India’s unreal estate: Why you still can’t afford to buy that home

Are you wondering if home prices will fall in the post-Covid world? There’s something you should know: the real estate industry in India doesn’t want this to happen

File photo
File photo

The film director Basu Chatterjee who recently died was known for making slice-of-life cinema. Among his lesser known movies is a movie called Kirayadar (tenant) which was released in 1986. Showing the travails of renting a house in a big city like Mumbai, it’s one of the few Hindi movies based on the story of a tenant and the struggle with the landlord. Also, the title song of the movie, more than the movie itself, is a wonderful summary of all the problems that a tenant has to face.

In fact, from putting up a huge security deposit to dealing with huge insecurities and egos of landlords (simply because they happen to own a house and nothing more), and neighbours who don’t treat you well because you are a tenant, tenants in India have to go through a lot. On top of all this is the massive pressure from parents and relatives to get “settled” in life by buying a house.

Of course, there is some flip side to this as well, with tenants making life difficult for landlords by not moving out once the contract ends or creating a general nuisance.

The trouble is that in most Indian cities, home prices went up at a massive pace between 2002 and 2015. And even though they have fallen in a few places and remained stable in others, home prices still remain unaffordable for the average Indian

Why have people gone slow on buying homes?

In an environment where even the FMCG sector is expected to contract, and car sales and two-wheeler sales have already gone down, it is very difficult to see people queuing up to buy homes to live in. The financial commitment required for this in an environment where jobs are being lost and incomes are going down is just too much. (Of course, the example I have used is an average, but the logic applies to the economy as a whole.)

The trouble with the residential real estate sector in India is that there is very little agglomerated data going around, which would help us understand broad trends. But we can draw inferences from the data we have available.

Let’s take a look at the growth in incremental home loans of banks over the years. In Table 1 and Table 2, we looked at home loans disbursed. Along with home loans being disbursed every year, they are also being repaid. Once we adjust for that repayment, what remains are the incremental home loans. In Figure 3, we plot the growth of incremental home loans for banks. Banks control around two-thirds of the home loan market.

Why don’t home prices fall?

Home prices need to come down for homes to become affordable. Even the so-called affordable homes aren’t really affordable. If they were, they wouldn’t have seen such a massive pile up of inventory, as has been the case.

The question is, why don’t home prices fall? The answer to this is a rather complicated one and there are several reasons for the same. Let’s look at this in detail

Will home prices fall in the post-Covid world?

What we have discussed up until now are reasons from the past. The question is, how will things evolve in a post-Covid world? Will real estate prices fall?

Let me put it this way, before I get into the details: the deep state of Indian real estate that prevails (the real estate companies, the real estate consultancies, the governments, the banks, the investors and the NBFCs) will try their best to ensure that real estate prices do not fall.

The mathematics of the entire business works out such that builders currently cannot cut prices by more than 5-10 percent. Analyst Adhidev Chattopadhyay pointed this out in a recent report he wrote for ICICI Securities. The logic for central and south Mumbai, where the country's most expensive real estate is sold, is slightly different.

What did Chattopadhyay say? Let’s look at it pointwise.

  • The gross margins that real estate companies work with are around 15-20 percent. This is for non-Mumbai real estate companies operating in the biggest cities in the country. The average selling price is Rs 5,000-6,000 per square foot and has been stagnant post demonetisation. If we take construction costs, approval costs, land costs and marketing costs, this works out in the range of Rs 4,300-4,900 per square foot. What this implies is that there is a very limited scope for real estate companies to cut prices in order to make their homes attractive enough for prospective buyers.
  • Unlike manufacturing companies, the cost of building homes varies across different parts of the country. Also, money in building homes is spent over a period of four to five years; hence, costs cannot suddenly be brought down. In this scenario, it will be difficult for real estate companies to cut prices beyond 5-10 percent (again non-Mumbai). If they go beyond that, they will need to make loss-making sales and no one wants to sell at a loss. This means stagnation in the market and the low supply, low demand scenario that I had talked about earlier.
  • Chattopadhyay also feels that these price cuts will be more along the lines of indirect discounts from real estate companies, rather than a direct cut in the market price. The reason for this is very straightforward. No real estate company is able to sell all the homes that it builds in a particular project all at once. The initial sales happen at a certain price. If the real estate company cuts prices in the days to come, this does not go down well with the individuals who had bought these homes at the beginning. Hence, the pricing remains opaque and discounts need to be negotiated.
  • Over the long term, this has been a major reason why real estate in India has become sluggish. There is nothing like a market price. On the flip side, what this tells any prospective buyer is to negotiate hard. It might just be your lucky day.
  • In the days to come, labour costs are unlikely to come down. Many construction workers have gone back to their homes in states like Bihar, Uttar Pradesh, Jharkhand, Odisha, Chhattisgarh, etc. Given this, there will be a shortage of construction workers. Hence, the wages paid to labourers will go up, driving up the cost along the way.
  • Over the years, a lot of foreign money has come into Indian real estate (particularly commercial real estate). Analysts who track real estate expect the money coming in through this route to slow down in the time to come. Most of this money came in from Western economies. And now that these economies are in a recession, the money coming in is bound to slow down.
    • The problem with this argument is that an equally convincing and opposite argument can be made. Take the case of the United States. Between February 26 and June 10, the Federal Reserve, the American central bank, printed a little over $3 trillion. Other Western economies are also printing money. This money can easily flow to any part of the world. Of course, whether it does remains to be seen
  • Kunal Lakhan, an analyst at CLSA, makes a very interesting point regarding all the inventory that has piled up in central Mumbai (the areas of Dadar, Prabhadevi, Worli, Lower Parel, Parel, etc.). Lakhan says that there are 3,000 apartments in this area, with an average price of Rs 10 crore. The question is, who is going to buy these homes? There are 3,780 multi-millionaires in Mumbai. Most of these individuals already have homes in south Mumbai (which has the country’s most expensive real estate). So, how many more homes can they buy?
  • Lakhan estimates that some of the key projects in central Mumbai have seen a fall in price of 25-30 percent within one or two years of getting the occupation certificate. He estimates that prices might fall a further 12-15 percent in the post-Covid environment in case of some projects. The inventory piled up could take up to a decade to clear. There is a ghost city right in the middle of Mumbai. It’s just that it can’t be seen (like Greater Noida) because it’s all up in the air.
  • So, when it comes to central Mumbai, the market is at work and the home prices have taken some beating. But the average price of the apartment is still so high that demand has totally collapsed. As I said earlier, if you are the kind who can afford such an apartment, you probably already have one, but if you still want to buy another one, negotiate very hard

 

The new new real estate story

The above reasons are genuine. But the fact of the matter is that for any market to work, the price at which consumers are willing to buy should match the price at which suppliers are willing to sell. In the case of real estate, whatever the companies and their lobbies might say, transactions are not going to happen unless home prices come down.

Real estate consultancies and many analysts who follow the sector have now started talking about the economic environment improving by October and the demand coming back.

Why should this year be any different? If things did not improve during the years when economic growth actually happened, how can they improve during a year when the economy is expected to contract? No real estate analyst worth his salt is willing to answer this question.

If homes weren’t selling before Covid-19 struck, how are they going to sell in the post-Covid economic scenario, where incomes are likely to fall/stagnate, jobs will be lost, and businesses will be destroyed? This is another question that nobody is currently willing to answer.

The real estate industry is trying to sell a positive story all over again. One strand of this story is builders going digital in order to beat the post-Covid economic heat. This essentially involves the real estate company arranging a virtual visit of the home for a prospective buyer. They are also setting up virtual meets for the prospective buyer with banks and home finance companies for a home loan.

While it’s fantastic that companies are resorting to technology in order to boost their sales, I am really not sure about how many people are going to buy a home without going out there and seeing it for themselves. This might help a few big builders with some reputation to sell a few units here and there; nevertheless, it’s not going to help in clearing the massive inventory in any meaningful sort of way.

The other story being sold is that people who are losing their jobs in the Middle East will come back and buy homes to live in. There is a big hole in this argument. A bulk of these people already own homes in India. As a recent report in Mint points out: “Every fifth house in Kerala belongs to a person who works in the Gulf.” So, yes, some of these people may come back and buy homes, but again, this isn’t going to lead to any significant reduction in the inventory.

The big question

How will the real estate companies repay loans they have taken on from banks and NBFCs, if they don’t get around to selling the unsold inventory of homes?

In April earlier this year, the RBI came to the rescue of NBFCs by allowing them to extend by a year the date for starting operations for loans to real estate projects delayed for reasons beyond the control of promoters. This extension won’t be treated as restructuring of the loans given to real estate companies. This facility was already available to banks.

This move by the RBI allows real estate companies another year to meet their loan obligations. This helps banks as well as NBFCs in the short term, as the chances of real estate companies defaulting on loans are high, given the lack of new home sales.

As mentioned earlier, quite a lot of what looks like lending to NBFCs on the books of banks is actually indirect lending to the real estate sector. In this scenario, if real estate companies don’t pay up NBFCs, the latter won’t be able to repay banks. Hence, an NBFC crisis might turn into a banking crisis, something the RBI would like to avoid.

The moratorium on repaying principal as well as interest on term-loans is also going to help real estate companies in the short-term. But it is worth remembering that interest is not being waived off on these loans. At the end of the moratorium period, the interest for a period of six months (or three months, depending on the moratorium taken by the real estate company) will be added to the principal outstanding and that will have to be repaid. There is no free lunch available anywhere.

What this basically does is, it pushes the can down the road. The question is, what will happen one year later? Of course, the hope is that demand will come back, real estate companies will be able to sell the inventory they have built up, and use the money to repay loans. As far as hopes go, even cows might fly one day.

Conclusion

If we continue the way we currently are, the real estate sector will continue to stagnate, at least for the next five years, as it has for the last five years. Other than being a huge factor in improving the quality of life that comes with owning a house (children don’t need to change schools, parents are happy, and so on), the real estate sector also has huge forward and backward linkages with 250 ancillary industries.

As Keith Wardrip, Laura Williams and Suzanne Hague write in a research paper titled The Role of Affordable Housing in Creating Jobs and Stimulating Local Economic Development: A Review of the Literature: “During the construction of affordable housing — or any kind of housing, for that matter — the local economy benefits directly from the funds spent on materials, labour, and the like. If the builder is purchasing windows and doors from a local supplier, the supplier may have to spend money on materials and hire additional help to complete the order — examples of indirect effects. Finally, the construction workers, glass cutters and landscapers are likely to spend a portion of their wages at the local grocery store or shopping mall, which illustrates induced effects.”

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