How Rs 3,00,000 crore of investor money simply vanished down the real estate hole

That great gurgling noise you have been hearing over the last few years is the sound of Rs 3,00,000 crore of investor money in realty shares going down the drain.

Where did the money go? After all, even drains empty out into the sea. In the case of real estate, we know roughly where it went - into the pockets of politicians and their cronies - but cannot quite prove it.

The real estate business is simply not kosher and any commonsense understanding of visible signals can tell you that. For example, as the Sensex is hitting new highs, the BSE Realty Index is barely off its all-time lows.

From its all-time high of 13,848 in January 2008, the index is now down to 1,476 (around mid-day on 23 April), a drop of nearly 90 percent.

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That’s a value destruction of nearly Rs 3,00,000 crore in just six years. That’s the gurgling sound we talked about. And this has come at a time when real estate prices, though stagnant or weak currently, have simply gone through the roof.

Consider these discordant notes.

No real estate buyer has yet claimed he is getting a bargain while buying a house. In other words, she is paying through her nose to get a roof over her head.

As for real estate investors, they have lost close to Rs 3,00,000 crore on their investments, assuming they invested at the peak. Even if they invested last year, they would have lost a third of their money.

This is because real estate companies are overloaded with debt and are unable to sell their overvalued properties in a slowdown where few people are really buying properties.

The question is simple: if home buyers aren’t getting good value for their money, prices are still sky high, and investors have seen their money burnt to ashes in the last few years, who is making all the money - as represented in high home prices?

Clearly, the profits from high real estate prices are not being captured in the books of real estate companies. So where is it all going?

The one surmise - which we know anecdotally, but cannot prove due to the culture of silence enveloping benami money and real estate transactions in black - is that the real profits are being milked in the hands of realtors, the land mafia, politicians and other vendors in funny money.

The standard answer when one asks anybody about high realty prices is huge demand. However, this is the wrong answer.

High demand for housing and low supply of land is not the central reason why property prices are high almost everywhere. The real reason is land and real estate have become the principal source of illicit election funding. So politicians, and the businessmen who are linked to them, have a vested interest in keeping prices high.

The proof is all around us, but we are unable to see it. It is reflected in the sharp fall in real estate share prices, with DLF, the big dada of them all, today quoting at Rs 153 (23 April), 88 percent down from its all-time peak. Most of the value destruction - about half the real estate’s total - happened in DLF alone, and one can’t be sure the worst is over despite valiant efforts by the company to sell assets and reduce debt.

In the high priced Mumbai and Delhi markets, property sales have fallen dramatically in the last few months as money has shifted from building activity to funding the election expenses (of unnamed politicians). Since the market is anyway weak, builders are struggling to complete existing projects. People who have already paid the money are waiting longer to receive their properties.

As Firstbiz noted recently, property research firm PropEquity, Gurgaon, Noida and Mumbai have seen the sharpest falls in new project launches and sales, down by 74 percent, 73 percent and 44 percent respectively, in the January-March period of 2014. This is the period just ahead of the elections.

So the point is simple: property prices are high because businessmen and politicians use it to make illicit money. If property prices fall they will lose. This is why they contrive to keep it high. Moreover, almost everyone is invested psychologically in high property prices. If prices fall, banks will lose. If prices fall, sentiment gets affected. If our own property prices fall, we feel less rich even if we never intend to sell it.

But can prices keep defying the laws of demand and supply? Currently, prices are kept high by controlling the amount of land - the key element in property prices - that is made available for development. This way, new property does not come onto the market before the existing ones are sold.

Another way to keep property prices high is by refusing to develop infrastructure.

In a city like Mumbai, which is an island, there is a shortage of land in the southern parts, but just across south Mumbai - across the sea on the mainland - there is a huge quantity of land. If this land can be used to build houses, property prices would fall. All it needs is a bridge over the sea. But for 10 years the government has refused to even sanction the bridge. Obvious reason: till all existing land which can be rebuilt in south Mumbai, they will not allow this bridge to be built.

Land seems to be in short supply but if building laws allow for higher FSIs (floor space index) more homes can be built for lesser cost. In Singapore they not only build multi-storied tall buildings, but also several floors underground since they have very little land. Compared to Singapore, India’s metros and cities have almost unlimited land.

The solution to the issue of high real estate prices lies in politics and electoral funding reform - not in pretending that land prices will rise forever. The economics of demand and supply have been ruined by politics and corruption. That is the problem.