The real estate market is fast approaching the eye of a perfect storm. Demand has slowed down considerably and inventories have been building up. New regulation and market conditions, both global and domestic, will soon make access to land and capital more difficult. To weather this storm, builders need to let house prices fall. And the government needs to eliminate bureaucratic hurdles to make development a viable business at lower prices.

Indian real estate saw a gold rush-like craze in recent times because its vested interests had carefully planted the idea that property prices “never go down”.

To validate this notion, prices and price information were kept high and opaque high through implicit collusion. Media sound bytes were more often either from developers or financiers, who had everything to gain from sounding positive and optimistic.

Just the other day, the chairman of a large housing finance company went on record saying that he doesn’t feel there is a bubble in real estate prices. You don’t have to be a rocket scientist to figure that something is wrong when a similar-sized apartment is more expensive in Mumbai than in Manhattan.

Unfortunately, both the government and the academia have remained largely silent, letting vested interests rule the public debate on this issue. As a result, price speculation has been left to grow for too long, despite signs that it is no longer sustainable to do so.

Stalling economy

The Indian economy is no longer expected to grow at the heady rates of 8-9 per cent. Except for a few sectors such as IT, most of the economy faces dim prospects for job and earnings growth. High inflation will reduce the amount available to service home loans, while inflated house values increase EMIs and reduce the amount available for consumption. Unless house prices fall, it is hard to see how this vicious cycle can be broken. For businessmen and the self-employed, the slowdown will directly lower the surplus they can invest in a property.

Financing for both builders and buyers has also become more difficult in the last several months. Already, banks have been slowing down their exposure to this sector, leaving builders to depend either on the shadow economy or on private players such as non-banking finance companies and private equities (PE).

The hit on the currency has scared overseas PE players as their returns got reset by 10-20 per cent. Moreover, the volatility in the currency would make anyone think twice before committing to a longer term investment. Builders will also no longer be able to borrow using buyers’ credit quality after the RBI woke up to shut down the dubious 80:20 and 75:25 schemes.

Tough RBI talk

The new RBI Governor has shown that he can walk the walk, by not lowering rates in his first policy review. The State Bank of India has already hiked its lending rates and it is a matter of time before other banks follow suit. Buyers will face higher EMIs just when builders push for sales during the festival season. With both builders and buyers facing higher costs, the appetite to build and buy new homes will be muted in the coming months.

The government, through its passage of the land acquisition Bill, has also made it more difficult for large developers by diminishing their bargaining position vis-à-vis land owners, especially farmers. The pro-consumer Real Estate Regulatory Bill, which is in the offing, will further curtail the freedom that builders have, such as being able to move funds from one project to another. While these Bills address a long-felt need, it is yet to be seen whether their rules are clear and transparent, and can encourage new thinking and capital into the development business.

Black money factor

There is another surprise factor that could impact builders in a big way. Real estate has always attracted people with dubious backgrounds, partly because of the opaqueness surrounding it and partly the lack of sensible regulation. We all know that black money is rampant in this sector. It is also known that black money surfaces during elections to fund party objectives.

Therefore, it would not be inconceivable to imagine that black money may be sucked out of this sector in the months leading up to the election, which may further reduce financing options for developers or force them to sell their inventory at a discount.

There is one prior academic study — done by the Centre for Global Development — that is consistent with this hypothesis. The authors of the study looked at cement prices and election cycles, and found that cement prices (proxying for construction activity) have fallen systemically during elections.

The macroeconomic situation and builders’ own practices have now put them in a deep hole. To dig themselves out, they need to consider bringing down prices to make houses affordable once again. A two bedroom apartment in a Mumbai suburb is priced today in the range of Rs 1.5-2 crore. The few who can afford them are willing to buy and lock them up, expecting future price appreciation. Such investment demand-led price increases can lead only to asset price bubbles. Natural demand — those who buy to live — has been driven away from this market.

Prices dipping

Bubbles grow fast but also eventually pop. Already, there is some indication that this is happening. The National Housing Bank’s Residex, which tracks residential prices in a few cities, had started to decline even before the crisis set by a chain of global events erupted. But the decline in real estate prices is happening at a slower rate than expected if the market was more transparent. A significant price correction is needed to sustain this industry in the face of declining demand and increasing cost of capital.

It would be unfair to expect builders to lower prices without eliminating some of the root causes that ail them. The government should seek to streamline the processes that burden land development today. Many developers, including those in the affordable housing segment, complain about the maze of approvals that need to be sequentially obtained before the shovel can hit the ground. Delays in project completion have a direct impact on house prices. The government can capitalise on the grim situation and force through changes like a one-stop approval window that will help attract capital. Only a structural change can attract serious, long-term capital to this crucial industry.

(The author is Associate Professor of Finance and Coordinator of the IIMB-Century Real Estate Research Initiative, IIM-B.)

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