Caveat Emptor: Guidelines for purchasing an apartment unit in India – due diligence to be carried out

One of the biggest issues one needs to factor in is to make all payments to the seller in plain cheque. That should be the right logical approach. This is easy on first sales where you buy a property directly from a reputed builder where you make payments by cheque and in instalments.

Second sales are invariably having this complication where cheque payments may not be accepted in entirety (its different if you buy directly from a builder as they accept money only in cheque) and this is where I felt there was a lacuna of information and therefore tried to fill in this gap with below due diligence/analysis.

Some of the principles used in Real Estate investing are highlighted below. These are from my own experiences in dealing with this tricky (and murky) world of business.

1. Whenever you go in for a flat second sale be wary of the following aspects:

The seller might want to sell at a 1:3 appreciation (as is the situation today – the investor invests Rs. X and expects a return of 3X!). Thankfully, the recent curb by the RBI on interest rates of HFC’s and home loan providers has kicked out speculators from the market and thereby has controlled the ratio of 1:3 to about 1:2. This means a potential investor can make a 100%-200% profit on his investment by buying a flat when its low and selling at the peak of the boom. This is pure speculation and I have seen all too many chaps in the second sale market who are in the market only because they want to cash in on this boom in the real estate market.

2. Be extremely wary of the legalities of Real Estate. Its very easy to think with your heart and not with your head. Believe me – there are more conmen there than anywhere else.

Think about this : You are investing close to your/someone else’s lifetime savings into a property and you want to ensure the due diligence is comprehensive. You don’t want to trust anyone in this game – its too risky and not worth it. I have met Lawyers/Advocates (Attorneys) and tax consultants and they have all advised me on this one simple rule: If it was meant to happen, it will happen – in a clean way. There are no two sides to this story. Due diligence starts with the buyer and seller and pricing negotiations but goes far beyond that:

A sample list of documents one might need to scrutinize are as follows: Encumberance certificate of the property for last 50-100 years, RTC, No objection from the local civic body (ex: BDA/CMC etc.), DC conversion of agricultural land for non-agri purposes, Khata, previous sales agreement, tax receipts, clearance from other bodies, water supply boards (ex: BWSSB), Power supply etc. – the list is long and endless.

Furthermore if you are going through a second sale process here are some essential steps you need to follow:

1. Examine the flat unit and ensure it is in a decent locality etc. suiting your needs/wants – this is the first step. Look at the location, area, unit itself, the lighting, the space, the basic necessities etc. as first priority. Don’t look at frills like swimming pool, etc. – hardly anyone uses such things and even if they do – those are not priority or a “Must have”. Negotiate with the seller or his middleman and find out exactly what are your total costs (including hidden costs) involved in such a process (many sellers and middlemen expect money in cash or expect a commission etc. – don’t fall for such traps and be wary of such proceeds). The Indian real estate market is a murky place to be in and you need to exercise utmost caution else you will regret later. Ask them for the breakup of the total costs – its your right again. ex: I heard somewhere that there is no sales tax on properties with more than 9 apartments – real estate laws always keep changing in keeping with the existing market situation so be knowledgable on such crucial aspects. 

2. Now, go to the builder and ask for all documents listed previously. It is your right to examine the property history and no one can deny you that – if they refuse because you are first time buyer and don’t know how to ask the right questions – bail out. Its a phoney deal.

3. Armed with these documents, do your first level of due diligence. Scrutinize these documents yourself. Don’t go to an advocate just as yet. You need to know what questions you need to ask the lawyer so your knowledge is critical.

4. Now, once you prepare a list of the questions to ask a lawyer, fix up an appointment with an attorney, and meet him. Put down the nuts and bolts of the deal to him. If the seller wants money in cash, tell the lawyer that or if the seller wants the money in cheque, tell him that. Then give him the documents you have collected from the builder for scrutiny and ask him to examine them. In particular be wary of the following three and the clauses contained thereon:

a. Sale agreement between the buyer and the seller

b. Assignment agreement – a tripartide agreement between the buyer/seller and the builder.

c. Sale of Registration or the sale deed (done at the Government Sub registrar office)

Don’t  force the lawyer to expedite his process – remember – he can detect deals that are a fake from a single word of the documents you have handed over to him so have patience.

Many attorneys I have met have told me that they fight cases on behalf of banks (these are on the legal team of the banks) against gullible buyers of flats where the flat has been involved in a double mortgage case. Such a case happens this way:

A builder would have usually leveraged on a bank’s money to finance his project as is common in project financing (say HDFC bank). This means he has pledged all his land papers with HDFC bank as mortgage and HDFC has first stake/claim on that land should the builder default on his payments. Therefore it is prudent that you get an NoC (no objection certificate) from HDFC before you buy a flat from either a second sale or a direct sale from that builder) because even you might leverage on another bank’s (say ICICI) money (a mortgage for that flat as security).

Suppose there is an arbitration, then, as per legalities, the first right for that flat to takeover/sell to cover for dues lies with the bank that has the first mortgage and not your bank. You don’t want to be put into a situation where you invest a crore rupees and find that there is some murky deal and you receive a notice to vacate your apartment because some bank is selling it to cover for dues not paid by someone else. You don’t want to be taking on foolish risks such as that.

Many sellers insist that you give a small option amount (a token advance – usually 5-10% depending on comfort level of buyer and seller) to prove intent of purchase of land/flat by buyer.

Between that sale agreement and the sale deed (the registration of that property), you should ideally not pay anything to the seller. If you do, you are again taking an unnecessary risk.

Many times, in second sales, sellers insist that they lose their rights to the property (in cases where they have purchased a property but not registered it as yet) once an assignment agreement is executed between the seller and the buyer with the builder in the loop and therfore demand almost 50-75% of the amount of the flat at the time of assignment. This means you have already paid the seller 10% on sale agreement initially and then another 40-50% of the cost upon execution of the assignment agreement and in theory, you are then bound by the seller and are left to his whims and fancies as the property is officially not registered in your name as yet.

The bone of contention here is that the seller thinks he loses his right to the property and you think you might lose your right to the property if the seller plays games. What is interesting to note here is that only after registration will the seller issue an NoC to the builder/developer that your dues to the seller are cleared in entirety you are the new owner of the flat. Think about this. This is where the catch lies in people like the seller in this example who wants to buy a property and not register it (rem. he is only a 50% owner of the flat as it is not officially registered in his name as yet). Why do sellers do this? To save on registration costs (that work out to be almost 10% of the flat cost). What is your risk: What if the seller does not give the NoC and sells the same flat to multiple parties – probably not possible since builder is part of your tripartide agreement but you never know.

Other tactics sellers use is to expect some money in cash that is again not a good practice and you should not go for such deals either as they are equally fraught with risk. Remember – these people are pros in this game and if you are to play with them – you need to be 10 times more cautious than they are!

5. Be a tough negotiator and record your conversations with a neutral party for transparency. Many sellers think it is a sellers market so they tend to act smart. Think about this: You are the one with the money and He is the one who wants that money (with the ridiculous profits he is making on the transaction) and therefore you need to think with your interests in mind – not his. Its very easy to get drawn into ludicrous discussions with the seller or his brokers where they pitch themselves with having muliple buyers and having a lot more muscle power or simply having more clout. Do not get intimidated about such things. You are negotiating and you need to be clear about your needs and priorities. Else, you are going to dig a deep hole for yourself very soon!

6. Many times, there is something called a guidance value that estimates the value of the property (usually applicable for a land and these days even flat owners use this terminology). This estimates the current minimum market value of the property. In other cases, there is a cost index calculator that estimates the cost of land/property in a particular area/zone of the city. ex: Bangalore South Kanakapura road will have a particular value for land as given and that appreciates by a particular index factor. Be aware of this as this might be the price your seller might want to get the registration of the property for (as its the Government accepted minimum market value of that property though the actual property value might be more than that value by a certain factor – sometimes even double or more!)

7. Many times, sellers register their property at the Government office for that minimum market value and not the value they are charging for the flat in reality. They do this to save on registration costs as a thumb rule for regstration is 10% of the unit’s cost.

8. Try to always leverage on a bank to lend you some money to buy this property. This serves two purposes:

a. The Bank does its own due diligence process (obviously because it is lending its money)

b. The Bank pays for a large percentage of the total cost so you are reducing your equity participation in the purchase thereby passing the risk onto the bank. The bank will get everything from top-bottom scrutinized including the legal papers though some banks are more strigent/lax (as the case maybe).

9. Last but not the least, if the deal falls through for some reason (say the attorney rejected the documents or did not give an NoC), don’t fret – there is a better deal out there. Maybe this one wasn’t meant for you at all in the first place! Be cheerful – its a painful but a worthy process to ensure you get your dream property at the price you want!

Above procedures work for both commercial and residential properties where floors/units/builders are involved.

Caveat emptor: Again, this is not legal advise so you are advised to be prudent and go by your own due diligence process – this is narrated from my own experiences and NO ONE should treat this as an authentic statement. Its totally a case-by-case scenario and you cannot take my words for granted. I found that there were many buyers and few sellers who were willing to walk the talk and toe the legitimate way in a deal such as this and hence have narrated it from my own experience. Please take your own independant legal/professional advise before embarking on any deal.