Every entrepreneur should be an optimist but financial decision-making should also be done with some realism
For real estate developers to end up in a cash flow crisis is not unheard of. This has been commonly seen in the last 5 years when the developers did not realise the expected market trends of sale price increase, high volume sales etc. and thus ended up in a cash-flow crisis. There are various reasons why one could end-up in a situation as such.
Typically, a cash flow crisis means that your receipts are lesser or worse than the payments one needs to make and is desperately trying to salvage the situation.
Bad Financial Discipline
Developers have been known to be over-ambitious and buy many lands or undertake far more work than what they handle in terms of management bandwidth and financial strength. The lack of financial discipline ensures a situation of chewing more than one can. Money collected for a project gets used for something else and crisis stings. Time and effort to be spent on running projects is then spent in raising financial resources.
Bad Financial Decisions
Every entrepreneur is and should be an optimist, but financial decision-making should be done with a certain degree of realism. Many developers have defaulted because of the financial decisions they have taken. These include buying land at wrong prices.
In Mumbai and many other places, land has been bought assuming change in policies, increase in FSI in future, prices increasing in future etc. Many of these assumptions have been proven to be wrong in recent years and land bought at astronomical prices has eventually hit the developers.
Loading projects with high debt or paying expensive interest rates and not selling projects while waiting for sales prices to increase also contribute to bad financial decisions. In the last 5-7 years, many developers (and lenders/investors) started valuing SRA or redevelopment projects like normal projects and did not account for the risks associated. These lead to delay in projects.
In this scenario, the delay results in cost escalation and a lot of interest being paid to the lenders. Besides, paying compensation and other costs to customers who invested early on is also to be worked out. All this leads to a net-negative tag on the project. But this can be resolved by taking the right steps in a realistic manner.
Project Assessment Required
Understanding where the project is headed from an overall cash flow perspective requires clarity about future in-flows and future out-flows – whether the project is going to be net-positive or net-negative. A cash flow crisis should divide project flow from lender equity flow.
Money should be spent in a highly disciplined manner ensuring it is not being spent on anything negative. Value engineering, talking to consultants and vendors on price reduction are needed. A net-positive project means it is a temporary issue and will be resolved in time.
Being net-negative at the project level however means a tougher situation. Unless you put some money yourself or get your customers to pay more, there is no way the project can be completed. One will have to study incremental areas and then rework the tax-flow model to turn it around.
One ends up losing confidence and positive spirit to go after resolving a cash-flow crisis, making it the biggest issue. If people remain focussed and positive, solving it will be easier. One should practice all methods in the book to have a positive fighting attitude because that is the only way an entrepreneur can get out of this situation.
A cash-flow situation is like a hurdle race, where some are crossed and some hurdles you will carry along. The weight of carrying these hurdles is heavy, but once you are past the finishing line you can put it aside.
Focus and a positive spirit are the two most important things to have, because the rest is just about being straightforward and using common sense. The latter is frequently missing and developers overcomplicate their own situations and solutions by entering into deals that are not about untangling the crisis but just adding more to it.
The author is Managing Partner, Pecan Reams
DISCLAIMER: Views expressed are the author's own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.