Protecting Yourself in Real Estate Leases in India
By Stephen Mathias
Wednesday, March 31, 2004
The setting up of huge BPO and software development facilities in India is resulting in an unprecedented boom in the country’s real estate industry. These types of facilities require large space, often in excess of 100,000 square feet. This is also leading to a higher level of sophistication in commercial practices in the real estate industry in India.

Leasing out real estate in India is not necessarily easy. It requires some amount of sophistication to understand the numerous legal pitfalls and ambiguities in real estate law in India and the way it is practiced.

Understanding these issues is important for a company that wishes to protect its interests adequately while deriving maximum benefit from its real estate.

Location
The first thing to understand is the local zoning regulations relating to usage of real estate. As a general rule, one cannot have a commercial operation in a residential area (though some states like Maharashtra, in an effort to attract investment, have permitted software operations to be set up in residential areas). This aspect of the law may not be followed strictly in some places. In Bangalore for instance, you have an area like Koramangala, where vast areas of land designated for residential purposes are used for software operations. It is rather confusing for a foreigner, who identifies a facility that appears to be perfect, is surrounded by commercial activity, was occupied by a reputable company, but the use of the land for software development is illegal.

For the tenant, the concerns are several. Firstly, the tenant may not want to do something that is not permitted by law. Secondly, the risks associated with doing this are difficult to evaluate. On one hand, the government may continue to turn a blind eye to all of this. On the other hand, it is possible that the government, concerned citizens through public interest litigation or a pro-active judge may sit up one day and take action. This leads to concerns over the stability and continuance of operations at that location.

Building Regulations
Typically, local building regulations will stipulate a floor space index—the amount of space you can construct on a particular size of land, depending upon its location, etc. The builder has to submit his proposed building plan and obtain a sanction. It is acceptable for buildings to have a certain amount of deviation up to a stipulated maximum level.
However, some builders may build extra space, even several additional floors. Given the sophistication that has taken place in the industry, this is less of a problem with the leading builders today, but it is more common among smaller builders.

Another type of violation relates to use of space for parking. There are generally regulations dealing with use of basements for parking. Often, these are violated and a company will be offered space in the basement of a building. You might also have premises where the regulations of the fire department have not been met—for example, not having adequate fire escape facilities. Typically, these facilities are cheaper than others and it is a disappointment for someone who thinks he is on to a good deal to discover the legal inadequacies of the building. This also sometimes leads to a conflict between the business people, who see an opportunity to save costs and the legal people, who want to ensure full compliance.

Dealing with Violations
For a foreign investor, it is most confusing to receive conflicting advice from different sources regarding compliance with real estate laws in India. She may be told by many that this is the way things are in India and that she has to accept it if she wants to do business here.

Some companies will insist on being totally compliant. This points to a definite refusal to the use of these kinds of facilities. Many other companies are willing to traverse beyond the basic issue of legal compliance to evaluate the risks associated with taking up such a premises.

Often, the best way forward is for these companies to seek some intelligence from real estate experts—for example, a small deviation beyond the acceptable limits may be acceptable, but having operations in the basement of a building may not be. The risks of being in a building built on land permitted only for residential use may be okay but being on the floor of a building that is not sanctioned may not be acceptable.

Protecting Your Security Deposit
The rates for security deposits in India are somewhat higher than in many countries, typically between 8 to 18 months of the rent. Real estate developers in India do not necessarily have deep pockets. When the time comes for the tenant to vacate, it is not unusual for the landlord to tell the tenant that he is strapped for cash right now but will return the security deposit once he finds a new tenant. The tenant is then left with the dilemma of deciding whether to vacate the premises and lose the key protection he has on his deposit (i.e., possession of the premises) or stay on in the premises till the security deposit is repaid.

There are several ways to tackle this. It is important to make sure that repayment of the security deposit is to take place simultaneous with return of possession, not 15 days or one month later. Added to this should be a condition that until the security deposit is returned, the tenant can stay on in the property rent-free and in addition, earn interest on the security deposit. In this manner, the tenant can hold on to the premises and earn interest on the deposit amount, thereby putting pressure on the landlord to return the money.

Another option that appears to be acceptable to builders today is to reduce the security deposit over time. One can fix months in each year when rent would not be paid separately but be deducted from the security deposit. Or, one can specify that the tenant will no longer be obligated to pay rent upon issue of notice of termination. This way, when the time comes for vacating the premises, the amount of security deposit paid originally would have been reduced.

Determining an Exit Strategy
Apart from securing repayment of the security deposit, there are other issues that a tenant needs to consider while terminating a lease and vacating the premises. For one, other deposits that the tenant might have paid, such as the deposit to the electricity service provider for increasing the load. This may need to be applied for and paid in the name of the owner, in which case, the tenant has to rely on the owner to recover the deposit.

Recovering the electricity deposit from the local electricity board for example may take several months. It may be worthwhile to consider negotiating an obligation on the owner to return the deposit immediately and then leave him to do what he wants, depending on whether he intends to keep the same electricity load or reduce it. The owner is of course entitled to claim deductions from the security deposit for damage caused by the tenant. The tenant is obligated to return the premises in the same condition in which he took it, normal wear and tear excluded. If for example, the tenant has re-tiled the premises, must he rip the tiles off, when re-tiling actually improves the flooring?

Often, if the contract is not carefully worded, the landlord will use this as a lever to obtain improvements free of cost. He may for example say: “Give me everything free of cost, otherwise, take it all away and return it exactly in the condition it was in originally”. The wording of clauses dealing with the state of the premises on termination therefore becomes important.

Sophistication of the Real Estate Industry
One of the benefits of the outsourcing boom in India is the increasing sophistication of the real estate industry in India. It is now possible to negotiate complex deals that provide coverage for various scenarios. A company can negotiate for temporary space, while the facility is being built, secure hard and soft options for expansion, should it be required and obtain other value added options.
This gives the company flexibility for expansion, without incurring costs, until the space is actually required.

Negotiating Deals
It is good advice to tell a tenant to negotiate initially with more than one developer.

Negotiating with more than one party provides clarity to the tenant in terms of what he can get and what he cannot, particularly in a less organized, fast changing market. It also improves negotiating power with the landlords, who know they may lose the deal because there is someone else bidding simultaneously. This is particularly crucial if the tenant has a short timeframe for setting up the operations.

When dealing with smaller developers, such as developers of single buildings or small investors in real estate, moving quickly to close a deal is important. Some smaller developers are open to negotiating with other parties even after a handshake deal is completed or a letter of intent is signed. It is therefore important to ensure that developments in the due diligence, negotiation and contract execution take place at a fast clip, with few intervals in between. When you are on to a good deal, you can be sure the landlord knows it and he may well look out for someone else with a better offer up till the date of signing.

Negotiating a real estate deal in India therefore requires some sagacity in figuring out what is acceptable and what is not and in closing a deal which not only leverages on the facility to the maximum extent but also protects the company’s interests, particularly for BPO and call center facilities that cannot afford a shut down for even a short duration.
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