February 08, 2017
Post demonetization, this topic remains one of the most google searched one. The reason is quite so obvious. Let’s accept it; Indians being a net saving society, love to invest in tangible assets. That said, what could beat Real Estate in fixed asset class?
However, 8th of November 2016 changed many things. One thing was quite obvious to everyone that if any asset class gets devalued hereon then Real Estate shall top the list. Such instinctive thought was the result of the fact that deep inside we all know that much of cash was used to transact while properties exchanged hands. It pretty much was as if it remains a “no-brainer”.
Being from Real Estate & Technology space, the imminent situation causes concerns to me. However as Aldous Huxley once said “Facts do not cease to exist because they are ignored.” In this essay, I shall be discussing threadbare as to why property prices shall go down and create a new value normal. I shall endeavor to keep my argument succinct and simple. However, where required, I shall get into numbers as well. The essay is focused on residential properties and the scope has been restricted to class A and class B cities only. For this essay affordable housing segment has been kept out of ambit. That said, the story flows via 4 main sub titles. Pre-Demonetization, Post-Demonetization, Future Demand Influencers & The Solution, as I see it.
Situation that existed Pre-Demonetization
Properties in 20 class A and 25 class B cities were the ones being invested heavily by investors as well as first time buyers alike. Again, in class A cities circle rates (circle rate is such government declared value at which a property can be registered in the purchaser’s name. This rate is determined by the state government and is reviewed by it from time to time) follow three patterns. Pockets where circle rates are lower than the market rates, sections were circle rates are higher than the market rates & finally pockets were the rates are more or less in agreement with each other. It’s the first two scenarios that cause concerns. Let me explain; when the government determined rate or circle rate is lesser than the market value, the differential is such amount that is transacted via cash between the buyer and the seller. The cash figure could range between 15% to as much as 45% of the deal depending upon case to case. Government pretty much remains the net loser in such cases as it would lose on the stamp duty tax as well as the income tax (subject to the appropriate provisions) which would have been otherwise paid by the buyer.
In the second case were the circle rate is higher than the market rate the buyer remains skeptical to buy since such sale shall be construed by law as being partly done in cash, given that the buyer, though having paid a lesser amounts, would now have to register the property with state government at a higher price thereby paying higher stamp duty.
In case of class B cities, there aren’t many reputed/branded developers and this situation read with substantially lower circle rates in many ways opens up room for price variations to be settled majorly in cash.
Situation that remains Post demonetization
Post November 8th 2016, if there has been one sudden change then that is invariably in Indian consumer’s behavior pattern. Ask any educated citizen around you and chances are they use one or the other digital/plastic medium to transact. (Again kindly bear in mind that I am focusing on residents of class A and class B cities for the scope of this essay). Cash hoarders have got penalized to an extent enough for them to consider a serious change in plan going forward. That being the background a potential buyer would look at the situation as under:-
In areas where circle rates are still quite low, he/she remains well advised that the prices would have to eventually drop to the level of the circle rates. That’s a clear signal of the discount that one can expect. How long does the developers hold on is a matter of another dissertation. However, my gut feel is that developers would have already initiated the process to reduce price to match the respective circle rates.
In cases where circle rates remain higher than the market rate, well, that terretory is pretty much going to have a deserted look until the state governments realistically amend/revise the circle rates southwards.
Class B markets where majority of the transactions were carried out in cash would suffer the most. The developers there would have to substantially amend their cost base as in the new world of accounted money they shall not find buyers at their pre-demonetization level pricing.
Future Demand Influencers
To analyze the typical demand-supply mathematics it would be worth to run some numbers on the state of over supply in the market.
As per Assocham’s recent study, the unsold inventory in the residential cum commercial RE segment in India have risen to a range between 22% and 43% in different cities, over the last one year, with the maximum unsold stock lying in the Delhi NCR followed by Mumbai MR. An efficient market maintains 8-12 months of inventory, which indicates downside pressure on price across all the major cities in India. Maximum annual increase in inventory was seen in Chennai, where months inventory reached 45 months from 30 months a year back.
New launches in Bangalore have dipped by one-third as compared to the last year. This shows developers are focusing more on offloading existing inventory. The market is adjusting and preparing itself for a long gestation.
As per the Real Estate research Firm Liases Foras, the unsold stock across the Tier I cities increased by 12% last year and the increase is mainly due to new project launches. Maximum yearly increase was witnessed in Kolkata, followed by Ahmedabad and MMR. Pune has already crossed 1-lakh units of unsold stock. As on Q2 FY16-17, the unsold stock for 8 Tier I cities had crossed 1,200 mn sqft.
The number of fully ready but unsold properties within 28 cities in India (as at 10th November 2016) stands at 1,24,906 units. By December 2016, this number would swell to 224,672 units. The cumulative figures by end of December 2017 and December 2018 would look like 5,82,754 units and 9,14,506 units respectively. The Delhi NCR and Mumbai MR being the worst hit of the lots. (To maintain clarity on the current situation we have contained our focus to the “fully ready but unsold inventory” part only).
Further Hon’ Delhi High Court in the case of Commissioner of Income Tax v/s M/s Ansal Housing Finance and Leasing Company Limited (ITA 18/1999 dated 31.10.2012) has ruled that all such properties that remain ready but unsold in the books of a developer shall be charged with Income tax on the Annual Lettings Value /Rental Value based on the prevailing market rental of all such property/units. This creates a situation of “DOUBLE WHAMMY or a TWO-FOLD BLOW” to all such developers holding on to unsold inventories.
So supply being where it is, the story of how much the property prices are going to come down would pretty much be a factor of demand augmentation. So what factors would effect demand?
Bank’s interest rate cuts: Demonetization has flushed banks with Cash. Needless to say, the cash in bank attracts interest payout. Banks would indeed like to advance loan at attractive pricing. So few rounds of rate cuts are imminent. Its net effect would be that buyer’s EMI rates get eased to a good extent. A positive step for Real Estate.
Imminent executive orders by US President Donald J Trump or the 20th January 2017 effect: It’s reasonably apparent that DJT intends to pass few executive orders on his first day at the oval office. One of the most tipped actions that might be exercised that day would be to cut the US corporate tax rates to 15%. This action (whenever it actually happens) shall undoubtedly have a pandemonic effect on the world flow of investable US dollar funds. Emerging markets risk to lose its sheen as risk adjusted US dollar denominated capital shall flock to United States, thereby bringing down the currencies in emerging markets. The effect, emerging market banks would have to increase the interest rates to control the inflation. Such an action would counter the earlier scope of banks’ interest rate cuts thereby creating yet another stroke of stress on Real Estate based assets.
Stricter Immigration rules: - With the recently announced Visa restrictions in UK, and US the most effected sector is the Indian IT service industry. As per Ministry of Commerce & Industry’s arm, IBEF “India is the world's largest sourcing destination, accounting for approximately 55 per cent of the US$ 146 billion market. The country's cost competitiveness in providing Information Technology (IT) services, which is approximately 3-4 times cheaper than the US, continues to be its Unique Selling Proposition (USP) in the global sourcing market. The contribution of IT industry to the GDP remains a mammoth 9.5%”. A large hit on ITES would have its ripple down effect in consumer spending, which in-turn would mar the Real Estate due to resulting imminent stress in consumer’s buying power.
Brent Crude price rise: And last but not the least is the Oil and Gas play. We have seen that in the last one year crude has advanced from its all time low figure of $28/bbl to $56/bbl. India being a net energy importer any appreciable rise in oil price could create a inflationary situation again demanding financial institutions to step in and introduce control measures like increase in interest rates. An action that as we now knows directly affects Real Estate.
Finally, Consumer perception: The power of perception cannot be underestimated. Post demonetisation the word on the street is that prices are expected to fall by 30% to 45% from its glory days. People are psychologically ready to wait it out for 24-36 months.
The Solution, as I see it
As I see it someone amongst the three players would have to take a hit. Either the bankers take a haircut on the large loans advanced to the developers (which seems pretty much as a straight nonstarter proposition) and allow them room to play or the buyer moves in to save the day and start entering at the current rates. These two scenarios seem very far-fetched to me. That said, what are we left with? Well, the developers. Yes all eyes are now on the developer. It’s them who need to act and act fast. There would be severe pain but that’s the result of the boom and bust cycle for every industry that we have seen. No matter who says what, unless prices are reduced drastically, these properties ain’t gonna sell.