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Will the RBI Rate Cut Bolster the Real Estate Sector?

Oct 7, 2015

In this issue:
» Insurance companies are powering NBFCs
» India needs to invest more in cleaner technologies
» ...and more!

As inflation in India began to ease off, the pressure on RBI to cut interest rates cranked up a notch. The RBI governor finally obliged, albeit reluctantly, and cut rates by 0.5% in its latest Monetary Policy on September 29. Sure enough, the markets reacted positively that day, and one of the biggest sectoral gainers was real estate.

Why is that?

The assumption is that, with the cut in interest rates, banks will reduce rates on home loans. And so the demand for houses will increase. Markets perceive this development as excellent news for a sector that has been down in the dumps for the past many quarters.

Is this perception justified?

Let us go back a bit and understand why the real estate sector has not been doing that great in recent times. Builders and real estate companies have been harping that high interest rates are dissuading the average Indian from buying homes.

But there is a much deeper rooted problem here. House prices in India are way too high. So high that even though there is latent demand for homes and there are enough first time buyers, the exorbitant prices have kept them on the sidelines.

In other words, house prices are way beyond what the average Indian can afford. So inventories have piled up. Meanwhile, banks have been wary of lending to the sector as they have their own asset quality issues to deal with. So the funding from this area has begun to dry up.

The real estate sector continues to be bogged by lack of transparency issues. This means that economic laws of demand and supply don't really work for this sector. So even if the demand for homes has waned, prices have not fallen at the same pace. In fact, there is this view that home prices will never fall.

But Vivek Kaul, the India editor of The Daily Reckoning, busts this myth. In one of his pieces on real estate, he has very aptly stated that unless real estate prices fall, even with such a massive cut in rates (which is likely to lead to lower home loan rates), home sales won't pick up.

Now an article in the Economic Times has talked about how some of the leading banks have cut home loan rates. And this is just the booster dose that real estate companies needed. They seem to be brimming with confidence that demand for homes will take off and improve the fortunes of the sector.

We are taking this news with a pinch of salt. We agree with Vivek that demand for houses will not pick up unless there is a significant fall in prices. Thus, we believe investing in stocks of real estate companies solely based on the fact that the RBI has cut rates is fraught with risks.

What more, if you are someone who is looking to buy real estate, or is just interested in the space, I recommend you read Vivek's detailed views in his just published report "The (In)Complete Guide To Real Estate". To claim your copy of this Free Report, please click here...

Do you think that RBI's rate cut will lead to a rise in demand for houses? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
The non-banking financial companies (NBFCs) have in the past derived a majority share of funds for operations from banks. But in FY15, there has been a 45% fall in investments by banks. This fall has come amidst banks themselves struggling with slowdown in credit demand as well as rising bad loans particularly in case of public sector banks.

But a sharp 82% jump in investment by insurance companies in FY15 has somewhat offset the overall reduction. Resultantly, insurance companies with a 40 % share in overall investments have now displaced banks as the major source of funding for NBFCs. Even asset management companies invested 33% more in NBFCs in FY15 as compared to the preceding year.

Insurance companies powering NBFCs

India has embarked on a journey to kick-start its economic growth engine. Therefore its power requirements are set to increase many folds. As 61% of the country's power plants still run on coal, the demand for the black gold is set to grow exponentially. The country has been opening up a mine a month in its pursuit to double coal output by 2020.

On the flip side, the huge clamour to burn more of the fossil fuel is expected to push India as the most polluting country among Asian nations. As per World Coal Association, China, India and Indonesia burn 71% of the world's newly mined coal. In comparison, coal consumption of developed economies such as Europe and North America is negligible as they have shifted to cleaner energy alternatives.

But India remains steadfast in its decision to increase coal production stating that its per capita emissions are far below the world average. However, as per Centre of International Climate and Environment Research, India may replace United States as the world's second largest emitter by 2025 as extra emissions from its coal drive will offset savings from solar and wind power. Therefore as India moves ahead to secure its energy requirements, it needs to also invest more in cleaner technologies to reduce its carbon footprint and achieve responsible growth. Currently green energy sources such as nuclear, hydro and renewable energy account for 31% of India's overall power generation.

Indian stock markets had a rather volatile trading session today as buying activity in the morning session was followed by bouts of profit booking in the subsequent hours. At the time of writing, the BSE-Sensex was trading up by around 57 points. Gains were largely seen in metals and auto stocks, while IT and pharma stocks were at the receiving end.

 Today's investing mantra
"We enjoy the process far more than the proceeds." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Radhika Pandit (Research Analyst) and Madhu Gupta (Research Analyst).

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1 Responses to "Will the RBI Rate Cut Bolster the Real Estate Sector?"

Vipul Jasani

Oct 7, 2015


Interest rate was never criteria of buying home!!! You need to understand how real estate market operates.

Most of the flats (50-80%)are getting sold before start of project to "Investors". May be 5-10% gets sold to actual users.

If that is the case then why sector needs cut in interest rates??

Answer is simple - The investors who invested in project needs to get out of the project with profit so that they can reinvest the amount in new project.
In order to sell with profit, they need either another investor or actual user. If it is another investor then interest rate makes no difference but if it is actual user then interest rate make difference.

Today the situation is that in addition to empty flats (with builders) equal amount of flats are with investors whose money got stuck as they are not able to sell at high price.
Now the price have reached to so high level that even further cut in interest rate by 100 basis point, will not generate any demand!!!

I read in newspaper that direct tax collection fall short of target. One of the major contributor to this short fall is tax exemption given to investors of real estate.


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