|»5 Minute Wrap Up by Equitymaster|
On This Day - 3 JULY 2015
The real estate Ponzi scheme has started to unravel
In this issue:
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...
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.
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.
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.
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