In July 2006 I made a prediction: property prices in India will decline by 25% to 40% over the next 9 months.
By July 2007, property prices had increased somewhere in the region of 20% to 30%. So much for my prediction.
So much for sensible analysis.
The property markets were in frenzy in 2006 and 2007. Large developers were listing their stocks via IPO’s and they were all lapped up. Well-paid analysts were talking about the embedded Net Asset Value in the stocks of these property developers and the land bank they all owned.
The SEZ policy is the equivalent of the industrial license raj that ruled - and ruined -India’s economy till 1991.
Land was acquired at maybe Rs. 10 per square foot. A few approvals later, the land was re-zoned and re-born as a pretty garden villa real estate project selling at Rs. 4,000 per square foot.
The magic of the Indian rope trick.
The magic of an opaque approval process.
Land barons were born. They made it to the mega rich league of the market cap charts.
Investing in India: real estate is overpriced? Sam Zell, the legendary real estate developer and investor from USA, gave a talk at a conference in Bombay in December 2006. Not more than 5 feet 6 inches in height, he stood above the frenzy of the crowd. Sam Zell had just sold his company, Equity Office, to the private equity firm, Blackstone, for some USD 35 billion in November 2006. Why are you selling Sam? - all the commentators seemed to be asking him - the US economy has a long way to run.
I can picture Mr. Zell smiling in silence as he collected his cash.
He sold out at a level that - in hindsight - was the peak of the US property market cycle.
"There is no shortage of land in India", declared Sam Zell, "there is only a shortage of zoned land".
Read that statement carefully.
Read it again.
And think of the SEZ policies and the land grab.
Sure, India has a demand for some 20 million homes and some 5 million office units and some 200,000 hotel rooms.
And schools and colleges to educate the one hundred million young children.
And hospitals to take care of the 100 million elderly people in the country as they age in a changing society where the children don’t live with them anymore.
And we need many more cricket stadiums to watch overpaid cricketers sell you some TV sets, washing machines, and mobile phones.
A back of the envelope estimate indicates that India needs to build some 3 billion square feet of property in the next 5 years to partially meet some of this demand.
How much is that?
Well, visualise Nariman Point.
And now imagine that we have to build a string of Nariman Points from Bombay to Bangalore.
There is enough land to construct all of that.
The shortage is in the zoned land.
This is a man-made shortage.
A shortage created by policy.
Just as India had to suffer for 20 years with a regime that forced us to buy the Premier Padmini and the Ambassador - and we had to wait 3 years to get the cars delivered.
At the end of the wait, we got a useless product for a lot of money.
And Premier and Ambassador were profitable companies - whether their profits were declared in cash or cheque.
Just like the sheltered real estate developers.
Land is in abundant supply.
There is some special mechanism to convert this useless land to useful, zoned land.
My colleagues in our real estate arm tell me that there are 62 approvals required to get useless, un-zoned land converted into an end product that we can live on.
Artificial barriers have created an artificial price of the end product.
And this leads to a strange end market at today’s prices.
The very rich can buy any property anywhere in the world - or any city in India.
The rich can afford to buy one nice home in any one city.
The middle class cannot really afford to buy in many cities.
The poor have no hope of buying anything.
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Investing in India: a long term opportunity, short term dangers. The volume potential in India is huge - tens of millions of square feet can be bought every year by genuine buyers.
But not at these inflated prices.
Not at prices propped up with an industrial license raj mentality.
A policy that favours the few well connected developers.
Unlike a car ownership, home ownership is critical.
People don’t riot because they cannot buy a car.
People will get pretty upset if they cannot afford a home.
The current level of property prices is not sustainable because not many people can afford to buy homes.
A simple test: can you afford to buy the home you are currently living in at today’s real estate prices?
At what price level can you afford to "re-buy" the home you are living in?
And do the same mental test for the people you know.
Now where do you think the "real" level of property prices should be?
The real estate developers have land banks though these - in an open environment - are "unbankable" into cash and profits at these current levels of real estate prices.
But there is a large demand for real estate out there - at different price points.
But which developer - or business person - wants to work hard and build a volume business?
Why build 100 million square feet of homes and sell them for a profit of Rs. 200 per square foot when a "zoning process" allow you to build 10 million square feet and make a profit of Rs. 2,000 per square foot?
It is far easier to do what was done in the days of the license raj - limit the supply. Create these islands of favouritism called SEZs or earmark little islands of zoned land from friendly sources.
And when you are on an island, it is easier to milk paradise.
And if there is a back lash from the voters, the folks on the island may still get away.
But the investors in their listed stocks may not.
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Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.
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