How dangerous is it to invest in this asset? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

How dangerous is it to invest in this asset? 

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In this issue:
» Inflation makes govt.'s debt look better
» High oil prices to ensure deregulation of diesel?
» ECB looking to hike interest rates
» US dollar needs to be devalued
» ...and more!

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The property market has always caught the fancy of not just genuine buyers, but also individual investors, financial institutions and banks. But just how safe is property? Quite dangerous if one goes by the evidence. For starters, the current financial crisis had its seeds sown in the collapse of the housing market in the US. What is more, as pointed out by the Economist the five big banking fiascos in the rich world before this latest crisis (Spain in the 1970s, Norway in the 1980s and Sweden, Finland and Japan in the 1990s) had property at their heart.

Further, the size of the asset class is massive. For instance, the current values of just residential property, even after the bust, would be around 126% of the rich countries' combined GDP in 2010. Because of its sheer size, the moment credit policies loosen, money just flows into this asset to a point where prices reach unjustifiable levels and set the backdrop for a large plunge.

Property is also risky because of the leverage that this sector involves. For companies, this means borrowing heavily for setting up various projects. Which becomes a huge concern during adverse conditions. The same is the case for individuals as well. Many buyers take on loans worth 90% or more of the value of the property. Thus, during times of crisis, selling the whole house becomes the only option to bring this debt down.

The big problem really is the speculative tendencies that investors have with respect to this asset. Ideally, simple economics should play out in that higher prices will automatically dampen demand which will compel companies to lower prices. But property (let's say residential houses in this case) is not just bought because a buyer genuinely requires a home. Many a time it is purchased as an investible asset. And in countries like India, nexus of builders with politicians, murky disclosure norms and red tape only heightens the riskiness of this asset. Little wonder then that from a purely investment perspective, property market is fraught with considerable risks.

Do you think that property is a risky bet from an investment perspective? Share with us or post your comments on our Facebook page.

01:27  Chart of the day
Today's chart of the day shows that India's imports tend to have a higher YoY growth rate than exports. Part of the jump in imports could be attributed to the increase in oil imports as India imports a significant chunk of oil that it consumes. In the years that the country has a had a surplus on its current account has largely been a result of remittances. Although exports growth is expected to take over that of imports in FY11, the country will still end up having a trade deficit of US$ 104.8 bn this fiscal.

Data Source: CMIE

Call it one of the very few benign side effects of inflation. But leveraged entities do make the most of it. They use high inflation to project lower value of debt on their books. But this time even the Indian government is doing this. The attempt to make the government's ballooning debt to GDP ratio look better than its developed peers relies on inflated GDP numbers. The country's total debt to GDP ratio stood at 70% in FY10. The Finance Commission aimed to bring that down to 54% by FY11. A recast of public debt figures and an inflated denominator will certainly make the ratio smaller. But at the same time camouflage a grave risk. That of higher interest payouts on the lower debt value due to rising interest rates. Thus the risk of high debt cannot be sidelined, be it for companies or governments. One way or the other it tends to eat into productive use of surpluses and puts balance sheets at risk.

As crude prices continue to boil due to political unrest in the Middle East, the next round of fuel price hike could be any time soon. The government has already freed petrol prices and can escape the blame of price hike. Hence, the key thing to the watch out will be what it does with prices of diesel that is incurring losses to the tune of Rs 12 a litre and weighs the most in the energy basket. It is already a tough decision. What makes it worse is the timing as state elections are coming close and diesel prices remain a political hot potato.

The Government dashed hopes of public OMCs by keeping the duties same in the budget and offering a subsidy not enough to cover even one fourth of the losses. However, as crude prices remain high, ignoring concerns of public OMCs is not going to be easy.

A herd of buffaloes can only move as fast as the slowest animal. But, when the herd is hunted by lions, the slow and the weak get killed off first. This situation could not be truer of the European Union's current situation. ECB President, Jean-Claude Trichet made strong hints recently that the bank would raise interest rates during its April meeting. Germany has been growing, and is facing an inflation threat due to rising crude and food prices. Hence, raising rates would help quell inflation in the economy. However for peripheral countries like Ireland, Greece, Italy and Portugal, raising interest rates could be suicidal.

World renowned economist, Nouriel Roubini believes that by following a tight monetary policy, the ECB risks widening the gap between the strong and weak economies. The US is still following a loose policy. If the ECB raises rates too soon it may stall a recovery process in the weak countries that has barely even started. The Fed is concerned about 'core inflation' which does not include volatile components such as food and energy. The European Central Bank on the other hand is more worried about 'headline inflation' which is not adjusted for seasonality or volatile components. Either way, a 'herd mentality' solution may not be the best bet for the Euro Zone. Else the law of nature will prevail, and the weak economies will be sacrificed when more threats surface.

What would it take to set right the global trade economy? Author and trade expert, Clyde Prestowitz has something to say on this. Let us first explain his perspective before we hear out his solution.

A majority of the world's economies are attempting to grow and create jobs by exporting primarily to the United States. And despite the recent economic crisis, high unemployment and a fragile recovery, the US still continues to buy from them. It is this fundamental imbalance that is really plaguing the US economy. But can the US continue to do so considering its deficits, the level of indebtedness and the high unemployment? Not really.

Here is his solution to this problem. The US must solve its budget deficits. Household savings rates should double from the present rate. Massive investment should be made in US infrastructure and a renewed manufacturing base should be created. The US dollar should be devalued by 40-50% against the Chinese yuan. And finally, the greenback should seize to be the global reserve currency. While we may not agree with all the solutions, what is a given is that the US needs to repair its domestic state of affairs first before helping others.

In the meanwhile, Indian stock markets are trading strong led by a heavy buying in technology stocks. The benchmark, BSE Sensex was trading 185 points higher at the time of writing this. All stock market indices were trading in the green. Asian stock markets are trading strong led by Hong Kong and Japan; whereas the European stock markets are trading mixed with Germany trading lower.

04:56  Today's investing mantra
"We enjoy the process far more than the proceeds." - Warren Buffett
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24 Responses to "How dangerous is it to invest in this asset?"


Mar 10, 2011

clearly all black money is flowing towards real asset.
How many percentage of people can afford to buy asset of 25 lacs (a minimum price at this time) and more !? India is most likely to face SUB PRIME crisis, and people, more particularly salarised and middle class people will cry with blood tears. And that day is not much away.



Mar 10, 2011

The real Estate sector has continued to remain unregulated to accomodate the less than honest dealings of the developers and investors who have a vested interest in maintaining the current state of this sector.
The concept of selling SUPER AREA is indeed one of the devices used by the developers to keep the buyer guessing as to what really is being sold to them. A simple regulation asking the developer to specify the break up of CARPET AREA v/s THE SUPER AREA CAN AND WILL LEAD TO CLEARING SOME OF THE GREY AREAS IN THE REAL ESTATE SECTOR.
THE REGULATOR can very easily identify what ails the industry and set it right. THE GOVERNMENT MUST MUSTER UP A WILL TO REGULATE THE SECTOR and mitigate the pain of an average citizen looking for a roof over his/ her head.



Mar 9, 2011

A typical profile of an Indian would represent a major proportion of their net worth in terms of property. We do not have any independent analysis or study of the property market in our country, unlike the rest of the world where they have recognised the importance of this index and have committed adequate resources in terms of technical and human resources. As long as we do not have an independent body that guides the prices and establishes strict norms and lays down mandatory ethical practices that must be followed through an autonomus body like SEBI for shares & scripts we are heading towards a huge bottomless pit for real estate investment. Evry agent selling a product is registered with some authority, property brokers are not registered with any authority so thay can take a buyer to the cleaners, which they often do.Why is this state of free for all allowed to prevail ? Is it only because this sector receives a large sum of the black money of our country, be it freom politicians or public servants.
Jaago India Jaago.


Khanna Prakash

Mar 8, 2011

Similar to a recent action by China Indian anthority should make a rule that citizen have a right to first home and would pay penalty (say 50%) for second home and further stringent penalty (say 100%) for third home and so on. Prevent hoarding of homes and forcing poors to the uncomfortable compromises and last ones to sleep on road, envy others and resort to crimes.
Similar rules may be appropriatly be considered for life's essentials like Food and Education in order to have easy availability of basic Civilization needs of human being to the people at lower level (financially).


zephyrine goveas

Mar 8, 2011

During the financial crisis of 2008 it was expected that the property bubble will burst in India also. But nothing of that sort happened although prices must have remained depressed for a while. There are any number of people investing in multiple flats and renting out the property. The prices keep on increasing. If one sees around Pune, there is hectic construction activity and every property looks like is being sold. Even the newly developing areas if the prices were around 2000 sq. ft. a year ago, the same have gone upto 3000 sq. ft. now. The buyers don't look like they are doing for their own stay but are investing. In a colony where I reside at least 60% of the flats are rented out. I don't know whether it is right for people to invest in second or third homes just because they have money. This kind of investments makes the property beyond the reach of genuine and middle/lower class buyer and they end up going farther away from the city in search of affordable house



Mar 8, 2011

It would be a good idea to revisit the rating system - I think one was started - for builders and projects. That could help minimize the risk?



Mar 8, 2011

We have not reached that saturation stage yet as our population is more of young generation & all are dreaming of good living.
This asset class can not & will not become risky for at least 20-25 more yrs.
I remember a real story of my friend who lives in U.S. who joined a U.S oil company in 1981 when oil was hovering $30 at that time it was highest & then crashed to $16 in 2-3 yrs.I found him changing house every yr & I happened to meet him at Houston &I enquired why he was doing that.Then he explained that all our Indian friends were doing the same.On every weakend all of them got together with families & discuss & visit new housing projects coming up.1yr old house was getting appreciated meanwhile & so they were selling old house & shifting to new one every yr almost thereby pocketing hansome difference.Loan was never a problem there.It went on up to 20-25 yrs.Meanwhile their children got higher education & started earning & they also stated doing the same thing.Loans were even more easily available.But then we saw that property bubble bust crisis.They lost jobs & had to surrender houses as they were not able to pay loan.They invested in India & were handomely rewarded.As long as we have shortage of housing in urban area we wont have this asset class become risky but as we grow dependency on this class of investment will become risky in future.


Nagesh Kini

Mar 8, 2011

An extremely timely warning. The property bubble, what some consider buying real estate an appreciating investment that will always go up needed to be demystified. people need to wake up to reality.



Mar 8, 2011

One hundred percent correct views and comments.


Aniruddha Deshmukh

Mar 8, 2011

our comments on real estate sector are true in case of developed world with negative population growth rate but look out of place in India with its massive and rapid urbanization . Moreover the historically low income levels and high interest rates kept people highly repressed even after buying a house - so the journey from say a 1 BHK costing 40 Lacs for a new couple to 3 BHK costing 90 lacs for a whole family adds to the problem. Eventually people learn to speculate on their obsession and get what they want eventually. Also notice that the property slumps are lately rather small and disappear in less than 6 months.

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