India's unreal estate: Why you still can't afford to buy that home

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• The rating agency Crisil expects the total revenues of the fast-moving consumer goods, or FMCG, sector to fall 2-3 percent (or what the analysts like to call “de-grow”) during this financial year. Before Covid-19 struck, the revenues of these companies were expected to grow by 8-10 percent.

• If one goes by basic economics and the law of demand, home prices should have fallen dramatically by now. But they haven’t. The reason for this, as we shall see, is that real estate in India has become a low supply, low demand market (yes, low demand — you read that right).

• In this environment, expecting them to buy what economists like to call “discretionary products” is rather low. Discretionary spending includes money spent by people on everything beyond food, toiletries, clothes, fuel, etc.

• In this context, it is very interesting to see what RC Bhargava, the chairman of Maruti Suzuki, the country’s largest car maker, had to say to Business Standard. Bhargava was confident that Maruti will be able to sell what it produces in the month of June. This confidence comes from the fact that the company will end up assembling only 30-40 percent of its cars in comparison to what it normally produces in June.

• The reason for this lies in the fact that the Maruti is basically an assembler of cars now and depends totally on its vendors and suppliers for everything that goes into the making of a car.

• Nevertheless, as Business Standard points out: “[Bhargava] however, added he could not predict the scenario after July, and whether the current trend was merely ‘pent-up demand’ after the lockdown.”

• In fact, two-wheeler sales fell by 16 percent and 20 percent respectively in January and February 2020. It is worth remembering that this was the period before the negative impact of Covid-19 started spreading through the Indian economy.

• If Das turns out to be right, as he is more than likely to be, this is the first time the Indian economy will contract since 1979-80, when the economy had contracted by 5.24 percent. This was the year of the second oil shock when, due to a revolution and regime change in Iran, oil prices had gone through the roof and impacted economic growth negatively all across the world.

• While Das did not specify by how much the RBI expects the Indian economy to contract in 2020-21, the World Bank expects the Indian economy to contract by 3.2 percent

• Of course, one of the reasons for the contraction in the economy will be the fact that Indians will cut down on consumption in 2020-21

• In 2018-19, the average home loan size for a home loan of less than Rs 10 lakh was Rs 2.97 lakh.

• The average home loan size in 2016-17, 2017-18 and 2018-19 was Rs 9.03 lakh, Rs 7.83 lakh and Rs 11.83 lakh, respectively.

• For people living in cities, the average home loan size might appear to be too small. And that’s because of the fact that the bulk of the home loans given by public sector banks and housing finance companies are up to Rs 10 lakh.

• While home loans of less than Rs 10 lakh form a significant proportion of the loans given by public sector banks and housing finance companies in numerical terms, in value terms, they aren’t really big.

• In 2018-19, loans of greater than Rs 25 lakh formed 62 percent of the overall home loan disbursements carried out by public sector banks and housing finance companies.

• A July 2018 newsreport in the Mint points out that the average home loan size for ICICI Bank was at Rs 30 lakh. So, the size of the average home loan given by private banks is generally slightly higher than that of public sector banks.

• What kind of a home can a borrower hope to buy if he takes on a home loan of this size? The median loan-to-value ratio of public sector banks as of March 2019 was 69.9 percent. For housing finance companies, this was at 72 percent.

• This is why the one-year all-India return in December 2011 stood at 26.3 percent. In fact, returns in some cities were even higher. The one-year return in Delhi in December 2011 stood at 48.4 percent. In Bengaluru, the return stood at 41.6 percent. But what takes the cake is the one-year return in Kolkata in December 2012 and March 2013, which stood at a whopping 57.5 percent and 59.7 percent, respectively.

• In fact, as we shall see, such astonishingly high returns still have some role to play in the currently dysfunctional real estate market in India.

• Housing price growth over the last nine years has slowed down big time. The all-India yearly return on housing in December 2019 stood at just 3.5 percent. A bank savings account could have possibly paid you more. The five-year return on housing works out to just 6.7 percent per year. Fixed deposits would have paid more with considerably less risk.

• Also, it needs to be pointed out here that the return on housing discussed above doesn’t really take into account the various expenses of owning a home. These include maintenance charges to the society, general maintenance charges, property tax, interest to be paid on the home loan and, above all, inflation.

• Also, one can rent a home out and earn money from it, though it needs to be said here that the rental yield (annual rent divided by the market price of the house) in most parts of the country is between 1.5-2 percent, which is very low.

• Once we take all these factors into account, the return on owning a house over the last few years may even be in negative territory. This explains why the so-called real estate investor is nowhere as active as he used to be a decade ago.

• So, the total number of unused homes — homes that have been built, but with no one living in them — is pretty huge.

• What this clearly tells us is that an astonishingly high amount of money is stuck in real estate, which is not a good thing in a capital deficient country like India. Also, unless these homes get sold, loans given by banks and NBFCs will continue to remain stuck.

• Between December 2010 and December 2019, home prices across India rose by 12.1 percent per year. But as mentioned earlier, this does not take into account the massive increase in home prices before that, between 2002 and 2011.

• The point being that even though the increase in housing price has slowed down since 2015, the base price of homes was already very high by then, making homes unaffordable for most people looking to buy one to live in. And that explains such a massive rise in the inventory of unsold homes.

• In November 2016, the government demonetised notes of Rs 500 and Rs 1,000. These notes had to be deposited with banks. Banks suddenly saw a huge inflow of deposits, without a similar increase in loans. Banks then started increasing their lending to NBFCs which, in turn, lent a lot of this incoming money to real estate companies.

• The business model of real estate funding has changed over the years. In the past, real estate companies would launch projects and sell under-construction property. This money would then be used to either buy land or complete a previous project or simply be siphoned off.

• This model broke down once many builders became too cavalier in their approach and did not deliver apartments on time. This started happening around 2009 and peaked a few years later.

• Gradually, under-construction property was looked down upon and real estate companies had to start depending on more formal sources of finance.

• With the passage of the Real Estate (Regulation and Development) Act, 2016, real estate companies need to have all approvals in place before the launch, unlike previously, where they used to launch projects with barely any preparation.

• As Subramanian and Felman point out: “While developers could in principle tempt buyers into the market by reducing prices, they couldn’t do this in practice because lower prices would have destroyed the (notional) value of the collateral that they had pledged in order to secure their lending.”

• What about individual buyers who bought flats over the years as an investment and continue to hold on to it, unwilling to sell it at a lower price? Buyers who bought flats late in the day, between 2012 and 2015, paid a high price for what they had bought.

• In some other cases, buyers are anchored on to the prices they saw before 2015.

• State governments decide on a certain circle rate for different areas. If a real estate transaction happens, then stamp duty needs to be paid on this rate, irrespective of the prevailing market price.

• But when the market price goes below the circle rate, it creates multiple problems. Let’s say the market price of a particular apartment in a city is Rs 50 lakh. The circle rate is Rs 60 lakh. If this apartment is sold, the stamp duty will have to be paid at the circle rate of Rs 60 lakh and not the market price of Rs 50 lakh.

• This basically ensures that real estate transactions in such markets don’t happen at all. This means that the inventory with real estate companies does not come down. Along with this, the individual buyers also cannot sell the apartments they own.

• A decrease in circle rates would mean that transactions will start happening at a lower price. This is something that politicians don’t want because it will mean a decrease in their overall wealth. They would rather have no transactions than have transactions at a lower price. Do remember, all these investments are in black.

• Then there is also the case of stamp duty on real estate transactions forming a significant portion of the revenue of state governments. While at lower stamp duty rates, the chances of more real estate transactions are higher, this is a risk that state governments don’t seem to be willing to take.

• The mathematics of the entire business works out such that builders currently cannot cut prices by more than 5-10 percent.

• Chattopadhyay also feels that these price cuts will be more along the lines of indirect discounts from real estate companies, rather than a direct cut in the market price.

• If the real estate company cuts prices in the days to come, this does not go down well with the individuals who had bought these homes at the beginning. Hence, the pricing remains opaque and discounts need to be negotiated.

• Lakhan estimates that some of the key projects in central Mumbai have seen a fall in price of 25-30 percent within one or two years of getting the occupation certificate. He estimates that prices might fall a further 12-15 percent in the post-Covid environment in case of some projects.

• As I said earlier, if you are the kind who can afford such an apartment, you probably already have one, but if you still want to buy another one, negotiate very hard.

• This is something that has been happening for the last five years wherein sometime during the middle of the year, those who make their money from real estate start talking about a festival season boom in the sector. The boom hasn’t come, at least not in the last five years.

• The real estate industry is trying to sell a positive story all over again. One strand of this story is builders going digital in order to beat the post-Covid economic heat.

• The other story being sold is that people who are losing their jobs in the Middle East will come back and buy homes to live in. There is a big hole in this argument. A bulk of these people already own homes in India.

• In April earlier this year, the RBI came to the rescue of NBFCs by allowing them to extend by a year the date for starting operations for loans to real estate projects delayed for reasons beyond the control of promoters. This extension won’t be treated as restructuring of the loans given to real estate companies. This facility was already available to banks.

• As mentioned earlier, quite a lot of what looks like lending to NBFCs on the books of banks is actually indirect lending to the real estate sector. In this scenario, if real estate companies don’t pay up NBFCs, the latter won’t be able to repay banks. Hence, an NBFC crisis might turn into a banking crisis, something the RBI would like to avoid.

• The moratorium on repaying principal as well as interest on term-loans is also going to help real estate companies in the short-term. But it is worth remembering that interest is not being waived off on these loans.

• What this basically does is, it pushes the can down the road. The question is, what will happen one year later? Of course, the hope is that demand will come back, real estate companies will be able to sell the inventory they have built up, and use the money to repay loans. As far as hopes go, even cows might fly one day.

• This basically means that when the real estate sector does well, many other sectors — right from steel and cement to furnishing and paints, etc — do well. The multiplier effect is huge.

• The more a government or a central bank tries to postpone a crisis, the bigger the eventual crisis is.