The Delusional Optimism of India’s Real Estate Companies

India-Real-Estate-Market

Daniel Kahneman, the Nobel Prize winning psychologist, in his brilliant book, Thinking, Fast and Slow, writes: “One of the benefits of an optimistic temperament is that it encourages persistence in the face of obstacles…[The] confidence [of the entrepreneurs] in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

This optimism of an extreme delusional variety has been visible among India’s real estate entrepreneurs. For the last five to six years, they have been saying that a recovery in the sector is just around the corner, and the fact that it hasn’t happened yet is because the Reserve Bank of India (RBI) refuses to play ball by cutting interest rates, adequately.
Rajeev Talwar, the Chief Executive of DLF, recently told the Business Standard: “We are in a new economic cycle… When demand picks up, it will take everybody by surprise.”

Niranjan Hiranandani, chairman of Hiranandani group, told the same newspaper: “Any depression will not last long.”

Isn’t a period of five to six years a long enough time?

A report by Crisil Research points out that the absorption of new homes (i.e. sales) in in top 10 cities (Ahmedabad, Bengaluru, Chandigarh, Chennai, Hyderabad, Kochi, Kolkata, Mumbai Metropolitan Region (MMR), National Capital Region (NCR) and Pune) has fallen by 8 per cent per year on an average in the last six years.

What does this mean? It means that if real estate builders sold 100 new homes in India’s top 10 cities in 2010, in 2016, they managed to sell only 63. In absolute terms, this is a fall of 37 per cent. And Mr Hiranandani is talking about any depression not lasting long. I guess six years is a long enough time.

In fact, things haven’t looked good even in the last three months. As per real estate research firm, PropEquity, housing sales stood at 22,699 units during the period July to September 2017, in eight key cities. The sales had stood at 34,809 units during the period April to June 2017. This means a collapse of close to 35 per cent in a period of just three months.

The eight key cities are Gurgaon, Noida, Mumbai, Kolkata, Pune, Hyderabad, Bengaluru and Chennai.

What are the reasons for this collapse? As I have been saying over and over again, real estate prices in India, are beyond what most people can afford and unless this anomaly is corrected, sales will continue to remain sluggish.

Over and above this, real estate companies have really worked hard to break whatever little trust the prospective buyers had in them, by not delivering homes on time.

Further, investors are no longer the driving force in the market, given the sluggish returns in the sector. For a real estate investment to be a viable proposition, after taking in the costs and the risk involved, it should be generating a return of at least 10 per cent per year. And this hasn’t happened for a while.

The overall economy continues to remain sluggish. Take a look at Figure 1, which plots the growth of the non-government part of the GDP, which forms around 90 per cent of the Indian economy.

non govt GDP growth

Source: Centre for Monitoring Indian Economy.

The growth of the non-government part of the economy has fallen from well over 9 per cent to a little over 4 per cent in a period of 18 months between January 2016 and June 2017. This also means that incomes are not going up at the same pace as they were in the past. And given this, it is but natural people are going slow on buying a new home, which is the biggest financial commitment that they make in their lives. During a time when the rental yield (annual rent divided by market price of a home) is around 2 per cent, this makes immense financial sense.

The fear of job losses in the IT industry has also had an impact. The state of the IT industry has a major impact on real estate sales in cities like Pune, Hyderabad and Bengaluru.

In this scenario, the real estate builders have been offering discounts in order to get prospective buyers interested. As Crisil Research points out: “Pressure on residential real estate prices across top 10 cities was clearly visible during H1 2017 [January to June 2017]. While several developers offered upfront per square feet discounts, a few large developers bundled financing schemes and reduced interest schemes to offer ‘all inclusive house prices’. Home buyers, in many cases, were also offered indirect benefits such as reduced floor charges or premium location charges. Taking into account these aspects, the effective price correction was 5-10%.”

But even this 5-10 per cent correction isn’t enough to pull buyers in. This basically means that home prices continue to remain expensive. As I have often said in the past, home sales will revive as and when home prices become affordable, which is currently not the case. For home prices to become affordable builders need to cut prices from current levels. Given that a majority of them are in no mood to do so, it basically means that home sales will remain sluggish in the years to come.

Crisil Research expects that “in the next 12-18 months, prices are likely to remain stable at current levels on account of weak demand and moderation in new supply additions.” This basically means that instead of a price correction, the real estate sector in India is seeing a time correction. If prices remain stable over the years, they lose value once adjusted for inflation and in the process, they might become affordable.
Keep watching this space.

The article originally appeared on Equitymaster on October 16, 2017.

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Where are the jobs?

jobs

One million Indians are entering the workforce every month. This makes it around 1.2 crore a year, which is around half the total population of Australia.

This is India’s demographic dividend, which is supposed to find a job, earn and spend, pull India’s crores out of poverty. At least, that is the story that we have been sold over the years. But the theory is not translating into practice.

The land-owning communities across large parts of the country have been on the streets, protesting. This includes the Marathas of Maharashtra, the Jats of Haryana, the Kapus of Andhra Pradesh and the Patidar Patels of Gujarat.

The average size of the land farmed by the Indian farmer has fallen over the decades and in 2010-2011, the last time the agriculture census was carried out, stood at 1.16 hectares. In 1970-1971 it had stood at 2.82 hectares.

This has happened because of the division of land across generations. Further, this fall in farm size has made farming in many parts of the country, an unviable activity. And this explains why the land-owning castes across the country have been protesting and want a reservation in government jobs.

The trouble is that the government does not create jobs any more. In fact, between January 2006 and January 2014, the number of central government employees went up by just 30,000. The total number of people working for the public-sector enterprises has fallen over the years.

Only three out of five individuals who are looking for a job all through the year, are able to find one. In rural India, only one out of two individuals who are looking for a job all through the year, are able to find one. This has been the state of things since 2013-2014.
In fact, as far as Indian industry is concerned it favours expansion through capital (i.e. buying more machines and equipment) than recruiting more people.

Nikhil Gupta and Madhurima Chowdhury analysts at Motilal Oswal, use data up to 2014-2015, from the Annual Survey of Industries, and based on it conclude that over a period of 35 years up to 2014-2015, the rate of employment in the Indian industry has increased at 1.9 per cent per year on an average. In comparison, the capital employed by industry has grown at the rate of 14 per cent per year.

Clearly, capital has won the race hands down. Or if I were to put it in simple words, when it comes to Indian industry, machine has won over man for a while now. The Indian corporates like the idea of expanding their production and in the process their business, by installing new machines and equipment, rather than employing more people.

One of the reasons for this is the huge number of labour laws that Indian firms need to follow. As Jagdish Bhagwati and Arvind Panagariya write in India’s Tryst with Destiny: “The costs due to labour legislations rise progressively in discrete steps at seven, ten, twenty, fifty and 100 workers. As the firm size rises from six regular workers towards 100, at no point between the two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra costs of satisfying these laws.”

The National Manufacturing Policy of 2011 estimates that, on an average, a manufacturing unit needs to comply with nearly 70 laws and regulations.  At the same time, these units sometimes need to file as many as 100 returns a year.

This basically ensures that an average Indian firm starts small and continues to remain small. In the process, jobs aren’t created. This is reflected in the fact that close to 85 per cent of Indian apparel firms employ less than eight people. As per an Economic Survey estimate, close to 24 jobs are created in this sector per lakh of investment. Despite, this firms in this sector continue to remain small.

The points discussed up until now are essentially big structural issues, which have been around for a while. In the recent past, demonetisation which overnight made 86.4 per cent of the currency in circulation, useless, ended up destroying many firms operating in the informal sector. The Goods and Services Tax has added to this.

These days the presence of informal sector is seen as a bad thing because it doesn’t pay its fair share of taxes to the government. This isn’t totally true. People who work for these firms do spend the money that they earn and pay their share of indirect taxes. Also, as the Economic Survey of 2015-2016 points out: “The informal sector should… be credited with creating jobs and keeping unemployment low.”

As economist Jim Walker of Asianomics wrote in a research note sometime back: “There is nothing intrinsic that says that the informal economy is a less effective or beneficial source of activity than the formal economy.” This is something that the Modi government needs to understand.

In its quest for more taxes, it is working towards destroying large parts of the informal economy, which is a huge part of Indian economy. Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital wrote in a research note: “India’s informal sector is large and labour-intensive. The informal sector accounts for ~40% of India’s GDP and employs close to ~75% of the Indian labour force.” 

And this is something that the government needs to remember in its bid to forcibly formalise the Indian economy.

The column originally appeared in the Deccan Herald on October 15, 2017.