The Delusional Optimism of India’s Real Estate Companies

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

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

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

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

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

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

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

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

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

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

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

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

non govt GDP growth

Source: Centre for Monitoring Indian Economy.

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

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

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

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

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

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

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It’s Time Enforcement Directorate(ED) Investigated “Errant” Real Estate Companies for Money Laundering

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Many real estate companies around the National Capital Region have taken money from homebuyers over the years, and failed to deliver homes. Some of these companies have also defaulted on bank loans.

Take the case of Jaypee Infratech, one such company, which has been in the news lately. The company has collected anywhere from 70 to 100 per cent of the price of the homes that they were selling, from around 27,000 buyers. These buyers have paid anywhere between Rs 40 lakh each to Rs 1 crore each, to the company.

On the other hand, the company has defaulted on a loan of Rs 526 crore.

Or let’s take the case of Amrapali Group. One of the group companies (Amrapali Silicon City Private Ltd.)  has defaulted on a loan amount of Rs 59.38 crore. Over and above this defaulted amount, overdue interest and penal interest adds to another Rs 11.77 crore.

This takes the total amount to a little over Rs 71 crore. On the other hand, a newsreport in The Times of India suggests that there are nearly 45,000 homebuyers to whom the Amrapali group hasn’t delivered the promised homes.

A report in the Business Today suggests that the group “owes over Rs 1,000 crore to about 10 banks”.

When a debtor defaults, the banks can file an application under the Insolvency and Bankruptcy Code, 2016, with the National Company Law Tribunal, to trigger the Corporate Insolvency Resolution Process and appoint an insolvency resolution professional.

Under this, the existing board of the company is suspended. The professional has 180 days to come up with a workable solution for the company to be able to repay the loans it has defaulted on. This can be extended by another 90 days. At the end of 270 days if no solution is in sight, then a liquidator is appointed.

The trouble is that currently the homebuyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated. Some suggestions have been made that the homebuyers can be compensated under Section 53(1)(f) of the Insolvency and Bankruptcy Code. This is after workmen, secured creditors, employees other than workmen, unsecured creditors, amounts owed to the central and the state government, etc., have been compensated and before preference shareholders and equity shareholders, are compensated.

In fact, Section 53(1)(f) lists “any remaining debts and dues,” under it. The question is can the money handed over by the homebuyers to these real estate companies be treated as debt? From the legal point of view this does not make sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. Even with this point, the homebuyers come to low in the hierarchy to hope to be compensated at the end of the liquidation process.

In the case of Jaypee Infratech, where the buyers went to the Supreme Court, in order to stall the insolvency resolution process, the Court has directed the insolvency resolution professional to come up with an interim resolution plan within 45 days. This plan is expected to take into account the interests of homebuyers i.e. those people who paid Jaypee Infratech for homes that were never delivered.

The Supreme Court needs to basically decide whether homebuyers can be categorised as financial creditors or not.

But does not answer the basic question: Where did the money that the homebuyers handed over to the real estate companies, actually go? This is an important question to ask because the bank loans that the developers have defaulted on are really very small, in comparison to the total amount of money they have raised from homebuyers and siphoned off.

Take the case of Jaypee Infratech. The company has defaulted on a Rs 526 crore loan from IDBI Bank. In comparison, various media reports and suffering homebuyers suggest, that the company has taken on more than Rs 20,000 crore from homebuyers. Where did this money go?

Given this, the bank defaults and the non-delivery of homes are two separate issues, and they need to be treated separately.

Of course, Jaypee Infratech is not the only company here. There are many other companies. A newsreport in The Hindustan Times suggests that 13 FIRs were filed against six such companies, Amrapali, Supertech, Alpine Realtech Private Limited, BRUY Limited, Today Home Builders and JNC developers, in early September 2017.

The question is where did the money all these companies and others, raised from homebuyers disappear? Did the promoters pad up the expenses and tunnel this money out to buy land? Or did they simply siphon this money off? Or did they use it to complete other projects? And if that was the case, where did the money that was raised for these other projects go? It clearly seems that money has been laundered by promoters of these companies.

Unless, these questions are answered and the homebuyers’ money recovered from the errant real estate companies, there is no way that this issue can be solved.

Hence, the questions listed above need to be investigated. Given that FIRs have already been filed against many real estate companies which have not delivered on homes, under the required sections of the Indian Penal Code, the Enforcement Directorate can register cases against these companies and carry out detailed investigations under the Prevention of Money Laundering Act (PMLA).

Of course, this would mean investigating many companies, but the modus operandi of laundering money in many cases would be similar. At the same time, this can set the record straight for the future. If housing for all is to be achieved by 2022 (or even 2032 for that matter), the private real estate companies need to play an important role in it. And given that, it is important that the errant real estate companies not be allowed to get-away with the crime that they have committed against the homebuyers.

A precedent needs to be set, so that in the future, things like these do not happen all over again. It is also an excellent opportunity for prime minister Narendra Modi to revive his fight against black money and show some concrete action on this front. The hard-earned money of most homebuyers has been laundered and converted into black money and that needs to be tackled.

The column originally appeared on Equitymaster on September 18, 2017.

How Do You Solve a Super-Mess Like Jaypee Infratech

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The real estate company Jaypee Infratech will go through insolvency proceedings. Earlier, this week, the Supreme Court asked the insolvency resolution professional to take over the management of the company. The insolvency resolution professional has also been asked to submit an interim resolution plan within 45 days. This plan is expected to take into account the interests of homebuyers i.e. those people who paid Jaypee Infratech for homes that were never delivered. In doing this, the Supreme Court modified an earlier order.

Here is an excellent example of messy situation which has probably got messier.
Jaypee Infratech has defaulted on a loan of Rs 526.11 crore from IDBI Bank. At the same time, the company took money from 32,000 prospective homebuyers with a promise of delivering homes. How much money was raised from these homebuyers? The numbers in the media vary from Rs 17,000 crore to Rs 25,000 crore.

This basically means that an average buyer paid Jaypee Infratech anywhere between Rs 53 lakh to Rs 78 lakh. That is clearly a lot of money. The Bankruptcy and Insolvency Code in its current form does not leave anything for the buyers. The homebuyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated.

From the legal point of view this makes sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. But then given that thousands of families are involved, should only the legal view prevail is a question even though tricky, worth asking. The Supreme Court now needs to decide whether the buyers are financial creditors or not.

Of course, the bureaucrats who wrote the bankruptcy code did not take the real estate sector and the way it operates, into account.

Let’s consider the situation with Jaypee Infratech. It has defaulted on a loan worth Rs 526 crore. The company would have offered an asset(s) as a collateral or a security against this loan. This asset can be sold and IDBI Bank can get the money, back. Of course, it may or may not get the entire defaulted loan amount back. This would depend on the current market value of the asset(s) offered as a collateral.

Of course, in the current scheme of things, the homebuyers are nowhere in the picture. The insolvency resolution professional has to come up with a plan that can correct for this scenario. One of the things that could possibly be looked at is to handover the project to another builder who can complete the project. But this builder would need more money for it. Where will this money come from? Will the buyers who have already paid anywhere between Rs 53 lakh to Rs 78 lakh on an average, be in the mood, to handover more money? More than the mood, will they have more money to handover? We aren’t talking exactly about small amounts here.

Further, if there is talk of compensation from selling the collateral, what sort of compensation can the buyers look at? The asset that Jaypee Infratech must have offered as a collateral was for a loan worth Rs 526 crore. How would that be enough to compensate 32,000 homebuyers who had invested anywhere between Rs 17,000 crore to Rs 25,000 crore in total, with Jaypee Infratech.

Another option is sell the half-built apartments (or in whatever shape they are in) to a new builder and then use that money to compensate the buyers. Of course, in this case, the buyers will have to take a haircut (i.e. they will not get their full money back). Also, will other builders be ready to buy in this environment where the real estate sector isn’t exactly going anywhere.

Jaypee Infratech defaulted on the loan it took from IDBI Bank. It also took a lot of money from homebuyers and did not deliver apartments. Where has all this money gone? Has it been siphoned off? Has it been used to build a landbank? Has it been used to complete previous projects? If it has been used to complete previous projects, then where did the money collected for those projects, go? Or has it been diverted to other group companies?

The bankruptcy and insolvency code in its current form does not allow for a forensic audit of companies which have defaulted on bank loans. But that is precisely what is required in case of Jaypee Infratech to figure out where did such a huge amount of money disappear. The amount that has been siphoned off from buyers is so huge that it cannot be repaid using the assets that may have been offered as a collateral against the bank loan which has been defaulted on.

Of course, any forensic audit will take time. But there is hardly any other market based solution that can be arrived at. Further, a situation as messy as this one is, cannot be set right in a short period of time. Also, it will set the tone for other similar cases, which are bound to come up in the days to come.

In the days to come, there will be great pressure on the government to bailout the homebuyers and if not that, at least compensate them to some extent. The government needs to resist this because if it doesn’t, it will send up setting a bad precedent.

The larger point here is that in this case the bank default is hardly an issue. The bigger issue is the fact that such a huge amount of money has been siphoned off from the homebuyers. The learning here is that the cases of bank defaults and homes not being delivered, are two separate cases and need to be considered separately as well. The central government now needs to work actively towards a market based solution.

Meanwhile many homebuyers will continue paying an EMI on the home loans they took to buy their dream homes. They would be paying money towards an asset which they won’t be getting their hands on, anytime soon. They will also have to continue paying a rent for the homes that they currently live in. Of course, this is not a great situation to be in.

But then that’s how big the mess in India’s real estate sector is. And that is not going to change anytime soon.

The column originally appeared on Firstpost on September 13, 2017.

India’s Big and Messy Real Estate Ponzi Scheme, Just Got Messier

 

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Over the last few years, many real estate companies across the country, particularly in Delhi and the National Capital Region (NCR), have taken money from home buyers and not been able to deliver promised homes on time.

Some of these companies have also taken loans from banks and defaulted on those loans as well. Basically, these companies have taken money from home buyers, they have also taken loans from banks, and still been unable to deliver the promised homes. In some cases, real estate companies have already booked sales on homes they are yet to deliver.

The question is where has this money gone?
I think there are two answers to the question. 1) Promoters of real estate companies have siphoned off a part of the loans they took on from banks and the money they took from buyers. 2) This money has been diverted for other uses, like completing previous projects and buying more land (or to put it in real estate parlance for building a formidable land bank).

Banks are now looking to recover their bad loans from real estate companies. And at the same time, the buyers are also hopeful that someday their dream homes will be delivered to them.

There are several interesting issues that crop up here:

a) It is now more or less clear that the real estate companies had been happily running a Ponzi scheme. A Ponzi scheme is basically a financial scam in which investors are promised very high returns. The money being invested by the second set of investors is used to pay off the first set. The money invested by the third set of investors is used to pay off the second set and so on. A Ponzi scheme runs until the money being invested in the scheme is greater than the money that is going to redeem the investment of the early investors. The moment this reverses, the scheme collapses.

The real estate companies essentially followed this model. They announced a new real estate project and then raised money against it. This money was then used to buy more land or simply siphoned off. Then a new project was announced. The money raised against the new project was used to complete the earlier project. Of course, I am simplifying things a bit here, but that was the basic modus operandi.

The key in this method of selling homes was the ability to keep launching new projects. Over the years, as real estate returns fell, the ability of real estate companies to launch new projects came own drastically. Once this happened, they couldn’t raise enough money to complete their existing projects. And this led to many buyers being left stranded in a rented home.

b) The inability to deliver on promised homes along with low returns has put off people from investing in real estate. The falling interest in owning real estate becomes clear from the savings figures as well. As per the recently released annual report of the Reserve Bank of India, in 2012-2013, savings in physical assets made up for 14.4 per cent of the gross national disposable income (GNDI). By 2015-2016 this had fallen to 10.7 per cent of the GNDI. GNDI is a concept similar to GDP which also takes remittances from abroad and food aid into account. India’s GNDI is around 1.03 times its gross domestic product.

c) A bulk of the buyers had bought homes by taking on home loans from banks. They are currently paying EMIs against these loans. They are also paying a rent to live in the homes that they currently do. Given this, they are monetarily stretched. Further, they are paying an EMI for an asset which they haven’t got as yet and will probably never get in the form they had originally envisaged.

d) When prospective buyers take a home loan from a bank, the home they are buying is the collateral or the security against the loan that is taken. In many cases, the real estate companies have offered these homes against which home loans had already been taken, as a collateral to the banks, and taken on more loans. So, the buyers have been taken for a ride here. Also, the question is how have banks allowed dual financing on the same asset?

It is worth remembering here that many real estate companies which have defaulted on banks loans and delivering homes, worked on a pay as you build model. This basically meant that these companies got paid in instalments from the buyers at every stage of construction.

Hence, the homes were technically owned by the buyer (or to put it more specifically the bank from which the buyer had taken on a home loan) and could not have been offered as a collateral, without the consent of the buyer. Nevertheless, that seems to have happened. This is something that the banks need to explain. (In case you want to understand dual financing in even more detail click here and here).

e) So, where does that leave the buyer? Recently, bankruptcy proceedings have been started against Jaypee Infratech which took money from more than 30,000 buyers and did not deliver on the promised homes. At the same time, it has defaulted on bank loans. The Supreme Court has stayed these proceedings.

The Bankruptcy and Insolvency Code in its current form does not leave anything for the buyers. The buyers are not on the list of entities that will be compensated for payment of what is due to them once the company is liquidated. From the legal point of view this makes sense given that the money that the buyers had handed over to the real estate companies was basically an advance and not a loan. But then given that thousands of families are involved, should only the legal view prevail is a question even though tricky, worth asking.

Of course, the bureaucrats who wrote the bankruptcy code did not take the real estate sector and the way it operates, into account. This is something that the government should hopefully correct for in the days to come.

f) Suggestions are now being made that like the banks, the buyers should also be ready for a haircut (i.e. be ready to accept a part of the money they had invested with a real estate company to buy a flat and not the entire amount). The trouble with this argument is that for the banks, the bad loans of real estate companies are just a part of their overall bad loans. For the buyers, the money they invested with real estate companies was probably the biggest investment they ever made and if they have to take a haircut on it, they will probably never recover financially from it.

The Supreme Court now needs to decide whether the buyers are financial creditors or not. This is a tricky question, which I shall elaborate on later in the days to come.

g) In all this, the real estate promoters seem to be having the last laugh. A part of the money they borrowed from banks and took from real estate buyers, has been tunnelled out. It is hardly likely that the bankers will be able to go after their other assets (i.e. the land bank they built by tunnelling out money) in order to recover their loans. Hence, they have clearly managed to limit their losses.

In fact, in a fair world, the balance sheets of these real estate companies would have been subjected to forensic accounting in order to figure out where did the money go. But the bankruptcy code has no such provision. If it did that would inevitably delay the resolution process.

And this brings me back to the point that I keep making for all my readers who forever seem to want solutions to all problems; everything in India does not have a clear solution.

Of course, now the central government will have to get involved if this issue has to be sorted at any level. I only hope that they try and arrive at a private sector solution and the taxpayer money is not used in any form. Already, a section of the real estate sector is talking about a government bailout. If the builders in India don’t have money, who does?

To conclude, the mess in the real estate sector in India is an excellent example of what follows when a Ponzi scheme goes bust. And as they like to say in Hollywood films, you ain’t seen nothin’ yet. Keep watching.

The column originally appeared on Equitymaster.com on September 11, 2017.

Why Basic Economics is Not Working in Indian Real Estate

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Over the weekend I appeared on the CNBC Awaaz’s Pehredar show, discussing what else but the ‘sad’ state of India’s real estate.

At some point of time we started discussing the unsold inventories of builders. I have always been of the view that the builders won’t be able to sell these homes unless they cut prices. The representative of the builders on the show took offense at what I said and was of the opinion that they had already cut prices by as much as they could, and a further cut in prices wasn’t possible.

I said what I did on the logic that if prospective buyers are not interested in buying at the current prices, they might see value once builders lower prices. The question is whether the builder wants to unload his inventory or not. If he wants to unload his inventory then he has to cut prices irrespective of the fact whether he is making money on the deal or not.

The market doesn’t care about that simply because the buyers are not interested in buying at current prices. Also, it is worth remembering that builders are not the only ones carrying a huge unsold inventory of homes.

There are huge number of investors (both professionals as well as amateurs) who have bought homes over the years, in the hope that prices will continue to rise at the same pace as in the past. Hence, the real unsold inventory of homes is many times the unsold inventory of builders. And if this inventory has to be cleared, then prices need to fall.
When the supply of any product is higher than its demand, then prices need to fall, that is how the demand will go up, and the supply will match demand. But for that to happen in the context of Indian real estate, the builders need to be willing to cut prices, which they aren’t. Why?

The first reason on offer is that they are already selling homes at almost the cost price (in some parts of the country). Any further cut in price, would mean selling at a loss, which they aren’t willing to do. I am neither a civil engineer nor an architect to be able to verify this claim. So, I really don’t know how valid this claim is.

But there is another reason why the builders (and their bankers) may not want to cut prices. And this is something the builders are not saying. At least, not in public. Hence, this seems to be the more likely reason. Builders have raised loans from banks and other sources. Against these loans the unsold inventory of homes has been offered as a collateral. If the prices of these homes are cut, then builders may have to offer more collateral to their lenders, which is something they are either not in a position to do or don’t want to do.

In fact, if you look at the total lending by banks to commercial real estate, it stood at Rs 1,77,064 crore. It was down by 3.8 per cent from April 2016 and it forms around 2.6 per cent of total non-food lending of banks.

Given this, builders are likely to stick to their current prices, even if they are not making any sales. As I said earlier, there is much more unsold inventory in the market than just with builders.

So, what about the investors, why are they not ready to cut prices? Some of them are anchored on to the prices at which their friends, relatives and acquaintances, had sold homes in the past. They want similar prices for their homes as well and haven’t adjusted to what is the new normal. There are still others who can’t get themselves to sell at a price which is lower than the price at which they had bought. So, they are waiting for the price to recover.

This is something that varies from buyer to buyer and how desperate he or she is to sell out.

Then there is another lot, which is simply waiting for enough indexed long-term capital losses to accumulate, before they think of selling. This will turn out to be the case given that real estate prices haven’t really gone anywhere over the last few years, especially once inflation is factored in.

Another major factor hampering sales is the lack of ‘enough’ cash in the market, given that sellers still want a part of the payment to be made in black. While the process of black money generation and accumulation has re-started post-demonetisation, it will take some time before it reaches pre-demonetisation levels.

Investors who bought real estate over the years, carried out a certain portion of the transaction in black i.e. they paid in cash. Hence, now even if they want to sell what they own, they can’t carry out an all-white transaction. A certain portion of the transaction needs to be carried out in black. And as I said earlier, there isn’t enough cash going around in the financial system.

Further, even those who are in a position to sell out, don’t know what they could possibly do with the money that they get. There is a huge reinvestment risk. Real estate is down in the dumps. The stock market is at an all-time high level. Gold hasn’t gone anywhere in years. And bank interest rates are at extremely low levels. Hence, the tendency is to hold on to the homes, not sell them at lower prices.

The larger point is that home prices have to fall till they interest the prospective buyers. Whether that price is viable for a builder or the investor, is not the question here.
We are beyond that stage now. The market will only clear once the prospective buyers become interested. Currently, they aren’t.

Builders who need to make massive debt repayments and do not have enough money going around are the ones who are more likely to cut prices than others. A Pune based developer DS Kulkarni has been defaulting on fixed deposit interest for a while now. He is likely to pulldown prices in the Pune market.

Many people bought homes assuming that the future will be similar to the past. Given the huge inventory of homes in the market, there is no way the prices are going to rise at the same pace as they had in the past. I will be surprised if anyone makes any return out of real state after adjusting for all the expenses, over the next few years. This is without getting into factoring inflation and the risk of owning real estate.

If builders don’t cut prices, we will see the deadlock continuing for a few years more till prices become viable in inflation adjusted terms. This is assuming that salaries and bonuses start to recover soon.

So, if this continues, I guess anyone looking at real estate as a viable investment option, will have to wait for a few years more, perhaps till 2022 (Don’t ask me why 2022. It’s just that it is not too near like 2019 and not too far like 2027).

The column originally appeared on Equitymaster on August 28, 2017.

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

250px-Underconstruction_Building

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.