The RBI cannot revive Indian real estate

Jan 19, 2015

- By Vivek Kaul

Vivek Kaul
Raghuram Rajan took over as the governor of the Reserve Bank of India (RBI) in September 2013. Since then, real estate companies and associations that represent these companies have been asking (i.e. putting it politely) for a repo rate cut. The repo rate is the interest rate at which RBI lends to banks and acts as a benchmark for the interest rate at which banks borrow money and in turn, the interest rate at which they lend.

Every time Rajan did not cut the repo rate, real estate companies and associations representing them, put out statements in the media saying how high interest rates were hurting the sector and were the main reason why people were not buying homes that were being built.

Hence, when the
RBI decided to cut the repo rate last week, the real estate companies had a reason to rejoice. Take a look at this statement made by Rohit Raj Modi, President of the Confederation of Real Estate Developers' Associations of India (CREDAI) in the National Capital Region: "We have been raising the concerns of developers over higher rates from the government. We are happy that RBI has taken a step by cutting the rates. We expect that this will encourage banks to ease their home loan rates...This will help developers to expedite their projects which were otherwise facing fund crunch. Home buyers' dreams of owning a home would also get a boost as we expect an accelerated purchase cycle(The emphasis is mine)."

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The most important part of the statement is the last sentence which I have italicized. Modi, who represents the real estate developers in and around Delhi feels that a 25 basis cut in the repo rate by the RBI will lead to more people buying homes.

This is a sentiment echoed by Rajiv Talwar, DLF group executive director. As Talwar told the PTI: "The move would definitely encourage buyers now to invest in new homes." [interestingly, Talwar uses the word invest and not buy].

City Weighted Average Price of a Flat Per Capita Income Years Inventory
Mumbai Metropolitan Region Rs 1.34 crore Rs 1.97 lakh 68 years 50 months
National Capital Region Rs 75 lakh Rs 2.31 lakh 32.5 years 83 months
Bangalore Rs 88 lakh Rs 1.08 lakh 81.5 years 41 months
Pune Rs 58 lakh Rs 1.83 lakh 31.7 years 23 months
Hyderabad Rs 75 lakh Rs 1.46 lakh 51.4 years 38 months

I wonder where this confidence comes from. The real estate story has gone beyond interest rates and EMIs for a while now. People are not buying real estate simply because it is too expensive. It has been priced way beyond what they can afford.

Take a look at the following table. The weighted average price of a flat in Mumbai is Rs 1.34 crore. The average per capita income of a Mumbaikar is Rs 1.97 lakh. This means that it takes 68 years of average per capita income to buy a flat in the Mumbai Metropolitan Region. For Bangalore, the number is at 81.5 years. This is a little difficult to believe. The average income of Bangalore is Rs 1.08 lakh. The number is very low in comparison to the average income of other cities considered in the table. The reason for it is that I have used the per capita income of Bangalore division (which is what I could find in the Karnataka Economic Survey of 2013-2014) and Bangalore division includes not just Bangalore but also other places like Kolar, Shimoga, Tumkur etc., where per capita incomes are lower than that in Bangalore and hence, drag down the overall number.

What this table clearly tells us is that Indians are not buying homes to live in primarily because homes are priced way beyond what is affordable. This becomes clear at the massive inventory numbers being reported (as can be seen from the table). "Months inventory denotes the months required to clear the stock at the existing absorption pace. A healthy market maintains 8 months of inventory," points out Liases Foras, a real estate rating and research firm in a report.

The following table shows very clearly that the months inventory across major cities is way over the healthy level of eight months and high price is the only possible explanation for it.

City Inventory Number of times healthy inventory of 8 months
Mumbai Metropolitan Region 50 months 6.25
National Capital Region 83 months 10.375
Bangalore 41 months 5.125
Pune 23 months 2.875
Hyderabad 38 months 4.75

One criticism of this piece of analysis which I can immediately see coming is that the average income of a city hides all kinds of variations. So, for a city like Mumbai it would also take into account the incomes of people who live in slums. And these people should not be considered because they cannot afford the flats being built. The point is that no one stays in a slum by choice. People stay in a slum because they cannot afford proper housing.

Another point that I would like to make here is that when such analysis is carried out in developed countries they consider the ratio of weighted average price of a home and disposable income. I had to make do with average income primarily because I could not find any disposable income data for Indian cities (I would be grateful to anyone who could lead me to such data, if it exists).

Nevertheless we can make an assumption that around 40% of income is disposable income (I guess that is on the higher side, but let's just go with it and see how the numbers work out. Also, I am leaving Bangalore out of the calculation for reasons already explained). The following table shows how crazy the situation actually is.

City Weighted Average Price of a Flat Per Capita Income Disposable Income Years
Mumbai Metropolitan Region Rs 1.34 crore Rs 1.97 lakh Rs 78,800 170
National Capital Region Rs 75 lakh Rs 2.31 lakh Rs 92,400 81.2
Pune Rs 58 lakh Rs 1.83 lakh Rs 73,200 79.2
Hyderabad Rs 75 lakh Rs 1.46 lakh Rs 58,400 128.4

Assuming that disposable income is 40% of average income it would take 170 years of disposable income to buy a flat in Mumbai. Hyderabad comes in second at 128.4 years. In fact, in a recent article in the Business Standard columnist Bhupesh Bhandari made a similar point when he wrote: "According to one study, it will take an Indian with the average per capita income 580 years to buy a top-end property in Mumbai, compared to 65 years in Hong Kong, 62 years in Paris and 47 years in New York."

So, the real estate companies and media reports may keep blaming high interest rates for people not buying homes, but that isn't really the case. Edelweiss Capital expects the RBI to cut the repo rate by further 100-125 basis points by March 2016. I can say this with confidence that unless real estate prices fall, even with such a massive cut in the repo rate (which is likely to lead to lower home loan rates) home sales won't pick up. I can also say with confidence that the real estate companies will continue blaming the RBI. But RBI clearly does not have a solution to this problem.

Comments on this edition of The Daily Reckoning: Post a comment | Read comments

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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21 Responses to "The RBI cannot revive Indian real estate"


Jan 20, 2015

Completely agree with you Vivek. Another point to be considered is the EMI amount getting reduced because of this rate cut.. A 25 base point cut means reduction of Rs 17 per lac in the loan amount (for 20 years tenure).. For a 50 lac loan, me reduced by Rs 850 a month..

I am sure that if the developers consider this as substantial, they definitely need to relook at their strategy.. this amount hardly changes anything..

Like (2)

Satish Dabholkar

Jan 20, 2015

Firstly it should be accepted by all of us is that a house should be considered as necessity and not to be look as investment item.The investor in housing sector should be eliminated by withdrawing concession given in Income tax act to the persons who are having one flat and wish to purchase 2nd flat as investment.When only genuine buyers exist,buyers will get the flats at reduced rate as per demand supply mechanism.

Like (1)


Jan 20, 2015

I think the problem must be viewed from a different lens. We must first filter down to the population that can buy homes being peddled by builders. I think anybody with an annual income of less than 5 Lacs should fall out of the sample because it is difficult for people earning lesser to have a surplus, so it is unlikely these individuals will buy flats.
Next, stratify the inventory on offer and exclude outliers that are designed for the super rich and non-residents. Similarly, remove those individuals that already paying emis for existing homes. Now you will have an inventory of houses and potential home owners with both the aspiration and the ability to buy.
Now, to find out whether Governor Rajan's rate cut will have an impact, the two questions need to be answered are- 1. 'what is the size of the 'willing and able' segment?' and, 2.'how large a proportion of this segment of 'willing and able' people is priced out of the market because of interest rates?'
That said, you are probably right about property prices. They are artificially high. The reason for that likely has more to do with inefficient market structure rather than demand and supply. If inventories are high, prices ought to come down; if they do not, society is not punishing inefficient allocators of capital (that BTW is the real problem in this industry); the incumbents have tremendous staying power. if you want real estate to function as any other market, builders should not be able to survive bad decision making.

Like (4)

V N Rao

Jan 19, 2015

Excellent analysis.Another important aspect of real estate industry is that during the last few years there is a large demand-supply mismatch especially in big cities and Pune. There is no supply of one bed room flats now for which there is a huge effective demand. As a result first time buyers are kept outside the market. Increasingly the developers are catering to luxury segment which is the reason for the huge inventory pile up.We need a housing policy which dis-incentivises supply of high proportion of unaffordable flats.

Like (1)


Jan 19, 2015

What Mr.Vivek suggests about the stamp duty collected by State governments and the double pricing which is invariably in vogue in all real estate dealings.Each state has its registration charges and stamp duties .

Like (1)

kumbesh E

Jan 19, 2015

For people to buy a property enough disposable income has to be there. For that to happen a persons salary needs to grow year over year beating inflation (which would never happen). Even if RBI cuts rates further the situation may not change.

Little curious to know how come builders are able to keep the inventory for so long? For this to happen either they need to have so much amount of money as capital or reserve. Never seen a case where there is a distress sale nor reduction of price by a huge margin, though inventory levels are high.

If the price points are reduced the inventory level could reduce. For that to happen the cost of acquisition of land could be controlled for betterment of society (assuming the end price would be less because the cost of land acquisition would be less)

Like (1)


Jan 19, 2015

Real estate industry is in soup primarily for two reasons- large scale diversion of funds from projects towards buying of land for new projects and excessive leverage. Prices would have come down steeply by now, but for the fact that parallel economy is feeding money to real estate In India.

Like (2)

AB Pereira

Jan 19, 2015

Fully agree with you. In fact, without even having these numbers in hand, I have been highlighting (in my personal/professional circles) the messy situation for the Indian housing sector.

One more key factor you need to consider is the existing number of housing units and therefore, the residue demand. Remember, many of these 'affordable' income earners already possess a house (either ancestral or owned in the last several years) and in case of most big cities, both husband and wife earn, and obviously have at least one dwelling unit. So, if you were to eliminate these, the problem (of excess inventory vs fresh demand) will get worsened. Unless significant new fresh employment is generated, and unless existing incomes of people increase, this problem is going to get worse.
While an interest rate cut affects the banks (except for fixed interest mortgages booked at higher rates) as they will get lesser income on existing loans, it benefits only the existing borrowers.

As we are seeing the meltdown in China's RE sector (through extensive corruption - a factor much similar to India's, but consciously hidden by the vested/connected politicians!), we are in for some real hard days ahead.

After all, the 2007-08 global recession was started by the mortgages (housing/RE) sector only!

Like (2)

Pankaj K Chaudhary

Jan 19, 2015

Very Apt. I have been reading Vivek's article on the equity master since the time it is on board. I must admit he writes with his feet on ground. Great piece. I don't when will builder/financer cartel break and price will come to normal/affordable level. At least the way things not are, its not happening in my life time though. These kind of real estate prices also keep we indians thinking that money can only be made in physical asset not in other class.

Like (2)


Jan 19, 2015

Well said sir, there is no way for real estate sector except to book loss and sell the inventory at discounted prices. I request the learned author to examine the hair cut the lenders more particularly PSU Banks have to take if the high flying real estate companies opt for CDR packages

Most of the pensioners are drawing more than the amounts they used to draw while they were in service
in Government it is high time govt reads the danger signals other wise it may implode. May be the real estate promoters may like to tap the pensioners segment to get rid of the inventory

Like (1)
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