The Worli-Lower Parel stretch in South Central Mumbai, once a vaunted spot for premium realty, has emerged as something of a problem zone for real estate developers, particularly for those building luxury residences. Sales are slow, and some projects now look unlikely to ever be completed.Just last week, Indiabulls Housing Finance (IBHF) auctioned off the Palais Royale project in Worli for `705 crore after the developer, Shree Ram Urban Infrastructure, defaulted on its debt repayments to IBHF. The 320-metre tall building with 56 floors was envisioned as India’s tallest tower, housing luxury apartments costing upwards of Rs 25 crore apiece.The Indiabulls group itself is into realty and has built some landmark towers in the region. Indiabulls Finance Centre (IFC), where the group is headquartered, is one. IBHF vice-chairman and managing director Gagan Banga works out of the 17th floor, an office with a panoramic view of the massive realty development going on all around. Today, only one crane can be seen working in the vicinity, however.When Banga met ET Magazine in mid-July, he had just concluded a meeting with a bulge-bracket private equity (PE) firm at a nearby hotel. PE firms such as Brookfield, Blackstone and KKR have been buying out commercial real estate in prime locations in India. IBHF had facilitated the Rs 2,500-crore sale of One BKC in Bandra Kurla Complex, a property developed by IBHF borrower Radius, to Blackstone in June.Blackstone had also picked up equity stakes in the group’s iconic towers IFC and Indiabulls One in 2018. The group has other properties to sell, including residential blocks in Lower Parel.However, a much bigger deal is simmering — Indiabulls is looking to exit realty altogether by selling a controlling stake in its real estate arm. Sitting in his office and sipping on warm water, Banga explained how the group is now focused on turning IBHF into a bank.The group already owns a 15% stake in a bank in the UK, and wants to merge its housing finance company into Laksmi Vilas Bank. To get the Reserve Bank of India approval proval, Indiabulls wants to move the real estate business, which normally has serious perception issues and political risks, away from the group.The Palais Royale distress sale apart, last week also saw quite a few key developments in Indian realty. The Supreme Court ordered that Noida-based realty developer Amrapali Group be de-registered by the Real Estate Regulatory Authority, and asked state-run construction company NBCC to complete the projects.In Mumbai, the Piramal Group informed investors that it was extending its realty-focused fund Indiareit Fund Scheme V by a year, exercising an available option to give itself another year for exiting some of the projects it is invested in.Earlier this month, the Supreme Court took up a petition filed by more than 100 builders challenging amendments to the Insolvency and Bankruptcy Code that accorded homebuyers the same status as financial creditors.Realty in India is in the midst of a churn that feels markedly different from the difficulties it faced in recent years on account of slack demand. It is reeling from a severe cash crunch created by the liquidity squeeze in non-banking finance companies — the Indian shadow banks.The defaults by IL&FS in August 2018 and subsequently by housing finance company DHFL triggered a squeeze that shut off two major sources of funds for the industry — the PSU banks and the commercial papers-based lending by the mutual funds industry.For almost a decade now, Indian realty, especially in the residential segment, has been leaning on the shadow bankers to refinance its loans, keeping them afloat in the face of flagging demand. Today, demand remains muted, funds are much harder to come by, and the NBFC loan books loaded with realty loans are no longer attractive for loan-asset traders, creating a multi-layer squeeze.In late June, credit-rating agency ICRA downgraded Piramal Capital and Housing Finance as well as Edelweiss Capital for the fear of defaults in their realty loan books. A month later, ICRA’s own standing has taken a tumble on its dealings with IL&FS.How big is the problem? For instance, at Piramal Capital and Housing Finance, out of the Rs 56,000-crore loan book, Rs 40,000 crore has been lent to realty. The Ajay Piramal-led group also has a realty arm, which has invested in big projects in central Mumbai.Banga of Indiabulls points out that the problem is much bigger today. He says: “It is no longer a liquidity crisis. It is a consumption crisis that will affect all sectors if not managed now and become a solvency crisis.”Property consultants Anarock said last week that there are 1.74 lakh homes stuck in different phases across seven cities in India. Out of these, 68% are already sold, which means home owners find themselves in a limbo, while having to pay EMIs on their bank loans. In Mumbai and Delhi alone, stalled houses add up to Rs 1.6 lakh crore in value.Large global investment firms such as Blackstone are scouting for value deals in this difficult environment for builders, as are others such as KKR, Blackrock and Brookfield. Distress funds such as SSG and Apollo are also sniffing around for deals.However, most of this interest is around office spaces — commercial real estate, whose dynamics are different from residential properties. Commercial buildings are sold only after they are ready and cannot use buyers’ funds, unlike residential units. Therefore supply is limited, at least for two more years.A CEO of a large PE firm, who asked not to be named, said the rental yield from a commercial building at 8-9% of its price makes way more sense for investors compared with the rental yield of a residential building at 2-3%.Another Mumbai builder, who has struck a PE deal, is Niranjan Hiranadani. Brookfield has acquired commercial space from his companies in Powai for $1 billion. Hiranandani now also heads the National Real Estate Development Council (NAREDCO) under the Union Ministry of Housing and Urban Affairs. He told ET Magazine that the Hiranandani Group avoided the Lower Parel area of Mumbai, focusing instead on Powai and then areas such as Panvel and then moving out to other cities such as Chennai, as it prefers to develop an entire area, building schools, malls, offices and residences at the same place.He, too, foresees a real crisis. “There has been 69 lakh apartments sanctioned under PMAY (Pradhan Mantri Awas Yojana), and 46 lakh have started. But how will they be built now? Where are the funds? The banks are sitting with Rs 175,000 crore of money that they are refusing to lend to real estate.” Hiranandani adds that the GST rule that has incentivised sale of buildings with an occupancy certificate with zero tax has also pushed buyers to delay their purchase.There is another reason that private equity players as well as individuals are shying away from buying luxury residences in India. Hopes for a price correction are in the air. And once a correction starts, there is no guessing the bottom.Prateek Jhawar, MD of Avendus Capital, points out that realtors never drop prices in their existing buildings even if they have to wait for years to clear their inventory of flats.For one, a cut in prices leads to a drop in value perception, and secondly, they usually have a huge margin to play with, and can afford to wait.Analyst Sudip Bandyopadhyay, also chairman of NBFC Inditrade Capital, explained how it works. “Imagine a builder with costs of building an apartment at Rs 30 lakh and a price point of Rs 50 lakh. If there are no buyers, the builder takes a loan at say 23% interest to refinance his current loans.It allowed them to hold on and the high margin means there are enough profits to be made even at this high interest rate. The NBFCs sourcing their funds at 8-9% through short term commercial papers from mutual funds and insurance industries also had a good deal. They got huge collateral security, too, often two or three times the value of the loan.”He explains that once the loan tap to NBFCs shut down, there was no way for either the NBFC or the realtor to get out of the situation unless they were able to sell the apartments. As the loan books look like problematic assets in the absence of sales, the NBFCs have a classic asset-liability mismatch on their hands.Piramal Capital, which plans to bring down its realty exposure from 73% of its book to 50%, and also reduce large single-borrower exposure to less than 10% by March 2020, has already cut its loans to the Lodha Group, probably the largest developer in Mumbai. According to reports, in May, Piramal Group managed to sell Rs 500 crore worth of loan assets to Goldman Sachs.Reports also suggest that it managed to bring in fresh funds into Piramal Capital last week. The company declined comment as it is in a silent period pending announcement of its first quarter results. The Lodha Group, which has now deferred a listing of its shares through an initial public offering at least thrice, also declined to participate in the story.While insolvency stares at many realtors, especially the ones that have high component of residential realty in their portfolio, the goings on at the insolvency courts are not looking too promising either.Srini Sriniwasan, the managing director of Kotak Investment Advisors, told ET Magazine that it is not fair to expect much from the IBC process. He explained that a residential realty project that is stuck has obviously used up all the money paid by homeowners.“Now do you expect a new developer to come in and complete the project, but for no cash – because the homeowner has already paid up? A project in trouble has obviously seen some siphoning off or misuse of funds.” Sriniwasan also questioned the wisdom of making a homeowner in a project equal to a financial creditor. “A financial creditor in the IBC process is expected to take a haircut in his outstanding loan to salvage the project. If the homeowner asks for the same status, what will he do for a haircut? Give up a room or pay up more money to get his apartment?”Yesh Nadkarni, MD and head of real estate at PE firm KKR that has been active in the Indian residential and office realty market as a lender, says that while the current conditions remain challenging, the market, particularly residential, will bottom out as supply-demand forces work out. “It will take time, but the NBFCs will come back to lending, and so will the banks, as they get recapitalised.” He adds that the real estate sector is important as it is a big job creator.As a result, there is much hope pinned on the government, too. But did Finance Minister Nirmala Sitharaman do enough for the sector in her maiden budget on July 5? She announced a model tenancy law and extra tax incentives for acquiring affordable houses. However, critics say that measures to back acquisition of top-rated NBFC loan books by banks is meaningless as the top NBFCs have been able to raise bonds, even in this market and are not starved of cash. However, the budget announced a housing for all target for 2022, which means the government intends the sector to get going three years ahead.As Nadkarni and Hiranandani point out, the government will need to prod the PSU banks to lend to realty again and open the taps that have been shut. And Banga points out that many markets in India are still doing well. Hyderabad and Bengaluru in particular or even far-flung Mumbai suburbs have seen steady sales. A decade or so back, private equity itself had turned lenders to realty sector. In different phases since then, stock market profits, PSU banks money and the shadow-banking route have kept the realtors going. With all that turned off, are we still looking at ways for going back to business as usual or is there a paradigm shift happening now?Nikhil Shah, India MD of turnaround specialist Alvarez and Marsal, feels the way out of the residential realty mess is a price correction, discounts and haircuts for lenders to attract new money to problematic markets.Gulam Zia, executive director of property advisory firm Knight Frank, often wonders if his own decision to buy an apartment in Mumbai was correct and whether it ties him down to the city permanently. He notes that the new generation prefers to rent. Goldman Sachs has invested in student housing in Manipal, Zia points out, and adds that players like Airbnb and Zolo are also becoming active players in student and worker residences across the country.Zia adds that modern mass transport infrastructure can always help keep realty prices in check, and prevent a build-up in a concentrated area, as people can stay away from their workplace and travel to work in a relatively short period of time. Price cuts are already happening, Zia says.In Mumbai, in the last three years, there has been a 12% downward revision of prices he says. If one adds discounts and inflation, it should be 25-30%. Some new developers have tried and priced apartments at `1 crore in the middle of super luxury offerings — at least 600 of them are there. “This is not the bottom yet. The prices in many areas are set for a crash,” says Zia.Currently, the situation is complicated. It is not just the IBC. A homebuyer has many options and can approach the consumer court or RERA [Real Estate Regulatory Authority]. Today, we have different customers and lenders approaching different authorities. If we can focus on one, it will be easier to find a solution. I think RERA should tackle this since it is designed for real estate and the problems homebuyers face. IBC, on the other hand, is designed to return money to lenders.In the last three years, we have seen banks giving less and less money to real estate. Funding is not available to the sector and because of this, the oil in the economy is drying up. We have to be clear: this is not an issue of liquidity only for the real estate sector. We have to seek a solution so that the banks start to lend more.The Reserve Bank of India will surely try to bring in more liquidity into the market through the banks and non-banking finance companies. I also feel more banking licences should be given out and there should be more nimble-footed but strong private sector banks that can then lend to small and medium enterprises and real estate developers.