Real Estate: Next Bubble to Burst?
An Interview with Prof Venkatesh Panchapagesan
While the spotlight so far has been on the rupee and the equity markets, real estate prices have started to bear the impact as well. Experts believe that the endgame of speculation in Indian real estate has begun. Is real estate the next in line to collapse?
Yes, it is true that real estate prices have started to decline, both in the residential market as well as in the commercial market. NHB's Residex, which tracks residential prices in a few cities, had started to decline even before the rupee started to unravel. Adding to that, the inventory of unsold homes has been going up steadily as well. Certainly things are not looking good for the sector. Growth is stalling (we are now to 4% growth rates from the heady 8-9% a few years back), currency is at an all-time low, interest rates have shot up, elections are coming along with the dole outs that normally follow and so on. All of these should impact the real estate sector as they influence the incentives of key players in this market. However, on the specific question of whether the real estate bubble in India is about to pop, I think it has to. Except that we may not hear it. Indian real estate market is notoriously opaque and controlled by vested interests that it will be hard to see the impact that one would normally expect in, say a developed market, given these economic conditions.
Some local and regional markets may continue to thrive even in these tough conditions. For example, Bangalore may fare relatively better because of the predominance of joint developments (where land owner and developer join hands) and its reliance on the IT sector that has been given a fillip by the depreciation of the rupee. Joint developments make it easier for developers as they don't need to borrow big to buy land.
Let me mention a few factors that I believe will have a big impact on the prospects of this sector. First, the slowdown in the economy will make people think twice before lining up to buy a property, whether it is their first or second one. For working professionals, high inflation will eat into what they can spare for their home EMIs. For the businessmen and self-employed, the slowdown will directly lower their surplus that they can park in a property. Second, financing has just gotten more difficult for this sector because of what happened in the last few months. Already banks have been slowing down their exposure to this sector leaving most of developers to either depend on the shadow economy or private players such as NBFCs (non-banking finance companies) and PEs (private equity). The hit on the currency has definitely scared the overseas PE players as their returns just got reset by 20%.
Unless developers have access to land, I cannot imagine them lining up financing to buy it under the current prices. The government, through its passage of the Land Acquisition Bill, has just made it more difficult for the developers by diminishing their bargaining position vis a vis land owners, especially the farmers. Moreover, the Real Estate Regulatory Bill is on the horizon that will further curtail the degrees of freedom that developers have, such as being able to move funds from one project to another. If you add to these, increases in construction cost through increases in cement and steel prices (which depend on imported coal) and a slowdown in investor demand, why would any developer in her sane mind want to develop new property?
There is also one more conjecture that I would like to make. I am calling it a conjecture as we don't have data to prove this. Real estate has always attracted people with dubious backgrounds partly because of the opaqueness and lack of sensible regulation. Though no one has estimated it well, most of us are aware that black money is rampant in this sector. It is also known that black money surfaces during election cycles to partly fund party objectives. Therefore, it would not be inconceivable to imagine that black money may be sucked out of this sector in the months leading up to the election which may further reduce financing options for developers or force them to sell their inventory at a discount. There is one prior academic study - done by the Center for Global Development - that is consistent with this hypothesis. The authors of the study looked at cement prices and election cycles, and found that cement prices have fallen systemically during election cycles. Their hypothesis is that politicians park their illicit assets with builders who may need to return them during election cycles.
Overall, I definitely think there will be a decent price correction in residential house prices over the next few years, even if it doesn't look like a slide that the rupee went through.
RBI is sucking out liquidity like a sponge and the sector that will be most affected is real estate. Added to this is the exit of private equity (PE) players from the market. What should the government do in such a scenario?
I wouldn't say that RBI is sucking out liquidity. In fact, with slow growth projections, it is expected to do the opposite to stimulate demand. What we have seen over the last few weeks is a shift in the epicentre for global capital, from the emerging markets to the developed markets. In other words, the trigger for what we saw had to do more with what was happening in the US rather than what was happening in India. Unfortunately, we did not take care of some fundamental issues when times were good that made us more vulnerable to these global shocks.
But the point remains the same. Cheap foreign capital is no longer guaranteed for us. We now have to compete for this capital with projects from the developed world including Japan, which like Kumbhakarna, is showing signs of coming out of deep slumber. Most investors, whether they are foreign or domestic, look for return that can be realized. They do not care about the Indian growth story if they cannot realize profits in a meaningful time frame. Many private equity players, who had funded a large part of the previous construction boom, have either exited at a loss or have been unable to exit. The currency depreciation has also overnight wiped out 20 percent of their return. I cannot imagine how they could raise money overseas for future projects in India anytime soon. The irony is that India still needs large investments in infrastructure, including land development, more so now to dig itself out of this slowdown.
While there aren't many ways to quickly channelize capital to this sector, it is best that we let the price correction run its course. Real estate prices have increased to such an extent that much of India's population has been priced out of this market. A two bedroom apartment in a Mumbai suburb is in the range of 1.5-2 crores. To bring back consumers into this market, prices have to decline, especially as we expect incomes to decline in the next few years.
Meanwhile, the government can do simple things that can help once the market turns around. For one, it should actively seek to streamline the processes that burden land development today. Many developers, including those in the affordable housing segment, complain about the maze of approvals that need to be sequentially obtained before the shovel can hit the ground. Delays in project completion that tend to put off financiers are more because of the uncertainty in the approval process than anything else. The government can capitalise on the grim situation and force through changes like one-stop approval window that will help attract capital. I feel only a structural change can attract serious, long-term capital while a financial or tax sop would only attract short-term investors who will flee at the first sight of trouble.
A recent Business Standard report points out that of the 26 cities surveyed by the National Housing Bank (NHB), as many as 22 including Delhi, Mumbai, Pune, Bangalore and Chennai saw a drop in property prices during the April-June quarter, compared to the first quarter of this calendar year. An all-round squeeze in liquidity and dearth of buyers have led to a fall in prices across the country. Do you agree?
As mentioned before, the decline in real estate prices is happening though at a slower rate than what one would expect if the market was more transparent. Most people that I talk to seem to believe that house prices in India will never go down. Sometimes it may be true if they are referring to "nominal" prices that do not adjust for inflation. Unlike stocks and bonds, real estate is a local market where several factors may uniquely influence a property's worth. A house may fetch a much less price than another house in the same street because of various factors including faith-based ones such as Vaastu. So it is very hard to come up with one statistic that describes what is happening across the whole market. In many developed markets, this problem is partly circumvented by examining repeat sales data. That is, we examine prices of the same house over time to see whether it has gone up or down relative to inflation. In India, it is hard to find any transaction data, let alone data on the same property over time.
You mention liquidity squeeze which I rephrase as financing squeeze. Slowness in buyer demand is definitely one factor that has an impact. Developers had been savvy for quite some time now in the face of reduced investor demand not to lower prices. I think the macroeconomic shocks were like the proverbial last straw. No longer can they justify holding inventories expecting demand to resurface. They have already started testing the waters by providing incentives to buyers. It is only a matter of time before they start giving discounts explicitly. The people who are going to be really caught up in this are those who had sought to buy property in the last couple of years. It is entirely possible that developers would stall new development and focus on reducing inventory at lower prices. These buyers would have been better off buying properties off the shelf than waiting for a custom built one that may take several years.
And as I mentioned earlier, the price decline may speed up as we get closer to the elections.
Given this background - lowering prices, do you see a spike in NRI investments in the housing sector?
I think NRI money will come, with a lag. I believe they will wait till currency stabilizes before increasing their investment in the sector. We have seen in the last month greater money coming in from the Gulf countries. While this trend will continue but the real investment in projects by NRIs will increase only after they get confident about the value of the rupee may not change after they make their move. NRIs will especially impact investment-driven markets like Mumbai and NCR Delhi more so than occupier-driven markets like Bangalore.
The Real Estate Research Initiative, at IIMB, has been born at an exciting time. What is your priority for this Centre of Excellence?
We are in the kindergarten of research on this sector. We have actively decided to pursue a strategy of data collection and research that is more of an academic nature than spouting policy prescriptions. We believe that good data leads to good research, which in turn leads to good policy. We don't want to jump into policy discussions early without data and analysis to back us up.
We believe information about the real estate industry is currently controlled by vested interests that make policy formulation difficult for want of alternatives. We want to provide the key stakeholders with good objective research that is transparent and can be replicated easily by others. We also want to take the initiative in building data necessary for such research so others can join us in bringing sunlight into this industry. We thank IIMB and Century Real Estate for encouraging us and providing us with support. Despite being a small team, we have been able to accomplish much over the last year through data and original research. We expect to carry this momentum this year and hope to take on larger research projects. We invite the broader IIMB fraternity to join us as this sector is like a green field waiting to be explored.
(Interviewed by Kavitha Kumar and Pragathi K.)
Real Estate: Next Bubble to Burst?
An Interview with Prof Venkatesh Panchapagesan
While the spotlight so far has been on the rupee and the equity markets, real estate prices have started to bear the impact as well. Experts believe that the endgame of speculation in Indian real estate has begun. Is real estate the next in line to collapse?
Yes, it is true that real estate prices have started to decline, both in the residential market as well as in the commercial market. NHB's Residex, which tracks residential prices in a few cities, had started to decline even before the rupee started to unravel. Adding to that, the inventory of unsold homes has been going up steadily as well. Certainly things are not looking good for the sector. Growth is stalling (we are now to 4% growth rates from the heady 8-9% a few years back), currency is at an all-time low, interest rates have shot up, elections are coming along with the dole outs that normally follow and so on. All of these should impact the real estate sector as they influence the incentives of key players in this market. However, on the specific question of whether the real estate bubble in India is about to pop, I think it has to. Except that we may not hear it. Indian real estate market is notoriously opaque and controlled by vested interests that it will be hard to see the impact that one would normally expect in, say a developed market, given these economic conditions.
Some local and regional markets may continue to thrive even in these tough conditions. For example, Bangalore may fare relatively better because of the predominance of joint developments (where land owner and developer join hands) and its reliance on the IT sector that has been given a fillip by the depreciation of the rupee. Joint developments make it easier for developers as they don't need to borrow big to buy land.
Let me mention a few factors that I believe will have a big impact on the prospects of this sector. First, the slowdown in the economy will make people think twice before lining up to buy a property, whether it is their first or second one. For working professionals, high inflation will eat into what they can spare for their home EMIs. For the businessmen and self-employed, the slowdown will directly lower their surplus that they can park in a property. Second, financing has just gotten more difficult for this sector because of what happened in the last few months. Already banks have been slowing down their exposure to this sector leaving most of developers to either depend on the shadow economy or private players such as NBFCs (non-banking finance companies) and PEs (private equity). The hit on the currency has definitely scared the overseas PE players as their returns just got reset by 20%.
Unless developers have access to land, I cannot imagine them lining up financing to buy it under the current prices. The government, through its passage of the Land Acquisition Bill, has just made it more difficult for the developers by diminishing their bargaining position vis a vis land owners, especially the farmers. Moreover, the Real Estate Regulatory Bill is on the horizon that will further curtail the degrees of freedom that developers have, such as being able to move funds from one project to another. If you add to these, increases in construction cost through increases in cement and steel prices (which depend on imported coal) and a slowdown in investor demand, why would any developer in her sane mind want to develop new property?
There is also one more conjecture that I would like to make. I am calling it a conjecture as we don't have data to prove this. Real estate has always attracted people with dubious backgrounds partly because of the opaqueness and lack of sensible regulation. Though no one has estimated it well, most of us are aware that black money is rampant in this sector. It is also known that black money surfaces during election cycles to partly fund party objectives. Therefore, it would not be inconceivable to imagine that black money may be sucked out of this sector in the months leading up to the election which may further reduce financing options for developers or force them to sell their inventory at a discount. There is one prior academic study - done by the Center for Global Development - that is consistent with this hypothesis. The authors of the study looked at cement prices and election cycles, and found that cement prices have fallen systemically during election cycles. Their hypothesis is that politicians park their illicit assets with builders who may need to return them during election cycles.
Overall, I definitely think there will be a decent price correction in residential house prices over the next few years, even if it doesn't look like a slide that the rupee went through.
RBI is sucking out liquidity like a sponge and the sector that will be most affected is real estate. Added to this is the exit of private equity (PE) players from the market. What should the government do in such a scenario?
I wouldn't say that RBI is sucking out liquidity. In fact, with slow growth projections, it is expected to do the opposite to stimulate demand. What we have seen over the last few weeks is a shift in the epicentre for global capital, from the emerging markets to the developed markets. In other words, the trigger for what we saw had to do more with what was happening in the US rather than what was happening in India. Unfortunately, we did not take care of some fundamental issues when times were good that made us more vulnerable to these global shocks.
But the point remains the same. Cheap foreign capital is no longer guaranteed for us. We now have to compete for this capital with projects from the developed world including Japan, which like Kumbhakarna, is showing signs of coming out of deep slumber. Most investors, whether they are foreign or domestic, look for return that can be realized. They do not care about the Indian growth story if they cannot realize profits in a meaningful time frame. Many private equity players, who had funded a large part of the previous construction boom, have either exited at a loss or have been unable to exit. The currency depreciation has also overnight wiped out 20 percent of their return. I cannot imagine how they could raise money overseas for future projects in India anytime soon. The irony is that India still needs large investments in infrastructure, including land development, more so now to dig itself out of this slowdown.
While there aren't many ways to quickly channelize capital to this sector, it is best that we let the price correction run its course. Real estate prices have increased to such an extent that much of India's population has been priced out of this market. A two bedroom apartment in a Mumbai suburb is in the range of 1.5-2 crores. To bring back consumers into this market, prices have to decline, especially as we expect incomes to decline in the next few years.
Meanwhile, the government can do simple things that can help once the market turns around. For one, it should actively seek to streamline the processes that burden land development today. Many developers, including those in the affordable housing segment, complain about the maze of approvals that need to be sequentially obtained before the shovel can hit the ground. Delays in project completion that tend to put off financiers are more because of the uncertainty in the approval process than anything else. The government can capitalise on the grim situation and force through changes like one-stop approval window that will help attract capital. I feel only a structural change can attract serious, long-term capital while a financial or tax sop would only attract short-term investors who will flee at the first sight of trouble.
A recent Business Standard report points out that of the 26 cities surveyed by the National Housing Bank (NHB), as many as 22 including Delhi, Mumbai, Pune, Bangalore and Chennai saw a drop in property prices during the April-June quarter, compared to the first quarter of this calendar year. An all-round squeeze in liquidity and dearth of buyers have led to a fall in prices across the country. Do you agree?
As mentioned before, the decline in real estate prices is happening though at a slower rate than what one would expect if the market was more transparent. Most people that I talk to seem to believe that house prices in India will never go down. Sometimes it may be true if they are referring to "nominal" prices that do not adjust for inflation. Unlike stocks and bonds, real estate is a local market where several factors may uniquely influence a property's worth. A house may fetch a much less price than another house in the same street because of various factors including faith-based ones such as Vaastu. So it is very hard to come up with one statistic that describes what is happening across the whole market. In many developed markets, this problem is partly circumvented by examining repeat sales data. That is, we examine prices of the same house over time to see whether it has gone up or down relative to inflation. In India, it is hard to find any transaction data, let alone data on the same property over time.
You mention liquidity squeeze which I rephrase as financing squeeze. Slowness in buyer demand is definitely one factor that has an impact. Developers had been savvy for quite some time now in the face of reduced investor demand not to lower prices. I think the macroeconomic shocks were like the proverbial last straw. No longer can they justify holding inventories expecting demand to resurface. They have already started testing the waters by providing incentives to buyers. It is only a matter of time before they start giving discounts explicitly. The people who are going to be really caught up in this are those who had sought to buy property in the last couple of years. It is entirely possible that developers would stall new development and focus on reducing inventory at lower prices. These buyers would have been better off buying properties off the shelf than waiting for a custom built one that may take several years.
And as I mentioned earlier, the price decline may speed up as we get closer to the elections.
Given this background - lowering prices, do you see a spike in NRI investments in the housing sector?
I think NRI money will come, with a lag. I believe they will wait till currency stabilizes before increasing their investment in the sector. We have seen in the last month greater money coming in from the Gulf countries. While this trend will continue but the real investment in projects by NRIs will increase only after they get confident about the value of the rupee may not change after they make their move. NRIs will especially impact investment-driven markets like Mumbai and NCR Delhi more so than occupier-driven markets like Bangalore.
The Real Estate Research Initiative, at IIMB, has been born at an exciting time. What is your priority for this Centre of Excellence?
We are in the kindergarten of research on this sector. We have actively decided to pursue a strategy of data collection and research that is more of an academic nature than spouting policy prescriptions. We believe that good data leads to good research, which in turn leads to good policy. We don't want to jump into policy discussions early without data and analysis to back us up.
We believe information about the real estate industry is currently controlled by vested interests that make policy formulation difficult for want of alternatives. We want to provide the key stakeholders with good objective research that is transparent and can be replicated easily by others. We also want to take the initiative in building data necessary for such research so others can join us in bringing sunlight into this industry. We thank IIMB and Century Real Estate for encouraging us and providing us with support. Despite being a small team, we have been able to accomplish much over the last year through data and original research. We expect to carry this momentum this year and hope to take on larger research projects. We invite the broader IIMB fraternity to join us as this sector is like a green field waiting to be explored.
(Interviewed by Kavitha Kumar and Pragathi K.)