Why Real Estate Prices are Going Down at a Slow Pace - Vivek Kaul's Diary
Free Reports

Why Real Estate Prices are Going Down at a Slow Pace

Mar 23, 2017

28

A few days back an email popped up, asking us, why had we stopped writing on real estate. We would like to assure the reader that we haven't stopped writing on real estate, just that we have taken a break from writing on the topic.

It's just that it is very difficult to write new things about Indian real estate in a scenario where very little data is available. But yesterday while reading a book we came across a concept from behavioural economics which weaves in beautifully with the real estate scenario that prevails in India currently. So, let's discuss that in today's edition of the Diary.

In his book A Man for All Markets-From Las Vegas to Wall Street, How I Beat the Dealer and the Market, Edward O Thorp discusses the concept of anchoring in real estate. As he writes: "Anchoring is a subtle and pervasive aberration in investment thinking. For instance, a former neighbour, Mr Davis (as I shall call him), saw the market value of his house rise from his purchase price of $2,000,000 or so in the mid-1980s to $3,500,000 or so when the luxury home prices peaked in 1988-1989. Soon afterward, he decided he wanted to sell and anchored himself to the price of $3,500,000."

And this is when the troubles of Mr Davies began. Luxury home prices started to fall pretty soon. But Mr Davies was anchored to a price of $3,500,000. While the price of $3,500,000 had meaning to Mr Davies, it did not have any meaning to the market in which he was trying to sell his house because the prices had come down. In fact, that is exactly how anchoring is defined. As John Allen Paulos writes in A Mathematician Reads the Stock Market: "We... become attached to any number we hear. This tendency is called the "anchoring effect"."

Anyway, getting back to the story of Mr Davies. As he hung on to his "anchored" price, he didn't find any buyers for his house. As Thorp writes: "During the next ten years, as the market price of his house fell back to $2,200,000 or so, he kept trying to sell at his now laughable anchor price. At last, in 2000, with a resurgent stock market and a dot-com-driven price rise in expensive homes, he escaped at $3,250,000."

Advertisement
  Multibagger Stocks Guide
(2017 Edition)
 
   
  In this report, we reveal four proven strategies to picking multibagger stocks.0

Well over a million copies of this report have already been claimed over the years.

Don't miss it for anything.
Go ahead, grab your copy today. It's Free.
As soon as you sign up, You will start receiving The 5 Minute WrapUp,
a Free-for-life newsletter from Equitymaster

NO-SPAM PLEDGE - We will NEVER rent, sell, or give away your e-mail address to anyone for any reason. You can unsubscribe from The 5 Minute WrapUp with a few clicks. Please read our Privacy Policy & Terms Of Use.
 

In the end Mr Davies ended up selling the house at more or less his anchored price. Of course, what he forgot or perhaps ignored in the process of being anchored to the price that he was, was that there is a certain time value of money. As Davies writes: "In his case, as often happens, the thinking error of anchoring, despite the eventual sale price he achieved left him with substantially less money than if he had acted otherwise."

The point being that if Davies had sold at a price slightly lower than his anchored price and invested the money somewhere else, he would have ended up with more money by 2000, than the $3,250,000 he managed for the house.

Now how is this concept of anchoring relevant in the Indian context? In a weak real estate market the dangers of anchoring are faced by the seller of a house. This is precisely what is happening in India right now. Over the last few years, in many markets in the country, real estate prices have fallen. Despite this, many sellers are still anchored on to the peak price their home had achieved a few years back. I see this phenomenon play out very well in and around Delhi.

And given this, they aren't ready to sell at the current market price. In some other cases, the home prices have been stagnant over the last few years. And investors are anchored to a higher price at which they are likely to make a good return on their real estate investment. I see this phenomenon play out in cities like Pune. These investors are also not in a mood to sell.

This has essentially led to a situation where real estate transactions have crashed across many markets in the country but the prices haven't. This isn't good for the real estate market because unless homes that have already been built are sold to buyers who want to live in them (and not invest), the huge inventory of built up homes with no one living in them, won't clear.

Unless this inventory clears, no new homes will be built or homes will not be built at the same pace as they were in the past. And the new homes that will be built will only add to the inventory of homes that is already there. Clearly, we have a problem here. Also, with the home owners anchored on to a price, they will lose money in the years to come, given that it is highly unlikely that real estate prices will go up or even if they go up, they will not go up at the rate that they did in the past.

Meanwhile, the home owners will have to bear the cost of maintenance, property tax etc. Hence, overall, they will lose money on their real estate investment. In fact, they might just be better off by selling their home and investing the money even in a fixed deposit.

But that of course is not going to happen given that the idea that real estate prices only go up, is highly ingrained (or should I say we are anchored to it) in us Indians. And that is not going to change anytime soon.

Postscript: I will be taking a break from writing the Diary next week and will be back in early April.

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.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Recent Articles

Trump Takes a Beating August 18, 2017
Donald J Trump, a wrasslin' fan, took a 'Holy Sh*t!' blow on Tuesday.
Which Gods Will Bring Down the US Empire? August 17, 2017
Mr Trump is in the White House and the gods are in their heavens; what's not to like?
Will They Haul Off Trump's Statue, Too? August 16, 2017
All across the country, the old gods become devils. New, gluten-free gods take their places...
Farm Loan Waivers: Why Bad Economics Makes for Good Politics August 14, 2017
It is because the negative effects of the waivers aren't clearly visible.

Equitymaster requests your view! Post a comment on "Why Real Estate Prices are Going Down at a Slow Pace". Click here!

4 Responses to "Why Real Estate Prices are Going Down at a Slow Pace"

Fair Perspective

Mar 25, 2017

Real estate prices are falling as per market dynamics. However i note Vivek is also anchored to his argument that if real estate prices are high they need to necessarily come down.
In a free market, these are driven by demand and supply and sellers optimism of future and buyers optimism / pessimism of future.

In general future is good with disposable income increasing in a growing economy with demand mostly outstripping supply on a long term basis for good housing with infrastructure and access. Long term CAGR of equity and real estate is same (At least in Mumbai).
There is no reason lots of people invest their hard earned money into real estate unless they saw logic in this argument. Having invested , buyers will stay anchored in this growth story over long term. Of course there will be cycles of ups and downs. 1997 to 2002 was one.. 2009-2011 was another. However unlike equity volatility does not mean buyers sell their existing homes at loss. they patiently wait like a long term equity investors (partly by force of long liquidation cycle of real estate) and over long term make up good CAGR.
Secondly buyers will be hesitant (and should rightly be ) to borrow and invest in equity. Whilst the same can be done via home loans. Home loan rates are 9% & may settle at 7.5% like 2002 and there by any long term CAGR of 12% to 15% is amply rewarding.

So i reckon Vivek should stop his one sided view of prices will fall and provide both sides of the picture

Like 

ashit j

Mar 24, 2017

i had purchased a property in pallava mumbai in 2013 for 60lakh now the offer i am getting is 40 lakh will it be wiser to sell it and invest the same in equity market?

Like (2)

Alok Kothari

Mar 24, 2017

Dear sir,
We should also take into count the falling affordability of real estate and also the pending decisions to buy a house by individuals who want to buy homes but keeping this decision pending in expectation of falling prices in future. also construction cost is moving up every year. once buyers come to the conclusion that the prices will have started moving up, they will come in droves and you will see a sudden jump in demand as price have remained same since 2007 (10 years now) real estate is a 7-10 years cycle and this time the hidden demand is huge and affordability is improving at a very fast pace. affordability which was @ 8.5 Years of surplus (income less expenditure) in 2005 has now dropped to just 3.5 years of Surplus in 2017 in 10 years. once the real estate prices start moving up you will see a sudden jump of minimum 20-25% in a single year. 2018-2019 should be that bright period for real estate price increase.
stay tight and identify best locations for purchase. the purchasing time is now or never.
Regards
Alok Kothari Bangkok

Like (4)

Jamal Mohamed

Mar 23, 2017

Very informative and useful

Like (3)
  
Equitymaster requests your view! Post a comment on "Why Real Estate Prices are Going Down at a Slow Pace". Click here!