Real estate prices are not just about corruption; they are also about affordability - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 15 October 2015
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Real estate prices are not just about corruption; they are also about affordability A  A  A

- By Vivek Kaul

Vivek Kaul
Last week, Suraj Parmar, a leading Thane builder committed suicide. In his suicide note Parmar talked about the corruption in the system. A report in The Indian Express quoted V V Laxminaryan, the joint commissioner of police of Thane, as saying: "The suicide note speaks of several problems that Parmar was facing, including difficulties in obtaining approvals and the stop-work notices issued to him. The note goes on to say that several people were repeatedly demanding bribes, that he had already paid them a lot in the past but that their demands were still continuing and it had become too much for him to deal with."

Corruption in real estate at the government level has always been an issue. But now if builders are to be believed it has reached never before seen levels. As Niranjan Hiranandani, director of Hiranandani Group told NDTV.com, after Parmar's suicide: "In the last couple of years, I think corruption is over but extortion has started. So, I think what was unbearable to the builder was the fact that there was no corruption in that sense of the term, but it had gone far beyond corruption levels that have ever happened."

A June 2011 news-report in The Economic Times gets into the details of the issue. In Maharashtra, which happens to be the biggest real estate market in the country, a builder typically needs around 60 approvals to construct a property. Of this, 50 approvals need to be taken from the municipal corporation where the property is being built.

The Economic Times report then goes on to quote Pune builder Kumar Gera, as saying: "These clearances should not take more than three months...But in most states, it takes anywhere between one year and four years. And they add 20-30 % to a builder's project cost."

This is, in turn, passed on to consumers who want to buy homes. As a report in the Daily News and Analysis points out: "At every step, there is a price to be paid to obtain necessary clearances. The 'Golden Gang', a group of corporators and civic officials, calls the shots and builders are bound to cough up exorbitant sums to avoid harassment. This expenditure, so to speak, is then passed on to home buyers. That explains why real estate in Mumbai, Thane and Navi Mumbai is so prohibitively expensive."

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In fact, as a real estate consultant told The Economic Times: "Builders don't just pass it on...They often add to it big time." So builders add their own corruption premium to the price of homes they sell.

Most builders use corruption in government and increasing input costs to explain that the price of homes won't fall anytime in the near future. Take the case of cement, a major input into building homes. As a recent newsreport in The Economic Times points out: "Cement prices have jumped 20-40 per cent over the past two months in top cities despite demand from the real estate industry, which is its largest buyer, being low."

In this scenario the price of homes won't fall, say builders. But this logic just takes into account the supply side of the equation. It only talks about the builders who supply homes and the costs they have to incur. What about the end consumers who want to buy these homes?

As John Kay writes in an essay titled Guess Who's Come to Dinner which is a part of the book Everlasting Light Bulbs - How Economics Illuminates the World: "But surely people can't spend an increasing proportion of their incomes on housing." The affordability of homes also needs to be taken into account.

Also, owning a house is just not about putting up a down-payment, taking a home loan and paying the builder. There are other costs involved as well. Hence, as Kay puts it, it is important "to focus on the costs of house ownership rather than the cost of houses."

Given this, affordability isn't just being able to pay the price of the house. There is more to it than that. As Kay writes: "Mortgage repayments [home loan EMIs basically] are only a...part of the cost of buying a house: you have to pay for repairs and maintenance, heat and light, property taxes." Then there is the cost of moving in, the cost of setting up the place, and so on.

In a scenario where home prices are anyway high all these costs make the entire cost of owning a home even more expensive. So, the point that builders make about their inability to cut prices doesn't have any meaning. They can build homes and sell them at prices they think are right, but the question is will there be any takers at that price? And the answer is clearly no.

In any market there are always two sides - demand and supply. And that is a basic point that our builders need to remember. So, they can continue holding on to their prices, but at those prices there will be not much demand for homes. As Kay writes in another essay titled A Fetish for Manufacturing: "The rewards of different activities [are] detached from their position in the hierarchy of needs. You only [get] paid for producing goods that people [want]."

Kay makes another interesting point, which I would like to talk about here. As he writes: "In classic bubbles - from tulip mania to the dot.com frenzy - people bought things, not for their intrinsic worth, but to sell on to others at a higher price. That rarely happens with houses."

This is not true in the Indian context. Homes in India have "not" always been bought "for their intrinsic worth" but they have also been bought "to sell on to others at a higher price". And that clearly is not happening anymore. Over the last few years you would have been better off letting your money sit idle in a savings bank account rather than investing in real estate. Given this, the interest in owning real estate has come down. That is clearly visible from the huge number of unsold homes across cities as well as fall in the launch of new projects.

As Kay writes: "As in every asset market, short term price movements are driven by beliefs, not underlying realities." The underlying reality is that at these prices it does not make any sense to invest in real estate. But the belief that real estate prices always go up is still reasonably strong. The question is for how long will the belief remain strong?

I think we are half way there.

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Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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6 Responses to "Real estate prices are not just about corruption; they are also about affordability"

ramana kumar

Oct 16, 2015

i enjoy reading these articles, usually because there is sound common sense underlying them.
but i am beginning to wonder if there is more to these articles. while i agree with the logic abt real estate prices having to come down, equitymaster and its affiliates seem to have become a quite hysterical abt it !! i remember equitymaster saying real estate is overvalued and theres a crash coming, around 5 years ago. and has the crash arrived yet ? sure, prices are a little down in some mkts, but nowhere can it be called a 'crash' !!

further, in large parts of the country, including many areas of Mumbai, we have seen handsome appreciation of property values !!

making the right calls in any market is tough !! real estate is no different. the equitymaster team shud re-assess their own analysis and see if they have missed somthing !!

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Mahesh k Rathi

Oct 15, 2015

How Do u explain the issue of real estate prices with ref to NRI or Fdi investment in the sector...For forwugners India is damn cheap in rupee dollar terms... so why should not billions of dollars lying idle abroad by pension funds etc sometimes earning 2%annually there not be invested in indian real estate...or arethere any restrictions i would like to know..

Like (1)

Penugonda Prabhakar

Oct 15, 2015

Iam Penugonda Prabhakar i read you send me dtiles but you published tomorrow date 11.59 to 16th octobar agree but hold in how much i know .you anderstand.

yours lovelly.

penugonda prabhakar

Like (1)

KD

Oct 15, 2015

Real estate is about purchasing power of Indian consumers. If purchasing power of Indian consumers drops then we are all doomed whether it is real estate or equity or fixed income.

It seems that the purchasing power of young consumer is dropping. We are reading on day to day basis that lakhs of people are applying for 40-50 peon positions in government departments. Many of those people are engineers, post graduates and PhDs. If PhD cannot get a job in India then who will?

Like (1)

MUKUND JAEEL

Oct 15, 2015

Sir,

If prices of homes are so hugely impacted due to extortion tactics of those giving approvals in Municipalities and Government, why their wealth and financial dealings are not being watched to prove that their wealth is coming from sources other than their known sources of income and book them under black money laws ?

Like (1)

Raja Rangnekar

Oct 15, 2015

Most of the times,the builders expose themselves to extortion because of their illegal construcions and their greed. How else can one explain so much of illegal constructions

Like (1)
  
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