The Finance Minister would be better off focusing on revving up industrial investment demand than trying to fix the housing market.

Finance Minister P. Chidambaram has asked public sector banks to prod real estate developers to reduce property prices, which might help revive a slowing economy. A correction in the property market is overdue no doubt, with current prices neither in sync with underlying rental values nor commensurate with affordability levels for normal middle-class home buyers. A simple rule of thumb is to look at the gap between rental incomes from a property and returns from a financial asset of equivalent capital value. The difference represents the additional yield that an investor expects by way of an appreciation in the property price. Thus, if a two-bedroom flat in a metro costing Rs 50 lakh today fetches an annual rent of Rs 1.8 lakh (Rs 15,000/month), while the interest income from investing the same amount in a bank deposit is in the region of Rs 4 lakh (at 8 per cent), it implies that the investor expects the income he is currently foregoing to be made up by property appreciation in later years. A widening gap is, prima facie, evidence of a property price bubble getting built up. The Indian economy has been witness to such a phenomenon in recent times.

If the correction isn’t happening at all, it means people continue to exude a sense of optimism over further capital appreciation — a potential sign of an asset bubble. Alternatively, sellers are just holding on, unwilling to take any hit in capital value. The fact that Mumbai and the National Capital Region alone are now saddled with estimated unsold inventories of 375 million square feet – equivalent to some five lakh flats – indicates that the resistance to price correction is coming largely from developers, whose very job is to sell.

That still does not justify banks being told to put pressure on builders to lower prices. They cannot do so unless the developers default on loans; whereas in real estate, it is the home buyers who account for bulk of the bank credit. Only when borrowers stop making payments can banks foreclose on the property, which could then be put on sale for the ‘right’ price. Neither of these – coaxing builders or foreclosure sale – is the best way to achieve price correction. It is preferable to leave the property market to correct itself, which is bound to take place some time.

The focus on making property buying attractive — or for that matter asking banks to make it cheaper for consumers to finance consumer durable purchases — is, moreover, misplaced in the current context. It is not that if prices correct or home loan rates come down, buyers will return in hordes. They will, but only when the economy revives sufficiently to guarantee some stability in employment and incomes. The Indian economy’s main problem today is lack of investment, without which there can be no fresh job creation or incomes to drive consumption in the first place. Addressing that requires removing uncertainties relating to land acquisition, environmental clearance and various other policy hurdles inhibiting firms from putting money in new projects. The Finance Minister and other policymakers would be better advised to concentrate their attention on these more challenging issues, rather than trying to fix the housing market.

(This article was published on August 22, 2012)
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