The real estate Ponzi scheme has started to unravel

Jul 3, 2015

In this issue:
» The brewing crisis in real estate
» Domestic institutional investments touch record
» Rajan sees domestic recovery coming
» ...and more!


Dear Readers,

We are constantly making efforts to bring to you opinions that go beyond long term investing in stocks.

In the past we have had Asad Dossani and Apurva Sheth share their perspectives on trading.

And today, we bring you some opinions on a different asset class altogether - Real Estate. That too from none other than Vivek Kaul.

Most of you would know Vivek as the India Editor of The Daily Reckoning. Vivek is also the author of a trilogy on the history of money and the financial crisis titled Easy Money (which by the way is highly recommended reading!).

In recent months, Vivek has written several extremely insightful pieces on the state of the real estate sector in India. Both from the perspective of the industry, and you, the consumer/buyer.

And I thought it would be great if Vivek penned his thoughts for you too, dear reader. And that's exactly what I am sharing with you today...

Just read on below for Vivek's views on real estate and why he believes that prices will continue to fall/stagnate in the near future...

Happy reading!
Tanushree Banerjee

"Buy land, they're not making it anymore," is a line attributed to the great American writer Mark Twain. Typically, any argument to buy real estate still includes a version of what Twain once said. Obviously, things are not as straightforward as that.

Sometime in early 2014 I wrote a column on real estate in which I basically said that believing that real estate prices will never fall is a stupid idea. I got a lot of flak for it. But nearly 18 months down the line, we all know who is having the last laugh.

Data on real estate in India is difficult to get. But over the years a few specialised agencies which are collating this data have emerged. One of them is Prop Equity. As per their data, residential demand across key cities in India fell by 21% in 2014-2015. This was after residential demand had fallen by 22% in 2013-2014. (Sourced from a Citi Research's India Property Report).

A key aspect in financing real estate projects is launching new projects. The money collected from launching a new project is typically used by the builder or the real estate company to pay off their past debts or to complete a project which they had launched in the past.

To that extent real estate companies have been running a Ponzi scheme where money being collected by launching new projects was being used to build/complete old projects. A Ponzi scheme is an investment fraud where old investors are simply paid off by raising money from new investors. It keeps running till the money being brought in by the new investors is more than the money needed to pay off the old investors whose investments need to be redeemed.

Once this no longer stands true, the Ponzi scheme collapses. Something similar seems to be playing out with Indian real estate as well.

Data from Prop Equity shows that the number of new projects launched in 2014-2015 fell by 37%. For the fourth quarter of the financial year (i.e. the period between January and March 2015) the number of new launches fell by 48% in comparison to the same period in 2014.

This essentially means that one of the ways in which developers used to fund themselves is not working as efficiently as it used to in the past, leading to a collapse of this Ponzi scheme. In fact, there has been a lot of anecdotal evidence of builders taking the money and disappearing.

One of the reasons why developers have been finding it hard to sell new launches is the fact that their delivery record over the years has been really very bad. As a recent news-report in The Economic Times pointed out: "Of the 17 lakh apartments launched between 2008 and 2011, 55% were delayed by at least one year and 20% by over 48 months, many of which have still not been completed, according to Liases Foras [a real estate rating and research firm]."

It has taken a few years for Indians who have always firmly believed in investing in real estate to realise that all is not well with the sector. In fact, buyers who have been taken for a ride by the builders are now getting together and exploring legal options.

Recently, the National Consumer Disputes Redressal Commission (NCDRC) asked Unitech to compensate buyers at 12% per year for any delays in home delivery. The company had offered 1.8%. The NCRDC also said that any further delays would have to be compensated at 18% per year. There is more data to show that all is not well with Indian real estate. A recent research report from ICICI Securities written by Sandeep Matthew points that data from the Reserve Bank of India shows: "net additions in outstanding home loan accounts in major metros have slowed significantly duringFY07-13 compared to the period FY02-07, reflecting a more mature market in the metros, and also high prices potentially impacting demand offtake for mortgages in more recent years."

The number of new home loans being issued is a good proxy for housing demand in the country. And things don't seem to be looking good on that front. This is simply because real estate prices are now way beyond what most people can afford.

All this analysis boils down to the basic question-where are real estate prices headed in the days to come? Citi Research analysts Atul Tiwari and Rishi V Iyer write in a recent research report: "Different data points continue to suggest broad-based deceleration in residential prices across India." In fact, data from Prop Equity shows that residential prices grew around 0.5% for the one year period ending in March 2015, in comparison to the one year period ending in March 2014.

Another thing that we could look at is the RBI's All India Residential Property Price Index. The latest data point available on this index is as of the end of December 2014. The price rise between December 2013 and December 2014 is at 3.6%, on an all India basis. Between March 2014 and December 2014 prices have been flat. Prices in cities like Mumbai, Kolkata, Greater Chandigarh etc., have fallen. In comparison, the prices between December 2012 and December 2013 had gone up by 10.7%.

What these data points clearly tell us is that real estate prices are not rising at the same pace as they were in the past. For the period of one year ending December 2014, the returns on real estate on an all India basis were lower than returns on a savings bank account.

Nevertheless, given the rapid fall in sales as well as the huge amount of inventory of unsold homes that real estate companies are sitting on, real estate prices on the whole should have fallen. But that hasn't happened. Why is that the case? A major reason for that probably lies in the fact that a lot of black money is still going into real estate and that has kept the real estate companies going.

For this scenario to change the Narendra Modi government needs to start focusing on domestic black money as well. Further, bank lending to commercial real estate over the years has always grown at a significantly faster rate than the overall lending. Things seem to be changing on that front as well.

Hence, I strongly feel that real estate prices will continue to fall/stagnate in the days to come.Watch this space.

Do you agree that most realty companies are running a Ponzi scheme? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Now while real estate does not offer much comfort, the story with stocks is rather different. One of the biggest reasons why we believe that the equity markets in India are hardly in a bubble is not the current valuations. Instead it is the miniscule proportion of household wealth that is invested in stocks! Of the total US$ 6 trillion of household wealth in India, only 2.2% is invested in equities at this point. The penetration of retail investors is also very low. As per an article in Mint, even if the investment were to rise by 1% to 3.2%, it will amount to an addition of US$ 60 bn in equities! And with that the Indian markets will be very resilient to whether or not the FIIs stay in India. In fact buoyed by hopes of better earnings and higher growth in Indian companies, the investments of domestic institutional investors (read mutual funds and insurance companies) has reached a record high. And even now there is a lot more domestic investor money expected to come in. So as an investor all you need to worry about is investing in the most companies at the right valuations.

Domestic Institutional Investments at peak

In what will be music to the ears of DIIs and other investors alike, India's growth looks set to pick up pace. And this optimistic view comes from none other than RBI governor Raghuram Rajan. Why the sudden optimism? A bunch of factors actually. For one, Rajan has mentioned that he does see some signs of capital investments picking up. Recently out data seemingly backs that observation too. A business daily highlights in their report data suggesting that new investment announcements during the June quarter rose 33% YoY to Rs 1.15 trillion. Not a bad number at all. Further, he also sees the government trying to address the problem of putting many stalled projects back on track. Another big positive for growth is that the month of June has seen rainfall much better than expected. What about the Greece turmoil? The governor opined that India's direct exposure to the country is very limited.

All these factors do make one optimistic about these early shoots of recovery. Nevertheless, it does not take away from the fact that a lot more needs to fall into place in the coming months for these factors to actually translate into higher growth.

In what would seem to further back Rajan's observations about the economy recovering, expat hiring across the country seems to be on an upswing. A report in Firstpost suggests that the quantum of expats being hired is going up to 35,000 so far this year, and this may further increase by 10% to 15% each year with a revival in the economy.

Post the 2008 bust, Indian corporates' appetite for hiring high cost expat employees had declined significantly. But the last year has seen this scenario change. Rapid growth in e-commerce seems to be one factor stimulating this change. Activity in traditional sectors like manufacturing, automobiles, pharma, transportation, urban infrastructure etc also seems to picking up as they too seem to be back in the lookout for the niche skills that expats bring to the table. While hiring appetite for expensive expat talent may be an indicator that companies are busy drawing up expansion plans once again, over the longer term it is important that the country fill these gaps in talent that exist in the workforce currently.

The Indian stock markets started the day on a buoyant note and remained in the green throughout the trading session. At the time of writing, the BSE-Sensex was trading higher by 107 points (+0.3%). The sectoral indices that led the gains were pharma and consumer durables.

 Today's investing mantra
"An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Vivek Kaul (Research Analyst) and Tanushree Banerjee (Research Analyst).

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6 Responses to "The real estate Ponzi scheme has started to unravel"

Satish Dabholkar

Jul 4, 2015

You should give wide publicity to your articles in all leading newspapers.This will help the people to take correct decision.
Similarly we should prevent the method tried by builders to raise funds through other countries by giving publicity of their projects to NRI.The Builders know that artificially raised prices can be supported only by NRI investors.The NRI should be band from purchasing flats as this raise the prices of flats and works against local residents.
Similarly the Government is also indirectly helping Builders by allowing to Real Estate Mutual Fund.The Indian investors should stay away from such funds and take the benefits of collapsed Housing Industry due to High inflated flat rates.

Like (79)


Jul 4, 2015

thank u for such a wonderful & informative article.what about investing in real estate investment trusts?will it helps us in any way?pls enlighten us?

Like (79)


Jul 3, 2015

Good analysis by Vivek Kaul. I remember his article in 2014 in the matter. All assets-Shares, Gold, Real estate, Commodities go thro cyclical ups and downs and stagnation. Nothing is one-way street.

Like (28)

Rishi Poddar

Jul 3, 2015

Despite high inventory levels and stagnating sales in RE, high debts and falling revenues of leading RE companies and rock bottom share prices, it is surprising that RE intermediary e-commerce companies like, and others are getting huge valuations and funding by PE players. What is the reason for this?

Like (28)

Vipul Jasani

Jul 3, 2015

Yes. I am also of the opinion that real estate companies are running on Ponzi scheme.
From where new investors come?? Those are new investors who generate black money on regular basis and they invest their black money in real estate making housing unaffordable for needy people.

If Gov't. Is really serious then they should attack on 2 fronts.

1. Stop generating black money by drastic change in tax structure.

2. Plug the holes where black money goes for investment.


Like (1)

chetan joshi

Jul 3, 2015


Like (7)
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