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Why Basic Economics is Not Working in Indian Real Estate

Aug 28, 2017

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Over the weekend I appeared on the CNBC Awaaz's Pehredar show, discussing what else but the 'sad' state of India's real estate.

At some point of time we started discussing the unsold inventories of builders. I have always been of the view that the builders won't be able to sell these homes unless they cut prices. The representative of the builders on the show took offense at what I said and was of the opinion that they had already cut prices by as much as they could, and a further cut in prices wasn't possible.

I said what I did on the logic that if prospective buyers are not interested in buying at the current prices, they might see value once builders lower prices. The question is whether the builder wants to unload his inventory or not. If he wants to unload his inventory then he has to cut prices irrespective of the fact whether he is making money on the deal or not. The market doesn't care about that simply because the buyers are not interested in buying at current prices. Also, it is worth remembering that builders are not the only ones carrying a huge unsold inventory of homes.

There are huge number of investors (both professionals as well as amateurs) who have bought homes over the years, in the hope that prices will continue to rise at the same pace as in the past. Hence, the real unsold inventory of homes is many times the unsold inventory of builders. And if this inventory has to be cleared, then prices need to fall.

When the supply of any product is higher than its demand, then prices need to fall, that is how the demand will go up, and the supply will match demand. But for that to happen in the context of Indian real estate, the builders need to be willing to cut prices, which they aren't. Why? The first reason on offer is that they are already selling homes at almost the cost price (in some parts of the country). Any further cut in price, would mean selling at a loss, which they aren't willing to do. I am neither a civil engineer nor an architect to be able to verify this claim. So, I really don't know how valid this claim is.

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But there is another reason why the builders (and their bankers) may not want to cut prices. And this is something the builders are not saying. At least, not in public. Hence, this seems to be the more likely reason. Builders have raised loans from banks and other sources. Against these loans the unsold inventory of homes has been offered as a collateral. If the prices of these homes are cut, then builders may have to offer more collateral to their lenders, which is something they are either not in a position to do or don't want to do.

In fact, if you look at the total lending by banks to commercial real estate, it stood at Rs 1,77,064 crore. It was down by 3.8 per cent from April 2016 and it forms around 2.6 per cent of total non-food lending of banks.

Given this, builders are likely to stick to their current prices, even if they are not making any sales. As I said earlier, there is much more unsold inventory in the market than just with builders.

So, what about the investors, why are they not ready to cut prices? Some of them are anchored on to the prices at which their friends, relatives and acquaintances, had sold homes in the past. They want similar prices for their homes as well and haven't adjusted to what is the new normal. There are still others who can't get themselves to sell at a price which is lower than the price at which they had bought. So, they are waiting for the price to recover.

This is something that varies from buyer to buyer and how desperate he or she is to sell out. Then there is another lot, which is simply waiting for enough indexed long-term capital losses to accumulate, before they think of selling. This will turn out to be the case given that real estate prices haven't really gone anywhere over the last few years, especially once inflation is factored in.

Another major factor hampering sales is the lack of 'enough' cash in the market, given that sellers still want a part of the payment to be made in black. While the process of black money generation and accumulation has re-started post-demonetisation, it will take some time before it reaches pre-demonetisation levels.

Investors who bought real estate over the years, carried out a certain portion of the transaction in black i.e. they paid in cash. Hence, now even if they want to sell what they own, they can't carry out an all-white transaction. A certain portion of the transaction needs to be carried out in black. And as I said earlier, there isn't enough cash going around in the financial system.Further, even those who are in a position to sell out, don't know what they could possibly do with the money that they get. There is a huge reinvestment risk. Real estate is down in the dumps. The stock market is at an all-time high level. Gold hasn't gone anywhere in years. And bank interest rates are at extremely low levels. Hence, the tendency is to hold on to the homes, not sell them at lower prices.

The larger point is that home prices have to fall till they interest the prospective buyers. Whether that price is viable for a builder or the investor, is not the question here.We are beyond that stage now. The market will only clear once the prospective buyers become interested. Currently, they aren't.

Builders who need to make massive debt repayments and do not have enough money going around are the ones who are more likely to cut prices than others. A Pune based developer DS Kulkarni has been defaulting on fixed deposit interest for a while now. He is likely to pulldown prices in the Pune market.

Many people bought homes assuming that the future will be similar to the past. Given the huge inventory of homes in the market, there is no way the prices are going to rise at the same pace as they had in the past. I will be surprised if anyone makes any return out of real state after adjusting for all the expenses, over the next few years. This is without getting into factoring inflation and the risk of owning real estate.

If builders don't cut prices, we will see the deadlock continuing for a few years more till prices become viable in inflation adjusted terms. This is assuming that salaries and bonuses start to recover soon.

So, if this continues, I guess anyone looking at real estate as a viable investment option, will have to wait for a few years more, perhaps till 2022 (Don't ask me why 2022. It's just that it is not too near like 2019 and not too far like 2027).

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

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.

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15 Responses to "Why Basic Economics is Not Working in Indian Real Estate"

Damodar Vinayak Bale

Sep 11, 2017

"ECONOMY" is created by "HUMANS". "HUMANS" are created by "NATURE". So 'Honor' Nature to "LIVE LIFE".

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Damodar Vinayak Bale

Sep 11, 2017

"DEMOCRACY" is something that even "ETHICS" could be challenged in the court of "LAW". Only "NATURE" cannot be challenged. That's because, if "NATURE" is honored, it can save "Mother EARTH".

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Shafique Ansari

Sep 7, 2017

Vivek, you had missed out on something which is also important. Let me explain:
The market for homes selling under ?5000 per sqft is different from homes selling ?5000 to ?10000 and also for above?10000 to 20000.
The effects of slowdown acts different on different market segment.
There is this typical situation where holding a stock for a builder is more costlier than selling at discounted prices. But the government does not allows/discourages selling at discounts due to a law which will tax developer as well as buyer dealing at below Ready reconer price. If a developer sells at below the RR price then the department will tax as per the RR value. Imagine for a developer who sells below RR has to pay tax for an amount which is not even his income. And the same goes for purchaser, the department will assume the RR value as purchase value and will tax the difference as undisclosed income.
Also, the other department in-charge of Ready reconer keeps revising the price index to ensure their stamp duty does not fall below their expectations.
Tell me who is to blame ?

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Sarat Palat

Sep 2, 2017

This issue of real estate is not going to get over and it is all over India. One thing is very clear. There are thousands of people like me invested in a flat and the project is getting delay indefinitely. Whom to complain ? what to do?

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Vijay M

Aug 30, 2017

I would like to disagree on builders not cutting prices since that will increase the collateral required. Cause if they cling on to the unsold inventories even then they will still be making interest payments to the lending banks on the original loan amount for the empty shells.

Under either of the scenarios, it will be like to like for the developers.

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Girish Patkar

Aug 29, 2017

Price of real estate is not crashing because of the " Safety net" provided by Housing finance Companies and since the sector is funded by " Black Money"

It is well known that hundreds of developers are defaulting on interest and loan repayments. But, have you heard of say HDFC Ltd repossessing flats in the nature of unsold inventory and disposing off the same.....No
Ever greening is continuously taking place to manage their balance sheets. Lenders have to repossess ready assets and sell @ market price.
Unless the lenders pull the plug, prices will not fall.

Girish

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joseph saldanha

Aug 29, 2017

I know couple of years back one of the famous broker asked me to buy D.S. Kulkerney shares but I did not. Real Estate is a devils game. Politicians and thugs were also involved in this game. For example if you buy $ 200000 house in America you will end up paying about $4500 as a town tax in a decent location. Taxes do vary in cities like New York it may be about $1000 per month and some locations may be more. When you buy a house you pay 6% to the broker and that's all. All dealings will be done with in few hours provided you have 20% down payment and bank loan for mortgage. In India earning ratio to house value is not justified and 18 century laws make it hard to give the houses on lease or rent even if somebody has one.

Like (1)

S K LIMAYE

Aug 28, 2017

What about the interest the builders have to pay on the huge loans they have taken from banks ? If they are not selling , they are not generating revenue and would not be able to pay interest.This puts them at risk of becoming defaulters like DSK in Pune. Then what will they do ? Won't they go for distress sale of their inventory ? And in that case it may be much before 2022.

Like (1)

Dinesh

Aug 28, 2017

The writer is fairly right that it is a triangle of price, demand and supply. However, unlike perishable commodity, Real Estate, Gold etc have long term holding returns normalising to long term CAGR. The long term CAGR of real estate in India is good and will hopefully get better as infrastructure improves and more employable youths come in.

About Builder inventory, writer view seems common view. However to expect resale property to be sold at loss given the intact long term story is wishful thinking by writer. And he seems to be going on and on for few years not modifying his views but expecting market to fall just because he writes it so.

Like (1)

Palani Prasad

Aug 28, 2017

My opinion on Chennai market - Many builders have invested their black money. Some through bank loans. If you take a project that has 1000 flats, he builds slowly, tower by tower, takes money towards, club house, swimming pool, compulsory corpus fund, monthly maintenance charges, etc. that gives him free cash float. Plus whatever sales he makes. Conditions in the agreement will put Shylock to shame. Today the rich do not invest in real estate, the poor do not have the money. And that GREAT INDIAN MIDDLE class will take a personal loan, housing loan and pledge his wife's jewels just to buy a pigeon hole going by some fanciful British name sold to a dream of aristocratic living amidst you know what. Though the MIDDLE CLASS earns Money, knows the price of everything, travelled the world, do not know the concept of Value for Money - their education is their mental block. It sure is a funny world.

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