'Investors' are realty's mafia; that's why prices can't come down

Property prices are weak but given the structure of the industry, there is no real hope that prices will come down to affordable levels

Rajanya Bose December 23, 2011 14:18:22 IST
'Investors' are realty's mafia; that's why prices can't come down

The real estate market in India is an ideal example of the subversion of demand-supply economics.

Everyone knows the real demand for both residential and commercial real estate is currently low. Inventories are piling up with builders and not even half of new launches are being sold in major cities. But prices still remain stubbornly high.

According to the makaan.com property index, prices have nationally dropped by around 1 percent last month, with cities like Mumbai, Ahmedabad, Bangalore and Hyderabad seeing bigger falls.

But one needs to follow the trend for a longer period to figure out if there is going to be any meaningful price correction where demand materialises. In all probability, it won't happen.

Investors are realtys mafia thats why prices cant come down

On the one hand, consumers are not ready to buy at the given price and if prices fall, investors will likely default on their payments.

Samantak Das, research head at property firm Knight Frank, tells us why. "The basic reason is this: the real estate market is driven mainly by investors and not end-users or consumers."

Investors comprise of 50-52 percent of total absorption. So when a builder is building 100 flats, he could sell 50 flats at one go to an investor at, say, Rs 5,000 per sq ft. Now even if his other flats are not getting a good response he cannot afford to bring prices below Rs 5,000, for it would mean negative returns for the investor, on whom his maximum sales depend.

And these investors are not generally you and me buying a second flat for investment, but non-resident Indians or even politicians channelising their black money into the sector. "Their lobby is so strong that negative returns on their investments by pulling down prices simply cannot be done," says Pankaj Kapoor, managing director of property research firm Liases Foras.

Says Kapoor: "Indian realty is in a Catch-22 situation where, on the one hand, consumers are not ready to buy at the given price. And if prices fall, investors will likely default on their payments."

So why have the prices risen so much in the first place? The answer mostly lies in foreign capital entering Indian markets. Foreigners are not directly allowed to buy land, but the foreign money entering the housing sector is used for nothing else but buying land.

Construction costs constitute just 10-20 percent of a property's price, with land accounting for the major balance - depending on where the property is located.Now, in residential buildings, customers themselves pay in phases, funding their own construction, which means the initial investment by the builder or private equity fund goes into buying the land. Between the financial year 2008 and till September this around, more than Rs 43,000 crore of foreign investment has flown into the housing sector.

Such capital flows have pushed prices up, with the weighted average price of a flat in Mumbai now being more than Rs 1 crore. Liases Foras estimates that even if interest rates come down to 9 percent from the 14-15 percent at present, the realty market needs to undergo a 33 percent price correction to go back to 2009 levels.

When a developer calculates returns on a flat, he has a certain velocity of sales in mind, which means he estimates the flats will be sold in a given timeframe. When the private equity investor is roped in, their margins increase the prices. When prices are held high, the sales velocity is bound to go down. The return on equity for the private equity investor falls and the consumer is hurt because of high prices.

In fact, private equity funds worth $3 bn-$5 bn are expected to exit real estate investments in 2012, Jones Lang LaSalle says. But the returns could be really low, hovering around even 2-3 percent, says Kapoor. So if both consumers and funds are losing, who is pocketing the gains is a question that needs to be answered.

The second question: if so much money has been transferred to the sector, what is the asset creation? Liases Foras estimates suggest that incremental construction floor space has gone down over the last two years in all major cities except Pune. Kapoor explains: "This tells us that land has almost been treated as a derivative that is traded with. It changes hand from owner to builder to PE funds and rises in value through the process. But nothing is created. With all capital being lost, realty has become the mother of all scams."

Third, there have been controversial deals for floor space index (FSI) where a higher number of floors has been allowed for a single apartments. In such cases, the cost per flat must come down as the cost of the land remains the same. But this benefit has not been passed on to the customer, thus inflating the total value of the land.

In all this, common people have lost out. In the last 10 years, the percentage of Mumbai population living in slums has gone up from 55 percent to 70 percent. If one looks at it closely, almost the whole of the incremental population has gone to slums because of unaffordable housing. Are not foreign funds and direct investments supposed to do exactly the opposite?

What we have today is a system only for investors, who can get full tax exemptions on interest if they rent the property out. But a first time buyer has exemption only up to Rs 1,50,000 on interest payments. A new regulator for the realty sector is welcome - which is now being promised by the Real Estate Regulation and Development Bill, which must bring under its purview all the stake holders in the realty story.

If the regulator turns out to be a toothless tiger who is hand-in-glove with politician and builder lobbies, no good will come of it. India needs structural changes in its opaque realty sector to give its people what should be a basic right: a roof over one's head.

Updated Date:

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