Busting a few more real estate myths

Jan 21, 2015

- By Vivek Kaul

Vivek Kaul
The last column on real estate which appeared on January 19, 2015, stuck a chord with a lot of readers. Given that, I thought it made sense to dwell a little more on this topic and the "spin" that real estate wallahs try to give it.

One logic that I have heard being given over and over again is that India has too little land and too many people. Given this, real estate prices can never fall. They will only keep going up ad infinitum and hence, you need to invest in real estate and earn a perpetual return. This is the most widely used logic to justify high real estate prices in the country. But a little bit of number crunching basically tells us that there is nothing right about this theory.

Let's look at India has "too many people" theory first. As per the 2011 census, India has an average of 382 people living per square kilometre. When it comes to density of population India is ranked 33rd in the world. Let's compare this with Japan. The country has 336 people living per square kilometre and is ranked 39th in the world.

Japan had a huge real estate boom in the 1980s. The boom came to an end towards the end of the 1980s and prices fell big time after that. As George Akerlof and Robert Shiller point out in Animal Spirits: "Urban land prices...in Japan (where land is every bit as scarce as it is in other countries)...fell 68% in real terms in major Japanese cities from 1991 to 2006." And if real estate prices could fall in Japan, which has a slightly lower population density than that of India, they can in India as well.

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Even in India real estate prices have fallen in the past. It's just that people don't rememember about it anymore. As Manish Bhandari of Vallum Capital wrorte in a report titled The End game of speculation in Indian Real Estate has begun: "The previous deleveraging cycle in year 1997-2003 witnessed price correction by more than 50% in Mumbai Metro Region (MMR) property." And this was just a little over a decade back. Bull markets lead to bad memories and theories justifying high prices.

In fact, real estate prices have been falling in some parts of the country. A December 2014 newsreport in The Economic Times suggested that "secondary market prices of properties in posh South Delhi localities have fallen 25-30 per cent over the last one year as a pileup of inventory and need for money turn many investors into desperate sellers." "Compared with peak prices, the discount is as much as 40 per cent, say brokers," the report added.

Another important point here is that the consumer sentiment seems to be turning against real estate. Recently a buyer sentiment survey was carried out by IIM Bangalore and Magicbricks. A report on the survey in The Economic Times said that: "[The survey] orecasts that the homebuyers expect real estate prices to drop over the next six months. In fact, the aggregate Housing Sentiment Index (HSI), measured across the 10 cities, dropped sharply by 29% in the 3rd quarter of 2014-15 to 81. (An HSI score of 100 suggests the prices would remain static)."

Now compare this with another survey that the business lobby ASSOCHAM had got done in June 2013, which said: "Over 85 per cent of urban working class prefer to invest in real estate saying it is likely to fetch them guaranteed and higher returns." So, the sentiment clearly seems to be changing. And there is no greater danger to the price of an asset class than changing sentiment of those who want to invest in it.

The second theory offered is that India has very little land to house its huge population. Again a little number crunching tells us that this is not correct. The Indian Institute for Human Settlements in a report titled Urban India 2011 esimates that "the top 10 cities are estimated to produce about 15% of the GDP, with 8% of the population and just 0.1% of the land area."

Economist Ajay Shah in a May 2013 column in The Economic Times did some number crunching to show that India has enough land to house its millions. As he wrote "A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India's land area assuming an FSI(floor space index) of 1. There is absolutely no shortage of land to house the great Indian population."

One corollary of this theory is that as cities expand they will take away land from agriculture and that will create a problem as well. Again this is a specious argument. Data from World Bank shows that around 60.3% of India's land area is agricultural land. The bank defines agricultural land as "share of land area that is arable, under permanent crops, and under permanent pastures."

In fact, only the United States has more agriculural land than India. As India Brand Equity Foundation, a trust established by the Ministry of Commerce and Industry points out: "At 157.35 million hectares, India holds the second largest agricultural land globally." Only, the United States has more agricultural land than India. Take the case of China. India has more arable land than China. This, despite the fact its total area is only a little over 34% that of China.

Hence, agricultural land near the cities can easily be diverted towards construction of more housing without it having any signficant impact on agricultural production.

The basic problem lies in the fact that too much black money has gone into real estate, and has driven up prices (as I wrote in the last column) to previously unimaginable levels. This has led to builders and politicians who back these builders to sit on a huge amount of unsold inventory instead of cutting prices to clear it. They have got used to these high prices. Also, so much money has already been made that sitting on inventory till prices start to recover, doesn't seem like a bad idea at all to them.

As an article in The Caravan magazine pointed out few years back: "There isn't a bubble of real homes...If all these apartments were actually built, and built fairly to schedule, I guarantee you that they would find real buyers. The demand is out there. But there is a huge bubble in imaginary homes."

And this is because the ill-gotten wealth of politicians and their cronies has found its way into the sector through "benami" means over the years. However, there continues to be demand for reasonably priced property even in big cities. Only if there was someone trying to fulfill this unmet consumer demand.

To conclude, it is worth sharing this example that Ruchir Sharma talks about in his book Breakout Nations: "Lately Indian businessmen have been regaling one another with accounts of a leading politician from Mumbai who is known to have amassed a huge wealth through property deals. At a private screening of a new Bollywood movie, this politician asked the producer to replay a particular song-and-dance number, over and over. When the producer asked if he was taken with the leading lady, the politician said no, he was eyeing the location and wondering where the producer had found such an attractive stretch of open space in Mumbai."

And this is where the real problem lies.

Are real estate prices falling in your city? Post your comments or share your views in the Equitymaster Club.

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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20 Responses to "Busting a few more real estate myths"

N Jayakumar

Jan 22, 2015

I think real estate prices in India won't crash. We can not compare Japan, just because in Japan population growth was near zero for several years, but in India population has always grown and is growing. Moreover with the rising disposable income of Indians, people like to live in larger homes and people think that real estate investment is real investment.

Like (4)

N Jayakumar

Jan 22, 2015

I think real estate prices wont crash in India especially smaller cities where the investment and speculation are low, as people are not willing to reduce the prices. But it may stay stable for a longer period (i.e. time correction) which is also technically correction.

Like (5)

Krishna

Jan 22, 2015

How and where can we get historical real estate data of any city in India?

Like (5)

V N Rao

Jan 21, 2015

While it is true that during 1999 and 2002 real estate prices crashed in Mumbai, its neighborhood and Pune, the prices have certainly gained over a 10 years horizon on an average compounded rate of more than 20@ pa. Secondly it is next to impossible to find out exact rates at which the properties are bought or sold due to varying proportion of undisclosed cash elements which are never disclosed by the builders or in secondary market.Though In Maharashtra we have government mandated ready reckoner property rates for each areas in cities, there is still 10 to 20@ cash element involved. The builders have always ingenious ways of hiding the real cost, such as through amenities charges. With all such shady dealings, no analysis of property market can reflect real state of affairs. I wish your article would have also covered about several hundreds of thousands of locked up flats all over the cities and their economic impact.Nevertheless I shall appreciate your in depth and no holds barred coverage of real estate industry because usually what we we read in news papers is the news placed by the builders' lobby itself.

Like (4)

KBSMani

Jan 21, 2015

Thanks for the Details. GodBless You.

Like (4)

G. Swaminathan

Jan 21, 2015

On the real estate subject, Mr. Vivek has pointed out that in Japan real estate prices have crashed and this can happen in India. But Mr. Vivek's inference is based only on denisty of population which i feel is a narrow view point. There are many other factors which influence the real estate market in India. Indian has huge middle class popualtion which do not won a house and their main objective is to own a house. This single factor alone could keep the property prices up. Ofcourse, it also depends on the purchasing power as well. One buys projects as to what suits them. Last week, i had wanted to book a property in Mulund, Mumbai in the project launched by Oberoi. I could not get an allotment of the liking i had wanted. 200 flats got sold in just 2 days. While on the other hand Mumbai has 34 to 37 months of inventory. There is always a good demand for projects of good builders if the pricing is correct.

Like (4)

Arun Galgali

Jan 21, 2015

The article is thought provoking & informative. Hope the figures published are true. Was happy to know our country is placed comfortably.

Like (4)

Arun Galgali

Jan 21, 2015

The article is thought provoking & informative. Hope the figures published are true. Was happy to know our country is placed comfortably.

Like (4)

Ajay

Jan 21, 2015

The other reason is in India we have a syndicate of Developers and Builders, which has causing he prices not to come down. As their interest is involved and the consumer seeks the legal option for his redress it is never ending situation. There is a proper syndicate between the Builders and the authorities. Which requires a proper overhaul of the system.

Like (4)

Vikram Navale

Jan 21, 2015

Dear Vivek,
you have hit the nail on the head. black money is the prime and only reason for increase in reality prices in metro cities. white money typically requires to generate specific IRR in specific time period which black money doesnt need to. hence in my honest opinion reality prices are far from falling, infact the size of houses n flats are reducing to compensate for lack of sales. there is data which proves the average 1bhk flat size in mumbai has reduced in recent years.only a miracle can make reality prices fall...which is possible only in SATYUG not in this KALIYUG. till then enjoy.
Regards,Vikram

Like (1)
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