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

Six Months After Demonetisation Cash is King Again and Questions Still Remain

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On November 8, 2016, the prime minister Narendra Modi announced his government’s decision to demonetise Rs 500 and Rs 1,000 notes, to an unsuspecting nation. The decision came into effect from the midnight between November 8 and November 9, 2016, and suddenly rendered 86.4 per cent of the nation’s currency in circulation, useless.

It’s been six months since then and more than four months since December 30, 2016, the last date for depositing the demonetised Rs 500 an Rs 1,000 notes, into bank accounts. But even after this period as far as the government is concerned, a few basic points remain.

a) How much demonetised money finally made it into bank accounts? When demonetisation was first announced, this number was shared regularly. Nevertheless, the last announcement on this front from the Reserve Bank of India(RBI) came on December 13, 2016. As of December 10, 2016, Rs 12.44 lakh crore of demonetised currency had made it back into the banks.
Given that Rs 15.44 lakh crore worth of currency notes had been demonetised, nearly 80.6 per cent of the currency had found its way back into banks, nearly three weeks before the last date to deposit demonetised notes into bank accounts.
Neither the Reserve Bank nor the government has told the nation how much money eventually made it back into the banks. This is an important question and needs to be answered.

b) The initial idea behind demonetisation was to curb fake currency notes and eliminate black money.
As far as fake currency goes the minister of state for finance Arjun Ram Meghwal told the Lok Sabha in early February 2017 that the total number of fake notes deducted in the currency deposited into banks after demonetisation stood at 2.46 lakhs. This amounted to a total value of Rs 19.5 crore.
As mentioned earlier, the total value of demonetised notes had stood at Rs 15.44 lakh crore. Given this, the proportion of fake notes deducted is almost zero and can be ignored. Hence, as far as detecting and eliminating fake notes was concerned, demonetisation was a total flop.
How did it do as far as eliminating black money is concerned? The hope was that the black money held in the form of cash will not make it back into the banks, as people wouldn’t want to get caught by declaring it. But by December 10, 2016, more than four-fifth of the demonetised notes had already made it back into the banks. Since then the government and the RBI have not given out any fresh numbers. It’s surprising that it has been more than four months since December 30, 2016, and this number is still not out in the public domain.
Also, it is important to point out here: “High denomination notes are known to facilitate generation of black money. In this connection, it may be noted that while the total number of bank notes in circulation rose by 40% between 2011 and 2016, the increase in number of notes of Rs.500/- denomination was 76% and for Rs.1,000/- denomination was 109% during this period.”
If high denomination notes facilitate generation of black money, then why replace Rs 1,000 notes with Rs 2,000 notes. Given that a Rs 2,000 note is twice the value of a Rs 1,000 note, it makes black market transactions even more easier. It also makes storage of black money in the form of cash easier, given that it takes less space to hide the same amount of money.
Again, this is a basic disconnect in what the government planned to achieve through demonetisation and what it eventually did. No effort has been made to correct this disconnect.

c) The government has still not offered a good explanation of what prompted it to demonetise. There has been no similar decision taken by any other country in a stable financial situation like India currently is, in the modern era. The best that the government has done is blamed it on the RBI. As Meghwal told the Lok Sabha in early February 2017: “RBI held a meeting of its Central Board on November 8, 2016. The agenda of the meeting, inter-alia, included the item: “Memorandum on existing banknotes in the denomination of Rs 500 and Rs 1000 – Legal Tender Status.””
Anybody who has studied the history of the RBI would know that the RBI would never take such an extreme step without extreme pressure from the government.

d) Other than eliminating black money and fake currency notes through demonetisation, in the aftermath of demonetisation, the government wanted to promote cashless transactions. As Modi said in the November 2016 edition of themann ki baat radio programme: “The great task that the country wants to accomplish today is the realisation of our dream of a ‘Cashless Society’. It is true that a hundred percent cashless society is not possible. But why should India not make a beginning in creating a ‘less-cash society’? Once we embark on our journey to create a ‘less-cash society’, the goal of ‘cashless society’ will not remain very far.”

How are things looking on that front? Look at the following table. It shows the volume of digital transactions over the last few months.

Month Volume of digital transactions (in million)
Nov-16 671.5
Dec-16 957.5
Jan-17 870.4
Feb-17 763.0
Mar-17 893.9
Apr-17 843.5

Source: Reserve Bank of India

While digital transactions picked up in December, they have fallen since then. The total number of digital transactions in April 2017 is higher than it was in November 2016. Nevertheless, it is worth asking, whether this jump of 25 per cent was really worth the trouble of demonetisation.

e) Falling digital transactions since December 2016 tell us that cash as a mode of payment is back in the system. There is another way this can be shown. 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. It also amounted to 35 per cent of the home loans given out during the course of 2016-2017.

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.

To conclude, six months after the declaration of demonetisation it is safe to say that demonetisation has failed to achieve what it set out to achieve i.e. if it set out to achieve anything on the economic front.

The column originally appeared on Firstpost on May 9, 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

Why The Real Estate Act Will Remain Ineffective Until The Builder-Politician Nexus Is Broken

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In the first half of Vidhu Vinod Chopra’s 1994 release “1942: A Love Story,” there are a series of characters saying: “Shubhankar Da aane waale hain (Brother Shubhankar is about to come)”. The movie is based around the freedom struggle and the hope every time the lines are said is that the man called Shubhankar will come and set everything right.

Shubhbankar, played by Jackie Shroff, does come, just before the interval shot. Things become messier after his arrival, though eventually, like in all good Hindi films, everybody lives happily ever after.

Dear Reader, you must be wondering why am I talking about a 23-year-old movie which everyone has forgotten about by now, except for its marvellous songs composed by RD Burman.

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

And it is expected to play the role of Shubhankar in the real estate sector in India. It is expected to come and set everything alright, at least that is the impression that has been given by many real estate experts in the media. But how correct is that?

RERA is basically a central Act. Given this, state governments do not need to pass separate Acts in order to implement it. But land is a state subject and given this the rules needed to implement the Act, need to be formulated and notified by the state governments. Many states are yet to come up with these rules.

As rating agency ICRA points out in a research note: “Except Uttar Pradesh, Gujarat, Madhya Pradesh, Maharashtra, Andhra Pradesh, Orissa, Bihar and the Union Territories, most have missed the deadline to notify its rules under the… Act.”

This tells us how serious the various state governments are about implementing the Act. Over and above this, the RERA mandates that every state set up its own real estate regulator. It so happens that Madhya Pradesh, Maharashtra and Rajasthan, are the only states up until now to have set up a real estate regulator. “Certain other states have set up interim regulatory authorities (as permitted under the Act),” ICRA further points out.

Also, as a newsreport in the Mint points out, Maharashtra is the only state that has set up a website where the real estate developers can register to set up new projects under the RERA.

Given that most states haven’t gotten around to setting up the real estate regulator and a website, this is something that will take time as they go around meeting the physical infrastructure and human resources requirements of the regulator as well as the website. And given this, RERA will not actually be implemented across large parts of the country, for some time to come.

Also, states which have formulated the rules to implement the RERA have diluted them in comparison to the rules framed by the union government. Take the case of Gujarat. Only projects launched on or after November 1, 2016, come under the aegis of the Act.

On the other hand, the central government Act defines ongoing projects as projects “for which the completion certificate has not been issued” on the date of commencement of the Act. This essentially allows many projects which are still work in progress not to come under the RERA.

Haryana, another state ruled by a BJP government, has done something along similar lines to help keep ongoing projects outside the ambit of the RERA. 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, as was the case in Gujarat, is another ploy to get around the central government Act’s definition of an ongoing project.

In Maharashtra, a new nomenclature called proposed plans has been introduced and proposed plans instead of sanctioned plans can be submitted to the regulator. In the case of RERA only the term sanctioned plans has been used and only sanctioned plans can be submitted to the regulator.

As per the RERA any changes made to the sanctioned plans needs the written consent of allottees in the project. As the bare Act points out: “Any other alterations or additions in the sanctioned plans, layout plans and specifications of the buildings or the common areas within the project without the previous written consent of at least two-thirds of the allottees, other than the promoter, who have agreed to take apartments in such building.”

In case of Maharasthra, the usage of the term proposed plan is basically being seen as a way of getting around the written consent of the two-thirds of the allottees, if the builder goes around making changes to the project.

Over and above this, the Maharashtra rules point out that a phase of a project “may consist of a building or a wing of the building in case of building with multiple wings or defined number of floors in a multi-storeyed building/wing”. This has again been done to give flexibility to the builder to operate in the way he wants to, without following the letter and spirit of RERA. It allows the builders to keep developing projects on a piecemeal basis, something that they excel at.

In Delhi, the rules allow the builder to give details of only those legal cases where courts have already given a deicision. He does not have to provide details of cases which are still on. This directly contradicts Section 4.2 (b) of RERA which essentially states that the builder needs to provide: “a brief detail of the projects launched by him, in the past five years, whether already completed or being developed, as the case may be, including the current status of the said projects, any delay in its completion, details of cases pending, details of type of land and payments pending.”

In the time to come more such dilutions will keep coming out. The trouble right now is that operational rules of all states are not available in English and hence, it’s difficult to get a pan India perspective.

So, the question is why are state governments diluting the implementation of the RERA? The simple answer lies in the fact that there is a nexus between the builders and the state governments. Currently, the regulations governing the real estate sector vary from state to state and are inherently complicated. Given this, anyone wanting to be even a marginally serious player in the real estate business, needs to be in the good books of local politicians. This also explains why there are no pan India real estate companies. Forget pan India, there are no real estate companies which operate through an entire state.

The politicians also see real estate to be a cash cow which helps them generate money to fight elections as well as enrich themselves. This explains why regulations governing the sector continue to be complicated. In many states, the politicians are builders themselves though they have other individuals fronting for them. In such a scenario expecting the RERA to be implemented properly is nothing but day dreaming. For politicians, it makes sense if RERA is not implemented in letter and spirit. Given that politicians benefit from builders, a diluted RERA is their way of a quid pro quo.

If RERA has to be implemented properly the nexus between the politicians and the builders at the state level needs to be broken. And for that to happen, one of the first things that state governments need to do is get rid of change in land usage regulations that are currently in force. Only once this happens will things start to roll.

To conclude, Shubhankar Da may have been effective in 1942—A Love Story, RERA in its current form will become yet another regulation which won’t achieve much.

The column originally appeared on The Huffington Post on May 3, 2017