With banks reluctant to lend to the real estate sector, developers are looking at alternative instruments of funding such as lease discounting for completing ongoing projects, especially the commercial ones.

The sector, which has been hit by the global financial crisis, has seen more than a 60 per cent fall in demand in the last six months, say experts.

Under a lease or rent discounting agreement, banks lend to developers for new projects against rents they directly realise for completed projects, which also is mortgaged with the bank. Thus, banks are assured of guaranteed cash flows and also have physical assets in case of defaults.

Also, the rate of interest charged by banks for loan against rent, generally for a tenure of five-six years, is generally 1-2 per cent lower than the benchmark lending rate. "Lease discounting is a much safer mode of lending, as the entire loan amount is covered through the rent agreement, and the banks are cushioned against defaults," admitted a senior official from SBI [Get Quote] Capital Markets.

According to real estate developers, for commercial projects, unlike the residential projects, where the funding is mostly through advances, lease discounting is a preferred funding option at present.

"Unlike other sources, bank loans against lease agreements have not dried up in recent months. Also bankers are more interested in such safer modes of funding," said Pradeep Sureka, president, Confederation of Real Estate Developers' Associations of India, West Bengal. Ravindra Chamaria, chairman and managing director, Infinity Infotech Parks, said, "For commercial projects, internal accruals and banks have been major sources of funding. However, banks are now selective in lending, and rent discounting is an option for developers who already have one commercial project on lease."

Sources in major PSU banks like Allahabad and Uco Bank [Get Quote] said, they had limited exposure in the real estate sector and little headroom for further lending. Banks preferred alternative instruments like lease discounting, only after assessing underlying risks, said sources.

"We have entered into lease discounting arrangements with developers. However, one has to take into account several factors like proper lease agreement, credit rating and market conditions before entering into such agreements," said sources in Allahabad Bank [Get Quote]. "We have limited headroom for real estate sector, and have already exhausted the stipulated limit for real estate lending. If we had the limit, we would have considered, alternative and safer lending options to the sector," said sources in another public sector bank.

In the recent months, the non-viability of commercial projects has prompted many developers to convert commercial projects into residential ones, said Pradip Chopra, chairman and managing, P S Group, which is also developing an IT project in Sri Lanka. 

"Recently, many banks have extended substantial credit to real estate developers. For example, one of the public sector banks recently funded as many as 10 real estate projects in Kolkata," said Chopra.

For real estate developers with a national presence, the withdrawal of funds by foreign institutional investors have also been a cause of concern, prompting newer instruments for completing the ongoing projects.