Why Mumbai property is a sell rather than a buy

Why are property prices not falling despite strong evidence that few people are buying? According to a recent _Firstpost_ report, the Mumbai Metropolitan Region alone is sitting on 58 months’ inventory, with around 1,40,000 housing units (of an average 1,000 sq ft) remaining unsold.

If few people are buying, and no one is also selling, prices can indeed stay aloft - though these prices are fictitious when no transaction is taking place. But the more important question is this: when property prices are so high, why is no one selling?

Let’s assume investors are sitting tight on the properties they own - either directly or through benami ownership - in the belief that prices will start their upward climb shortly. But does this assumption makes sense at all purely from an investment returns perspective?

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[caption id=“attachment_1197045” align=“alignleft” width=“380”]  Right now, unless you plan to live in your new home in the near future, it is best to sell property. For the rest, renting property is far superior, and more tax-efficient too.[/caption]

A small one-bedroom flat in Thane, a city on the outskirts of Mumbai, costs anywhere between Rs 50-65 lakh if it’s located in desirable parts of this booming mini metro. If you were to give this out on rent, you could get anything from Rs 10,000-15,000 per month.

As a pure investor, you have no income on this unless you rent out the property. In fact, you will have costs - from municipal taxes to society fees. If you do rent it out, your investments will earn you anything between 2.4-2.7 percent in terms of annual returns, which makes even idle funds in your savings bank account (paying 4 percent or more in some private sector banks) look attractive.

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But, hey, these are black money funds, and so they obviously cannot use bank deposits as an alternative parking slot, right?

Wrong. Funds lent in the informal money markets earn even higher returns in a tight money regime. This means if an investor has to choose between selling at a 5 percent discount to current notional market prices and investing that money in the informal market for funds, he would be a fool not to sell his property and earn more.

Take the case of a Rs 50 lakh property earning Rs 10,000 per month as rent as an example. If your investment is to earn even 4 percent, your rental income will have to rise by two-thirds (to, say, around Rs 20,000 pm) or the price of your property will have to fall by 40 percent to Rs 30 lakh to match the savings deposit rate. Since longer term fixed deposits earn 9 percent today, property prices have to really crash to be worthwhile.

Put another way, buying property purely for investment makes sense only if prices crash 30-50 percent. It makes better sense to sell.

Why then are investors holding on? Quite obviously, they too have bought into the fictitious logic that property prices have nowhere to go but up in a country (or city) where urban land is in short supply and home seekers in millions.

Nowhere does this wisdom appear more plausible than Mumbai, an island city that can grow only northwards into the mainland. As India’s commercial capital, prices are supposed to be invulnerable to demand setbacks or economic slowdowns.

Investors are thus betting on returns to come only from land value appreciation, since the quantum available is fixed, and they ain’t making any more of it.

But this is actually bunkum. Land is always available - either through redevelopment or by increasing the floor space index (FSI) or by expansion into the mainland.

The only explanation for investor optimism despite the absence of buyers is thus their belief that supply will be artificially curtailed by blocking increases in FSI and curtailing available land for development.

This is more than evident. Consider South Mumbai. If a trans-harbour link connecting south Mumbai to the mainland were to be built quickly, thousands and thousands of hectares of land would be available for development. This is exactly why the trans-harbour link project will never take off. If it were to happen, property prices in South Mumbai would crash.

However, the gap between affordability, investor returns and quoted prices will ultimately have to be closed. While one can always buy a home to live in if you can afford the EMIs - in which case the price does not matter - for investors the only logic is that of returns.

According to a Times of India report based on Jones Lang LaSalle data today (15 November), rental yields on Indian property are among the lowest in the world, ranging from 2 percent in Delhi to 3.5 percent in Mumbai. Compare this with New York’s 6.2 percent, London’s 4.7 percent, Toronto’s 4.6 percent, and Sydney’s 4.8 percent.

If you want to invest in property, these are the places to invest, since you can actually borrow money abroad at interest rates far below the rental yields. In India, borrowing costs for home loans are around 10.5-11 percent currently - when rental yields are a fourth of that level.

If rental yields in India have to catch up with those in New York and London, Indian property rates have to fall by a third to a half.

The market is clearly rigged, and it is corrupt politicians, criminals, builders and the land mafia who are artificially propping it up.

Right now, unless you plan to live in your new home in the near future, it is best to sell property. For the rest, renting property is far superior, and more tax-efficient too.

(Also read: Why property is the biggest con-job )

(Disclosure: I am currently acting contrary to my views above for personal reasons. I am in the market right now for a small property since I plan to live in it after about a year).