Properties shouldn't get expensive: Real estate consultants are just rigging home prices

So, the next time you read a report saying real estate prices will go up, check for the source. If a real estate consultant is saying so, the information needs to be taken with a pinch of salt.

Vivek Kaul August 30, 2014 13:17:12 IST
Properties shouldn't get expensive: Real estate consultants are just rigging home prices

The American author Upton Sinclair once said that "It is difficult to get a man to understand something, when his salary depends on his not understanding it."

This seems to be true about the "so called" real estate consultants who operate in this country. Their main job it seems is to bring out a research report every few months, where the conclusion is that "real estate prices will continue to go up".

This despite the fact when their own data contradicts this conclusion. Let's take the case of a recent research report titled India Real Estate Outlook brought out by Knight Frank. The report takes a look at the real estate scenario prevailing across some of the biggest cities in India.
In the case of Mumbai, the report points out that there is a huge demand-supply gap. The unsold inventory of residential apartments in the city stands at 2,13,742 units. In June 2014, the quarters-to-sell ratio stood at 12.

"Quarters-to-sell(QTS) can be explained as the number of quarters required to exhaust the existing unsold inventory in the market. The existing unsold inventory is divided by the average sales velocity of the preceding eight quarters in order to arrive at the QTS number for that particular quarter," the report points out.

What this means is that it will take close to three years to exhaust the existing number of unsold residential apartments in Mumbai, if people continue to buy homes at the rate they have been in the preceding two years. What is interesting is that the unsold inventory has gone up dramatically over the last few years. In December 2011 the number had stood at five, the report points out. This means that in December 2011, it would have taken around one year and three months to dispose of the inventory of unsold residential apartments in Mumbai. By June 2014, the number had increased to three years.

What this tells us is that the supply of residential apartments in Mumbai is substantially more than their demand. And anyone who understands basic economics will know that in order to clear this inventory the real estate companies need to cut prices, so that people come out and buy these unsold apartments.

Nevertheless, the Knight Frank report goes around to conclude that "On the residential pricefront...the forecasted increase for the entire year (2014) is 10.1%." It goes on to explain the reasons for this forecast. "This period [the first six months of 2014] has seen significant completion of transit infrastructure that has the potential to alter the dynamics of the region's property market," the report points out. The Versova-Ghatkpoar Metro, the Eastern Freeway and the Santacruz-Chembur Link Road are some of these projects.

The report writers forget(or rather ignore) a rather fundamental point here about how markets operate. Markets start factoring in information well in advance. They don't wait for a particular development to be completed before factoring in that information into the price. An excellent example of this are the real estate prices in parts of Navi Mumbai, which are close to the proposed new airport. The airport is nowhere in the picture, but prices have been driven up for years, around this story.

Hence, the infrastructure that the report points out to, has already been there in the minds of people for a while now. And if they had been so impressed by it, they would be buying homes, and the quarters-to-sell ratio would have come down. Now that as the report points out, hasn't happened, making the point irrelevant. Another reason, which is a favourite with most research report writers these days, has also been offered. Now that Narendra Modi is in power, things will improve and people will buy more homes.

As mathematician John Allen Paulos writes A Mathematician Plays the Stock Market "Because so much information is available...something insightful sounding can always be said." But what sounds insightful need not be correct.

The question that the research report does not answer is: why have the real estate prices in Mumbai going up, despite the fact that people haven't been buying residential apartments. The Residex Index of National Housing Bank points out that real estate prices in Mumbai have risen by 18.7% between the end of December 2011 and March 2014. This despite the fact that the inventory of unsold residential homes has been growing dramatically. In this scenario, where people are not buying as many homes as are being produced, prices should have been falling and not going up.

The reason for this is straightforward. The real estate market in India is rigged in favour of real estate companies and politicians who are the real owners of these companies. There is no free market in real estate. Most real estate companies are fronts for politicians. What makes this very clear is the fact that even though there are thousands of real estate companies operating across India, there is not a single pan India real estate company.

And these politicians and their real estate companies have an incentive in holding the prices to be high. They operate as a cartel to do that. Of course, no real estate consultant can "afford" to talk about these reasons given that they make their money from real estate companies. And real estate companies would want its consultants to keep constantly mouthing the lines that "prices will continue to go up". The research reports brought out by these real estate consultants play precisely that role. They help in managing the price expectations in the minds of prospective buyers.

Whenever such a report is released, its splashed all over the media. The media, in turn, because it depends on advertising from real estate companies, tends to highlight the price escalation and the sales will increase part (or they just don't bother to read beyond the press release). They don't bother to ask the most fundamental question: If there is so much inventory, why are prices going up? Take the case of South Mumbai. As the report points out "the inventory level in the South Mumbai market will take the maximum time of 18 quarters (4.5 years) to sell. The age of inventory, calculated as the time elapsed since launch, is also the longest, at 15 quarters." So why are prices still rising is something that no one has bothered to ask?

This is how real estate consultants help real estate companies manage price expectations in the minds of prospective consumers. So, the next time you read a report saying real estate prices will go up, check for the source. If a real estate consultant is saying so, the information needs to be taken with a pinch of salt. As Guy Sorman writes in An Optimist's Diary "Economic actors don't all have the same information at their disposal. Without institutions to improve transparency, insiders can easily manipulate markets." This is precisely what is happening in India-the insiders have managed to take all of us for a ride.

Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek

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