The Real Returns from Real Estate Have Been Very Low

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The best way to challenge myths is to look at data. The trouble is that India’s real estate sector is very opaque and does not give us enough data points to do a proper job of analysing it. In the process, the myth that any real estate investment yields massive amounts of returns at all points of time, continues to persist.

Thankfully, now we have some data which we can use. Sometime back, the National Housing Bank (NHB), the regulator of housing finance companies, launched a revamped RESIDEX, a housing price index. The index claims to offer home prices of 50 cities across the nation though I could find data for only 49. In this column, I look at data referred to as HPI@Assessment Prices based on the information furnished by banks and other lending agencies regarding home prices.

This should help us get some idea about which way the real estate prices have gone over the last few years. And for the first time we should be able to calculate the actual city wise returns. This should give all the real estate bhakts out there some idea of how their investments have done over the years.

As I said at the beginning, the NHB RESIDEX has price data for 50 cities. Let’s take a look at Table 1. It shows the per year returns of these cities between June 2013 and March 2017. It also shows the one-year return between March 2016 and March 2017. While the NHB RESIDEX claims to have data from 50 cities, I could find data only for 49 cities.

Also, even though it has data from 50 cities, it can’t claim to be a pan India index given that many of the cities represented separately are essentially the satellite cities of some of the bigger cities like Mumbai, Delhi and Kolkata. Further, some of the bigger cities in states haven’t found representation in the index. These include Jamshedpur in Jharkhand, Madurai in Tamil Nadu, Jalandhar in Punjab, Allahabad and Varanasi in Uttar Pradesh.

Nevertheless, the index is a good start which can give us a good sense which way the real estate market in India is headed. Also, it will give us a good idea of how well or badly has the real estate market in India performed, over the last few years. Typically, this sort of information is rarely available in the public domain and will allow us to settle once and for all, how good an investment real estate has been over the last few years.

Table 1: 

Name of the city Return per year between June 2013 and March 2017 (in %) One-year return between March 2016 and March 2017 (in %)
1 Mumbai 6.7 2.8
2 Delhi -2.6 5.8
3 Bengaluru 7.3 7.5
4 Kolkata 6.5 2.9
5 Chennai 7.1 10
6 Pune 7.2 9.5
7 Nagpur 5.6 11.2
8 Nashik 2.5 -0.25
9 Kalyan Dombivali 8.6 7.4
10 Mira Road-Bhayander 5.11 2.9
11 Navi Mumbai 3.4 -8.9
12 Panvel 2.9 -7.1
13 Thane 7.1 2
14 Vasai Virar 3.2 2.3
15 Chakan 6 0.7
16 Pimpri Chinchwad 5.2 3.5
17 Coimbatore -0.8 -10.5
18 Ahmedabad 0.5 6.8
19 Surat 3.5 3.6
20 Vadodra 1.6 7.9
21 Rajkot 2.5 0.3
22 Gandhinagar -7.8 -11.1
23 Kanpur 8.3 11.3
24 Lucknow 4.7 1.9
25 Meerut 13.5 6
26 Ghaziabad 2.9 9.7
27 Greater Noida 4.3 0
28 Noida 2.7 0
29 Howrah 10.5 15.6
30 New Town Kolkata 4.2 -7.8
31 Bidhanagar excluding Rajarhat 5.4 -1.8
32 Chandigarah(Tricity) 2.1 -5.4
33 Ludhiana 4.8 0
34 Faridabad 3.7 12.3
35 Gurugram 4.8 7.4
36 Jaipur 5.2 -1.5
37 Bhiwadi 1.6 -14
38 Indore 6.2 6.9
39 Bhopal 3.2 0.4
40 Vizag 10.3 24.7
41 Vijaywada 8.8 1.2
42 Kochi 6.8 4.1
43 Thiruvananthapuram 7.7 -0.5
44 Hyderabad 4.1 2.2
45 Patna 2.6 -7.1
46 Guwahati 4 8.2
47 Dehradun 0 4.8
48 Ranchi -2.6 -17.7
49 Bhubaneswar 1.5 7.5

Source: Author calculations on data obtained from https://residex.nhbonline.org.in/NHB_Residex.aspx 

Table 1 makes for a very interesting reading. If we look at returns per year across different cities from June 2013 onwards, very few cities have given a return of greater than 10 per cent year, which is what is needed, in order to meet the regular expenses for upkeep of real estate, along with beating the rate of inflation. Regular expenses would include the maintenance charge that needs to be paid to the housing society every month and a property tax that needs to be paid every year. Of course, the home could be put on rent, the rental yield would work out to around 2 per cent per year. (rental yield is essentially annual rent divided by the market price of the home). If you had bought the home on a loan, then interest would have to be paid on the loan. But a tax deduction would also be available.There are only three cities which have given a return of greater than 10 per cent per year (Meerut, Howrah and Vizag), since June 2013.

In fact, the median rate of return on real estate investment across the 49 cities is 4.3 per cent per year. As John Allen Paulos writes in Beyond Numeracy: “The median of a set of numbers is the middle number in the set.”

Hence, it is easy to see that unless a massive amount of black money has been invested in real estate, the returns have been meagre across the country since June 2013. This is the point from which the NHB RESIDEX data is available, in case you are wondering, dear reader, as to why have we taken this as a cut off.

The situation has gotten worse in the one-year period between March 2016 and March 2017. The median rate of return has fallen to 2.8 per cent. In fact, if we remove Vizag where one year return has been close to 25 per cent return during this period, the median rate of return falls to 2.55 per cent. Money in a savings bank account would have yielded more.

This basically means that real estate returns across the country have been subdued lately. In fact, between March 2016 and March 2017 prices have fallen in 13 out of the 49 cities under consideration. This is if we just look at prices. If we take other expenses into account (maintenance charges, property tax, interest paid on a home loan after adjusting for the tax benefit and inflation etc.) into account, the real returns would be negative in many other cases.

Of course, this logic works on weighted average prices for cities and individual experiences may have been different. Also, the logic could have been completely different if black money was being invested to buy real estate.

Hence, real estate as an investment hasn’t gone anywhere in the last four years and the situation has only worsened in the last one year. Having said that prices are not falling. This, despite the sales crashing in the aftermath of demonetisation.

Recently, the real estate consulting firm PropEquity released some interesting data. As per the data, for the period between January and May 2017, the housing sales fell by 41 per cent to 1.1 lakhs, across 42 major cities. During the same period in 2016, the housing sales had stood at 1.87 lakh.

But as we have seen the median price hasn’t really fallen between March 2016 and March 2017. While, real estate hasn’t made for a great investment for a while now, it hasn’t reached a stage where those actually wanting a home to live in, can buy one, in most cities. What are the reasons for the same?

a) Those who have already invested in real estate have a substantial amount of black money invested in it. The trouble is that if they sell right now, there isn’t much they can do with the black money that they will get in the form of cash after the sale. This is because black money generated by real estate finds its way into real estate all over again. But given the very low returns that real estate has given over the last few years, there is no point in doing that.

b) In some cases, the investors are sitting on losses and they are waiting for prices to rise before they will sell. As Richard Thaler writes in Misbehaving-The Making of Behavioural Economics: “Roughly speaking, losses hurt about twice as much as gains make you feel good.” This basically leads to a tendency among investors who are facing losses on their investment to continue to hold on to the losses, until they reach the positive territory again. This leads to a slow correction in prices.

c) In some other cases, investors are anchored on to the high returns that their friends, relatives and acquaintances, had made during the go go years of real estate between 2002 and 2011. They are waiting for that era to return. We wish them luck.

d) Up until last year, home loans taken to finance self-occupied homes, were allowed a deduction of up to Rs 2 lakh for the interest paid on the home loan against taxable income.

For home loans taken to finance non-self-occupied homes, any amount of interest on the home loan could be deducted to arrive at taxable income. This was allowed as long as the real rent (if the home was rented out) or the notional rent (if the home wasn’t rented out, but the rent the home owner was likely to earn if he would rent it out), was adjusted against it.

Typically, given the high home prices, the interest paid on a home loan these days, is many times the rent a home is likely to earn, if rented out. This essentially ensures that by buying a second home (or a third or a fourth or fifth home…), individuals could create a massive tax deduction and bring down their taxable income dramatically. The corporate crowd used this anomaly with great success by buying second and third homes, as they went up the hierarchy.

This basically ensured that even if the investment was not yielding any returns in terms of price increase, the tax arbitrage available was good enough to stay invested.

In his budget speech, the finance minister Arun Jaitley limited all such deductions (for self-occupied as well as other homes financed through home loans) to Rs 2 lakh. This has basically ensured that the market for homes to be create a tax deduction has now effectively come to an end. Whether this has an impact on prices remains to be seen.

To conclude, without a genuine price correction the mess in the real estate sector is likely to continue. Investors have sustained the sector for many many years now. It’s time the real estate companies realised this. If they want to continue to make money in the years to come, it’s time they addressed the genuine home buyers as well.

Until that happens, we don’t see any acche din for this sector.

Note: This originally appeared as a part of the Vivek Kaul Letter on July 14, 2017.

The column originally appeared on July 17, 2017, on Equitymaster.

Post Demonetisation Real Estate Sales Have Collapsed, But Prices Haven’t

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It has been a while since I wrote anything on real estate and the only reason for it is the sheer lack of data on the sector.

Recently, the real estate consulting firm PropEquity released some interesting data and that gave me sufficient reason to write one more piece on real estate.

As per the data, f or the period between January and May 2017, the housing sales fell by 41 per cent to 1.1 lakhs, across 42 major cities. During the same period in 2016, the housing sales had stood at 1.87 lakh.

The interesting thing is that the launch of new homes has also come down considerably. For the first five months of the current year, which are under consideration here, the launch of new homes fell by 62 per cent to 70,450 units. During the same period in 2016, the launch of new homes had stood at around 1.86 lakh.

The new home launches are a good indicator of the appetite investors have for real estate. And that has clearly come down big time. So, what is happening here? One, people are not buying ready to move in homes from builders. And two, they aren’t interested in under-construction property, where investment returns tend to be very high, either.

Why has that been the case? Typically, a significant portion in any real estate deal tends to be carried out in black. When going about a real estate deal, a significant part of the transaction is in the form of cash which changes hands, and for which there is no record. This cash may be black money where no taxes have been paid. Or it could even be white money, where taxes have been paid, but which is now becoming black.

For most of the period January to May 2017, there wasn’t enough sufficient cash going around in the financial system. This was because of the demonetisation announced on November 8, 2016, by the prime minister Narendra Modi.

Take a look at Figure 1. It plots the gap between the currency under circulation as on November 4, 2016 (a few days before demonetisation) and at the end every week between January and May 2017.

Figure 1:

What does Figure 1 tell us? On January 6, 2017, the currency in circulation was around 50 per cent of the currency in circulation as on November 4, 2016. This meant that the gap was also around 50 per cent. Since then, the currency in circulation has kept increasing every week, as the RBI has printed and pumped money into the financial system, and this has led to the gap coming down. Hence, as on May 26, 2017, the currency in circulation was at around 83 per cent of the currency in circulation as on November 4, 2016. Given this, the gap had come down to around 17 per cent.

So, what does this tell us? It tells us that there wasn’t enough cash going around in the financial system for people to carry out transactions in cash. Given this, people were not in a position to pay the black part of any real estate transaction in cash. This essentially meant that real estate transactions collapsed and were down by 41 per cent during the first five months of the year.

It also tells us that many of those who wanted to sell real estate just sat on it, instead of carrying out the transaction in 100 per cent white amount, as was the hope post demonetisation.

By the end of March 2017, the financial system had nearly 75 per cent of the currency in circulation as on November 4, 2016. The point being that there was enough money to go back to making black payments as a part of real estate transactions. But that doesn’t seem to have happened, with new home launches down by a whopping 62 per cent during the period.

One answer for that might lie in a change that finance minister Arun Jaitley made in this year’s budget. Up until last year, home loans taken to finance self-occupied homes, were allowed a deduction of up to Rs 2 lakh for the interest paid on the home loan against taxable income.

For home loans taken to finance non-self-occupied homes, any amount of interest on the home loan could be deducted to arrive at taxable income. This was allowed as long as the real rent (if the home was rented out) or the notional rent(if the home wasn’t rented out, but the rent the home owner was likely to earn if he would rent it out), was adjusted against it.

Typically, given the high home prices, the interest paid on a home loan these days, is many times the rent a home is likely to earn, if rented out. This essentially ensures that by buying a second home, individuals could create a massive tax deduction and bring down their taxable income dramatically. The corporate crowd used this anomaly with great success by buying second and third homes, as they went up the hierarchy. And after buying these homes, they kept it locked, thus creating a shortage for homes available for rent.

In his budget speech, the finance minister Arun Jaitley limited all such deductions (for self occupied as well as other homes financed through home loans) to Rs 2 lakh. This has basically ensured that the market for homes to be create a tax deduction has now effectively come to an end.

This is another factor which has basically ensured that the demand for finished homes as well as under-construction property has come down dramatically during the first five months of this year.

Regular readers would know that I have been recommending this for a few years now. In an era of exceptionally high home prices, why should the government be encouraging people to buy homes in order to benefit from a massive tax deduction. Also, those who buy more than one home, aren’t exactly poor. Hence, why pander them like this? So, finally after many years this anomaly has thankfully been done away with.

This brings us to the last and the most important point of the piece. While, the sales and prospective sales of real estate have come down dramatically, what has the impact been on the prices front?

The National Housing Bank relaunched its real estate index RESIDEX yesterday. As per the press release: “NHB RESIDEX for January-March,2017 revealed that price indices for residential properties based on actual market prices for ongoing construction prices have increased over the previous quarter in 24 of the 47 cities covered in the Index including in Jaipur, Chennai, Lucknow, Guwahati, Howrah, Hyderabad, Bidhannagar etc. In Delhi, Faridabad, Chandigarh, Patna and Nashik etc, prices have come down.”

What this tells us is that the broader trend in prices across India hasn’t gone anywhere post demonetisation. On the whole prices haven’t changed much What does this tell us? It tells us that builders have great staying power. The amount of money that they have made and stashed away in the real estate bull run between 2002 and 2011, allows them a tremendous staying power.

Also, many real estate companies are fronts for politicians and there is no point for them in annoying politicians by cutting prices and selling homes. Instead of selling homes at lower prices, the builders would rather sit on it, and which is what they are doing.

The trouble with this is that the longer they do this, the longer the time correction of prices will last i.e. the prices may not go down in nominal terms, but if we take inflation into account over the years, they would have gone down substantially.

The thing is that this time correction is not enough. If the real estate market has to revive, actual real estate prices need to fall. Yeah, I know I have been repeating this like a cuckoo clock over the years, but that is the only way out of the mess that prevails.

Postscript: In the next edition of the Vivek Kaul Letter, I will be discussing the newly launched NHB RESIDEX index in detail. For the first time, there is some detailed price data that has been made available across multiple cities. And that should make for an interesting piece of analysis and reading. Do keep a lookout.

The column originally appeared on Equitymaster on July 11, 2017.

 

RERA: There’s no way home prices will go up anytime soon

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The Real Estate (Regulation and Development) Act, 2016 (RERA), came into force on May 1, 2017. After this those who make their living in the real estate industry have been suggesting that real estate prices will go up in the days to come.

The logic being offered is that this will be because of compliance costs of RERA which the buyers will ultimately have to pay for.

Given that India does not have any data which agglomerates real estate prices at the country level, those connected with the real estate industry can get away with such statements, because no one else has any idea anyway.

Data from PropEquity Research shows that unsold home inventories stood at close to 4.72 lakh units in the top eight cities across India, as on March 31, 2017. These are homes that have been built but not been sold.

During the period January to March 2017, the inventory of unsold homes came down by 3.12 per cent. Despite this fall, the unsold inventory overhang continues to be huge, across the country. Data from PropEquity suggests that overhang is 60 months in Noida, 43 months in Mumbai, 38 months in Chennai and 30 months in Bengaluru.

If this unsold inventory has to be sold, the home-prices cannot go up from where they are, RERA notwithstanding. The fact that so much inventory has accumulated in the first place tells us very clearly that people are not buying homes to begin with. The only reason for this is that homes across urban India are fairly expensive in comparison to the capacity of people to pay.

This is obvious from the rental yield (annual rent divided by the market price of the home). Typically, the rental yield currently varies between 1.5-2 per cent. This basically means that in order to buy a home right now, one has to pay 50 to 67 times the annual rent. This tells us very clearly that it makes more sense to rent a home and at the same time that home-prices are very expensive. Of course, rental housing comes with its own set of issues in India, with insecure landlords being the biggest one.

Data from PropEquity suggests that property prices fell by 1.7 per cent for January to March 2017. This is clearly not enough. If this inventory overhang has to clear, prices need to fall further. What will force the builder’s hand further is that with RERA in place, new launches to raise finance for previously delayed projects or to pay off debt, will not so be easy, anymore.

A careful look at home loan data of 2016-2017 also suggests that home-prices have fallen.

In 2015-2016, only 16.8 per cent of the home loans given by banks were given to the priority sector. A housing loan of up to Rs 28 lakh in a city with a population of 10 lakh or more, which finances the purchase of a home with a price of up to Rs 35 lakh, is categorised as a priority sector housing loan.

In 2016-2017, 23 per cent of the home loans given by banks were given to the priority sector. This basically means that banks are giving out more sub Rs 28 lakh home loans for financing more homes worth less than Rs 35 lakh, than they were in the past.

This basically means that home-prices have either come down or builders are building more of sub Rs 35 lakh homes. Either ways, this is a good trend. It is not so obvious given that no agency agglomerates real estate prices in India at a national level. But the home loan data from banks clearly suggests this.

Last week, Keki Mistry, the bossman at HDFC, the largest housing finance company in the country suggested that given the low interest rates and the time correction of prices that has happened, it is a good time to buy a house.

Of course, for a home loan lender, it is always a good time to buy a house. What does Mistry mean by time correction of prices? He basically means that even though home-prices haven’t fallen much in absolute terms, they have fallen once we adjust for inflation.

It is worth re-stating here that if the builders have to sell off their unsold inventory of homes, they need to cut prices. Even if they manage to hold on to the current prices, they will not be in a position to increase prices, over the next few years. Hence, the time correction of prices is likely to continue. Given this, those who want a home to live-in and are in a position to continue to wait, should do that.

As far as interest rates are concerned, what Mistry forgot to mention is that home loans have a floating rate of interest, which keeps changing. Hence, over the 15-20 year term of a home loan, interest rates can and will vary. And given this, low interest rates initially, does not make much of a difference in the overall scheme of things. What is needed are lower home-prices.

The column originally appeared on business-standard.com  on May 9, 2017

The State of Real Estate, Six Months After Demonetisation: Falling Prices, Desperate Builders & Return of Black Money

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Housing and real estate is one area in India where writing anything is very difficult given the lack of data. Nevertheless, a few inferences can be made from the little data that is available.

In the last edition of the Letter we unveiled the Indian Economic Thermometer (IET). One of the inputs into the IET was retail loan growth. A major constituent of retail loans are housing loans. As of March 2017, housing loans formed around 53 per cent of the total retail loans given by banks.

By tracking the total amount of housing loans given by banks, we can make a few inferences regarding the state of the real estate sector in India. So, let’s take a look at Table 1. It shows the total amount of home loans given by banks during the course of a year, over the last few years.

Table 1:

Total Home Loans (in Rs crore) Increase/Decrease with respect to the previous year
2012-13 59,647
2013-14 81,900 37.3%
2014-15 89,935 9.8%
2015-16 1,18,245 31.5%
2016-17 1,13,323 -4.2%

Source: Centre for Monitoring Indian Economy.

Table 1 makes for a very interesting reading. For the first time in five years, the total amount of home loans given by banks during the course of a year, has fallen. The total amount of home loans given out in 2016-2017 was around 4.2 per cent lower than the total amount of loans given out in 2015-2016. This is another data point that shows the largely moribund state of the real estate sector in India.

One point that needs to be kept in mind is the fact that home loans are also given out by housing finance companies. The trouble is that regular data on the home loans given by housing finance companies is not available. And this is ironical because housing finance companies are regulated by the National Housing Bank(NHB), which is a 100 per cent subsidiary of the Reserve Bank of India(RBI). It is worth asking that when the RBI can put out month on month data on loans given by banks, what is stopping the NHB?

The latest data I could find on this front was as of March 31, 2015 and that is really not of much help more than two years later, given that we are trying to look at the current state of home loans. In 2014-2015, housing finance companies gave out home loans worth Rs 75,488 crore. During the same year, banks gave out home loans amounting to Rs 89,935 crore. This means that in 2014-2015, housing finance companies gave out around 45.6 per cent of the total home loans. In an ideal world, this data should not be ignored. But given that we don’t have access to it, there is nothing really that we can do about it.

Getting back to the point. Let’s get into a little more detail into the home loans given by scheduled commercial banks during 2016-2017. Let’s look at March 2017. During the course of the month, banks gave out total home loans of Rs 39,952 crore. This basically means that 35.3 per cent of the total home loans given out during the course of the year, got disbursed during one month, which happens to be the last month of the financial year.

What is happening here? Before March 2017, Rs 18,900 crore worth of home loans were disbursed in September 2016. This amounted to 17 per cent of the total home loans disbursed during the course of the year. Hence, between the two months, more than half of the home loans disbursed during the year, were disbursed.

It is well known that builders have got a huge amount of unsold inventory with them. This inventory has been in various stages of construction. At the same time, the builders have been trying to sell this inventory for a while now, by offering a better price as well as goodies on the side.

As some of this inventory has achieved completion stage, it has become slightly attractive for homebuyers given that people prefer buying finished homes these days in comparison to under-construction ones. Also, with builders wanting to show good year end numbers they have gone easy on the price in the month of March 2017, is what bankers tell me.

There is another phenomenon at work. These days people don’t apply for a home loan just at the point of time short-listing and buying a home. They apply for it in advance and get the loan sanctioned but not disbursed. The moment they get a good price for a home, they get the loan disbursed. That is another explanation for a jump in home loan numbers in March 2017.

Also, once people buy a ready to move in new home, there is activity in the secondary home market as well. They may want to sell the homes they were living in, and that also leads to more people taking on home loans. This phenomenon is likely to play out more in the coming months, if the basic assertion I am making turns out to be correct.

Another point mentioning here is that between November 2016 and February 2017, banks barely gave out any home loans. During the period, the banks gave out home loans worth Rs 8,851 crore. In March 2017, they gave out total home loans of Rs 39,952 crore, which was 4.5 times the home loans given out in the previous four months.

A major reason why people weren’t taking on home loans between November 2016 and February 2017 was demonetisation. There simply wasn’t enough currency going around. With this, the real estate transactions came to a standstill because without currency it wasn’t possible to fulfil the black part of the real estate transaction. Those who owned homes(builders and investors) were not ready to sell homes, without being paid for a certain part of the price, in black.

By March 2017, nearly three-fourths of the demonetised currency was replaced.

This basically means that by March 2017, there was enough currency in the financial system for the black part of the real estate transactions to start happening all over again. Also, the Rs 2,000 note makes this even more convenient.

This availability of currency ensured that the black part of any real estate transaction could be easily paid, which had become difficult between November 2016 and January 2017. Once the black transactions became possible, real estate started getting bought and sold again, and this in turn ensured that home loans started to be disbursed again.

Between builders desperate to end the financial year on a good note and currency finding its way back to the financial system, people started taking on home loans again. The interesting question is whether this revival in home loans will continue. For that we will have to wait for the home loan data of April 2017.

The big question here is that are real estate prices falling? If you listen to what the real estate industry has been saying you would feel that real estate prices have either not been falling or will not fall more.

Ashutosh Limaye, Head-Research & REIS, JLL India, told ET Now thatprices have come down but by and large prices are holding.” Or as Getamber Anand told Moneycontrol.com:  “I feel prices in most markets have bottomed out and stabilised with little or no margin for further reduction.”

Let’s look at some data to see if this is true. As I mentioned earlier, real estate data is not easy to get. The simple way to figure out whether prices are going up or down or are flat, would be to look at the prices at which deals are happening. But given that there is no such data at an agglomerated level, one has to try and look at this in a slightly different way.

Every bank has to carry out what the RBI calls priority sector lending. What kind of lending gets categorised as priority sector lending in case of home loans? As per a RBI circular dated April 23, 2015, a priority sector housing loan is defined as: “Loans to individuals up to Rs 28 lakh in metropolitan centres (with population of ten lakh and above) and loans up to Rs 20 lakh in other centres for purchase/construction of a dwelling unit per family provided the overall cost of the dwelling unit in the metropolitan centre and at other centres should not exceed Rs 35 lakh and Rs 25 lakh respectively.”

This is how priority sector home loans continue to be defined. Hence, housing loans of up to Rs 28 lakh in a city with a population of Rs 10 lakh or more, and financing the purchase of a home with a price of up to Rs 35 lakh, is categorised as a priority sector housing loan. In other centres, a priority sector housing loan is a loan of up to Rs 20 lakh used to finance the purchase of a house with a price of up to Rs 25 lakh.

Let’s look at Table 2. It shows the priority sector loans as a proportion of total home loans given by banks.

Table 2:

Total Home Loans (in Rs Crore) Priority Sector Home Loans (in Rs Crore) Proportion
2012-13 59,647 1,349 2.3%
2013-14 81,900 34,800 42.5%
2014-15 89,935 20,386 22.7%
2015-16 1,18,245 19,890 16.8%
2016-17 1,13,323 26,082 23.0%

Source: Centre for Monitoring Indian Economy.

What does Table 2 tell us? We are interested only in the years 2015-2016 and 2016-2017, when the definition of priority sector housing loans was the same. What we can see is that in 2016-2017, nearly 23 per cent of the loans given out were priority sector home loans. In 2015-2016, this figure was at just 16.8 per cent. In absolute terms, 31.1 per cent more priority sector home loans were disbursed in 2016-2017 than in 2015-2016.

What does this mean? It means that banks have financed more homes with an official registered price of Rs 35 lakh or lower in metropolitan cities and Rs 25 lakh or lower in other centres. We use the term official registered price, simply because a black component always gets paid in cash, over and above the official price.

With banks financing more homes of Rs 35 lakh or lower in metropolitan cities and Rs 25 lakh or lower in other centres, it basically means that either prices have come down or more homes have been built in that segment (which builders like to call affordable housing). Hence, more homes have become available in the sub-Rs 35 lakh segment in the metropolitan centres and in the sub-Rs 25 lakh segment, in other centres.

In fact, in the month of March 2017, when the maximum amount of home loans were given out in comparison to any other month during the last financial year, 28 per cent of the loans were priority sector home loans.

Given this, home loan data does suggest that home prices have fallen. Of course, there is no way of figuring out to what extent have the prices fallen. The answer would be different for different parts of the country.

But how does all this work at a personal level? One technique of driving down the price is to keep talking to the representative of the builder over a period of time, keep him interested and keep driving down the price. Of course, this needs a lot of patience and depends on how desperate the builder is to sell what he has already built.

The column originally appeared on Equitymaster on May 10, 2017

Mr Mistry, When It Comes to Buying a Home, the Price is More Important Than the Interest Rate

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Keki Mistry, the bossman at HDFC, India’s leading housing finance company, recently told The Economic Times, India’s leading business newspaper: “In my view, it is the best time to buy property. First, by virtue of the fact that interest rates are significantly low. Since 2008, we have not seen rates as low as this. I don’t believe rates will go down any further. Second, property prices haven’t gone up in recent times so one would believe there is time correction of prices.”

Asking Mistry if it’s the right time to buy a home is like asking Nandan Nilekani about the privacy concerns around Aadhaar. Or asking RBI governor Urjit Patel if demonetisation has been a success. Or asking me, if freelance writers should be paid more.

The answers in all the three cases will be a definite yes. Mistry is in the business of giving out home loans. And for him, it is always the right to give out home loans, as long as he takes a margin of safety into account and lends out only a certain portion of the price of the home being financed through a home loan.

Nevertheless, it is important to try and understand what Mistry is really saying here. The first point he makes that interest rates are low, and he doesn’t really see them going down anymore. Mistry might be right about this. Interest rates have been low because of the deluge of money that has come into banks because of demonetisation.

Mistry further says that home prices haven’t gone up in recent times and there has been a time correction of prices. And hence, this is the right time to buy property.

What does Mistry mean by a time correction of prices? Let’s say that a home was selling at Rs 50 lakh in a suburb of a big metropolitan city a few years back. Even today, it is going at the same price. Meanwhile, the price of every other thing has gone up. Once we factor in this inflation, the home has seen a time correction of prices, given that the purchasing power of Rs 50 lakh today is really not the same as the purchasing power of Rs 50 lakh, a few years back.

Given this time correction of prices, buyers should not wait any further and buy homes. This is basically what Mistry is saying.

The trouble is this makes little sense. As always there are several nuances that are involved here. First and foremost, there is the black part of that needs to be paid while buying homes across most parts of the country. It is difficult to generalise the proportion that needs to be paid in black, given that rates vary across the country. But let’s say around 20 per cent of the price of the home is to be paid in black. This works out to Rs 10 lakh (20 per cent of Rs 50 lakh).

Hence, the official price of the home works out to Rs 40 lakh (Rs 50 lakh minus Rs 10 lakh). A housing finance institution like HDFC will not finance the entire thing. HDFC’s average loan to value ratio at the origination of the home loan is 64 per cent. In this case that would mean a loan of Rs 25.6 lakh. (64 per cent of Rs 40 lakh). This is roughly around the average home loan size of HDFC at Rs 25.7 lakh.

Hence, HDFC will finance around Rs 25.6 lakh of the cost of the home of Rs 50 lakh. The buyer has to finance the remaining Rs 24.6 lakh. This basically means that the buyer needs to finance nearly half of the cost of the home. And that is the real equation that the buyer needs to take a look at.

This basically means whether the buyer has Rs 25 lakh of savings which he can use to buy a home of Rs 50 lakh. If he has the money he can buy the home. If he doesn’t, he can’t, irrespective of where the interest rate on the home loan is.

What about the low interest rate that Mistry was talking about? How much difference does it make? The EMI on a loan of Rs 25.6 lakh at 10 per cent per year for a period of 20 years would work out to Rs 24,801. This would have been the case a on a new home loan, a few years back. Now at 8.5 per cent interest, the EMI would work out to Rs 22,303 per month or around 10 per cent lower.

Hence, the lower EMI does help. But the basic question still remains; whether the prospective buyer has a savings of around Rs 25 lakh. Actually, the savings need to be more once we take brokerage, the cost of moving, making the home liveable enough, etc., into account. But for the ease of calculation we will leave all that out and just concentrate on the price of the house.

Now compare this scenario to where the price of the home over the last few years has fallen by 20 per cent and is currently going at Rs 40 lakh. Assuming a 20 per cent black part, the official price of the home works out to Rs 32 lakh. Of this HDFC would lend around Rs 20.5 lakh (64 per cent of Rs 32 lakh). Hence, the buyer would need around Rs 20 lakh to get the deal going.

This meant that anyone with savings of around Rs 20 lakh could carry out the transaction and buy the home. This requires Rs 5 lakh lower savings than the earlier example. In this situation, the prospective buyer is more likely to buy than the earlier one.

The point is similar to the one I have often made in the past, if people need to start buying homes again, the home prices need to come down. Lower interest rates just don’t help enough. And this is something Mistry needs to understand.

To conclude, it is safe to say that if 20 per cent of the price of a home being bought needs to be paid in black, then the buyer needs to have half of the price of the house as savings. Only then can he go ahead with the transaction and buy the home.

The column originally appeared in Equitymaster  on May 9, 2017

RERA is Not a Fairy Tale That It is Being Made Out to Be

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Fairy tales have happy endings.

The Real Estate (Regulation and Development) Act, 2016, or RERA for short, which came into effect from May 1, 2017, was supposed to be a fairy tale.

A fairy tale that would end all the trouble that homebuyers have while buying a house.

It would be put the big bad builders in their proper place.

But RERA is turning out to be like a bad art movie from the 1980s, where the system would inevitably crush the spirit of the hero, and win. (If you want to precisely know what I mean here try watching a movie called Paar).

This is what seems to be happening with RERA. Allow me to explain.

RERA is a central Act. But land is a state subject. Any real estate project needs land. Given this, state governments have the right to frame the operational rules for RERA.

And this has given them an opportunity to dilute the key provisions of RERA. This they have done with full impunity.

Before we get into the details, let’s try and understand why an Act like RERA was required in the first place.

Let’s say you want to buy a product. Let it be any product. It could be something as simple as an eraser for your child (I wonder if children still use erasers) or something a little more complicated like an air conditioner.

What do you do when you want to buy an eraser? You head to the local stationery shop, you pay the price of the eraser and you get the eraser.

What do you do when you want to buy an air conditioner? You head to a shop selling whitegoods and choose the air conditioner you want, given your budget, brand preferences, the preferences of your family and the space you have to install it.

The retailer doesn’t hand over the air conditioner to you immediately, like is the case with the eraser. (And that would be stupid given that how would you carry the air conditioner back to your house). So, the next day, the retailer delivers the AC at your house. In a few hours, a couple of people come and install it. And we are done.

What is the point I am trying to make here? When you buy a particular product from the market that is exactly what you get. I mean there is no chance of your buying an air conditioner of one and a half tonnes and the retailer delivering a one tonne air conditioner.

In the odd case that this happens, it is bound to be some mistake at the retailer’s end and will be soon corrected.

Along the same lines, when you buy an eraser, the stationery shop doesn’t insist on selling you a pencil sharpener or a ball pen for that matter.

At the cost of repeating, you get what you want and what you have paid for and not something else.

But when it comes to buying a home in India things don’t work in the same way.

Imagine you paid for a three-bedroom hall kitchen in a society which is supposed to have a swimming pool, a club house, a lot of greenery and what not.

The way things work in India, your chances of getting what has been advertised and what has been paid for, are very low.

In fact, in many cases, the size of the apartment gets smaller. In many cases, the number of floors goes up. In the original plan the number of floors planned were ten. By the time, the building gets built, it has fifteen floors.

And in such cases, no is bothered about the fact that the foundation was originally dug for ten floors and now 15 floors have been built on it.

In some cases, the builder does not deliver on time. This leads to the homebuyer who had bought the home with the idea of living in it, having to continue paying a rent and at the same time paying the EMI on the home loan that has funded the home.

In some cases, the builder simply takes money from the buyers and disappears.

Considering all these points, a homebuyer in India considers himself lucky if he gets a home at the end of the promised period, at all.

So what if it’s slightly smaller. So what if it doesn’t have the facilities that it was originally supposed to have. So what if the drawing room gets seepage after the first rains.

An Indian homebuyer can adjust with all this and more.

The RERA was supposed to help the homebuyer on such fronts. It essentially has four key provisions:

a) 70 per cent of the money collected for a home project by the builder is supposed to be held in a separate bank account. Further, the money can be used only for the project and can be withdrawn according to what proportion of the project has been completed. This has been done to ensure that the builder spends a bulk of the money for the project he has raised money for and not spend it on other things, as builders are wont to do.

b) RERA recommends a fine for the builder which can extend up to 10 per cent of the cost of the project and/or a prison of up to three years, if the provisions of the Act are not followed.

c) The builder needs to treat any structural defects in the project arising within five years of him handing over possession to the buyer, free of charge.

d) RERA includes ongoing projects within the Act as well, by defining an ongoing project as a project “for which the completion certificate has not been issued” on the date of commencement of the Act. This provision was put in to ensure that many projects which have been endlessly delayed over the years, come under the Act. And in the process the Act offers help to the harried buyers.

All these provisions have been diluted by the state governments in the operational guidelines of RERA that have been notified. Take a look at Table 1.

Table 1:

States Definition of on – going projects Penelties for non – compliance Payment Schedule Norms for escrow withdrawal Clause for structural defects
Andra Pradesh Diluted Diluted In line In line In line
Bihar In line Diluted Lacks clarity In line In line
Gujrat Lacks clarity Lacks clarity Lacks clarity Lacks clarity Lacks clarity
Kerala Diluted In line In line Diluted Diluted
Madhya Pradesh In line Diluted Lacks clarity Lacks clarity Lacks clarity
Maharashtra In line Diluted With conditions In line In line
Odisha In line Diluted Lacks clarity In line In line
Rajasthan In line Diluted In line In line Lacks clarity
Uttar Pradesh Diluted Diluted Lacks clarity In line Lacks clarity
Andaman and Nicobar Islands In line
Chandigarh In line
Dadra and Nagar Haveli In line
Daman and Diu In line
Lakshadweep In line
National Capital Territory Delhi In line

Source: Crisil ResearchThe conclusion that one can draw from Table 1 is that if you want to fully benefit from RERA you need to be a homebuyer in a union territory.

The interesting thing is that around two-thirds of the states still haven’t notified the operational guidelines of RERA as yet. This tells us how serious state governments are about implementing RERA.

To conclude, RERA hits at the heart of the basic problem with state level politics in India. The state level politics thrives on the nexus between builders and politicians. In some states builders are politicians and politicians are builders. It is difficult to differentiate between the two.

The trouble is that against whom the rules are being made are also the ones deciding on the rules. Hence, it is not surprising that the rules have been diluted or they lack clarity in comparison to the RERA Act of the central government.

But this is real life. And real life is not a fairy tale.

The column originally appeared on Equitymaster on May 4, 2017

RERA: With state govts diluting key provisions, can the Act protect buyers at all?

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The Real Estate (Regulation and Development) Act, 2016, or RERA for short, has come into effect from May 1, 2017.

In large sections of the media, the RERA is being projected as a saviour for the home buyers. But will it turn out to be like that?

Will builders stop taking home buyers for a ride?

Will home buyers get the same home and facilities, which had been advertised, and which had been paid for?

Will the home buyers ever come to know what is the exact size of the home that they are paying for?

Will a builder still manage to not finish the project and disappear with the money he had taken from home buyers?

Will builders stop demanding black money?

The RERA is expected to make things better for the prospective home buyer, at least in theory. But in practice it’s off to a bad start.

While RERA is a central Act, land is a state subject. The Indian constitution divides legislative actions into three lists: a) union list b) state list c) concurrent list, on which both the state governments and the union government can legislate. Land is a state subject. Construction of homes requires land. And given this, the different state governments need to come up with the operational rules to implement RERA.

And this is where the entire idea of RERA protecting the interest of the home buyers seems to be going for a toss. First and foremost, even though the Act has come into effect from May 1, 2017, many state governments are yet to notify the operational rules in order to implement RERA.

A Crisil Research note titled Most states miss RERA deadline and dated May 2, 2017, points out: “Despite continuous monitoring and follow up by the Ministry of Urban Development and Housing, Government of India, only nine states (Andhra Pradesh, Bihar, Gujarat, Kerala, Madhya Pradesh, Maharashtra, Odisha, Rajasthan, and Uttar Pradesh) and six union territories (Andaman and Nicobar Islands, Chandigarh, Dadra and Nagar Haveli, Daman and Diu, Lakshadweep, and National Capital Territory of Delhi) have notified their respective Real Estate (Regulation and Development) Rules, 2017.”

Given that Union Territories are largely in control of the union government, it isn’t surprising that the operational rules are in place. But only around one-third of the states have notified the operational rules of RERA. And this in itself shows how serious state governments are about implementing RERA.

Further, even those states which have passed operational guidelines have diluted the Act in the process. As per the RERA, an ongoing project  is basically a project “for which the completion certificate has not been issued” on the date of commencement of the Act. This basically makes sure that many home projects which are work-in-process come under the Act.

Several states have diluted this definition. Crisil Research points out: “Andhra Pradesh, Kerala and Uttar Pradesh have altered this definition in their notified rules.” In case of Gujarat, the operational rules do not mention any definition of an ongoing project.

The operational rules of the Haryana government also dilute the definition by stating that projects which have applied for a part completion certificate or an occupancy certificate will not come under the RERA, if the certificate is granted. This has led to many builders rushing to get an occupancy certificate to ensure that their project does not come under the Act.

As a newsreport in The Economic Times points out: “Developers in Haryana are making use of the window provided by the draft state RERA rule, published on Friday [April 28, 2017], to get out of the ambit of the regulatory authority. On the first working day after the draft rule was announced, over 50 applications were submitted with the department of town and country planning (DTCP), seeking occupation certificates (OC).” In the days to come, many more applications are expected to be submitted. This has basically made a mockery of what RERA was trying to achieve.

There are other dilutions that have been made as well. As Crisil Research points out: “According to the central legislation, the model sale agreement is required to specify 10% advance payment, or charge an application fee from buyers, while entering into a written agreement for sale. In addition, in case of any structural defects arising within five years of handing over the possession of project to buyers, developers will be liable to rectify such defects without further charge. However, there is no clarity on these clauses in most states’ RERA notifications.”

Another important clause in RERA is the escrow account clause. As the Act states: “seventy per cent of the amounts realised for the real estate project from the allottees, from time to time, shall be deposited in a separate account to be maintained in a scheduled bank to cover the cost of construction and the land cost and shall be used only for that purpose.”

Hence, 70 per cent of the money taken from the home buyers by the builder needs to be maintained in a separate escrow account and needs to be used only for the purpose of building the homes. Also, this money needs to withdrawn in proportion to the percentage of completion of the project.

This is a key clause in RERA and was put in to stop the builders from raising money for a project and then using it for other things like completing an earlier project or paying off debt that was due.

The operational guidelines of many states are not clear on this. Like the operational guidelines of Gujarat, do not mention the norms for withdrawal of money from the escrow account of the project. The operational guidelines of Kerala state that “70% (or less, as notified by the government) of the amount realised by developers to be deposited in a separate account.” There is no clarity on withdrawal of money from the escrow account. This is true even for the guidelines issued by Madhya Pradesh.

Over and above this, RERA recommends imprisonment and fines for non-compliance with the Act. Several states have diluted this as well. Long story short—while the idea behind the RERA might have been noble to protect the buyers from the builders, but the state governments have managed to dilute that core purpose to a large extent.

The column originally appeared on Firstpost on May 3, 2017.