all the pertinent paperwork. This is important in case the new owner seeks to sell the property again at some stage.
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