• APRIL 2, 2007

Property Punctured

Well, we have emerged from the weekend, but not that rested. Worried about the beginning of the end-of-the-world, we bundled up the family to head for the hills. No sooner had we managed to throw in the last blanket for the long drive up the dusty roads, the mobile phones began their incessant ringing.

No, it was not the lady from a leading private sector bank telling me that I had been pre-approved for my fourth home loan (that call came in last month and, yes, we did buy that fourth home) and nor was it the irritating call from the same private sector bank telling me that we had slipped behind on all our four mortgage payments but we could still get a fifth loan if we paid something to the bank to show we were still honouring our loan installments (that call came in last week). Nope, neither of them. (click here for our views on stocks including the private sector banks.)

It was our breaking news bureau saying that the Reserve Bank of India (RBI) had decided to suck some more money out of the market. Rs 15,000 crores of it. Over the next 4 weeks. That should send a shiver down the spine of the folks who lend the money (the banks) and the folks who borrow money (all of us). Not to mention the folks who manufacture and build the stuff we buy with all that money we borrow. Since September 2004 the RBI has been directly or indirectly increasing interest rates. The first few increases were of little meaning. When it costs 7% per annum to borrow for my home, what does it matter if the new interest rate is 7.25%? But today, when my borrowing cost is already 11% any increase in interest rates may see me delay my desire for that fifth mortgage for that fifth home.

If everyone begins to be more conscious about the cost of their borrowings and decides to slow down on their home buying (and the banks will also tend to be more careful on their lending) then all those apartments being built all over the country may see some sort of slower pace of sales. And businesses being built around the new consumption habits of the New India will also be hit. The banks will hire less people to sell me home loans for homes I don't really need (and, honestly, cannot really afford). Fewer new employees means less demand for new office space. And less demand for all those pizza places, and coffee houses to hang around and spend that monthly income. And less people to actually spend money in those 350 malls that are mushrooming all over India. Which again means that many malls will shut down and fail and real estate will lie vacant. Vacant means "more supply".

When supply is more than demand, prices decline. When demand slows down (as the RBI's interest rate increases will ensure) and supplies keep increasing (as developers roll out their new concrete junk), prices decline. It will not happen overnight. It may take six months more to feed into the system. But it will happen.

How can this happen? India is growing, India is booming, India is shining! Yes, India is all of that... and even more. No one doubts where India will be over the next ten years but every economic cycle that takes you from a lower level of existence to a next, higher level tends to fuel speculation. And builds up a mis-pricing of assets that tends to ignore risk. And real estate is, in our opinion, mis-priced. Banks, keen to build their "book" and show higher loans to individulas (as opposed to loans to companies who can borrow money directly from investors) tended to ignore the risk of giving larger loans. If prudent calculations indicated that a customer's income supported a loan of Rs 10 lakhs then, with a few nods and winks, that became a Rs 15 lakh loan. So that could have helped create an artificial demand for property. Now with some reassessment of risk, these inflated loans will disappear and demand will be more "normal". And prices will be more reasonable.

And my four mortgages on my four unnecessary homes? Not to worry, I can rent it out to the bill collectors who will need to employ people to help the banks get their money back!

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