The realty about demonetisation

Much has been written and said about demonetisation and the all-pervasive impact on the world of real estate — the good, the bad and the ugly. In the following paragraphs, we aim to dispel the myths surrounding the headlines as we outline our view on the aftermath of what is being regarded as a watershed moment for the real estate industry.

Wrong perceptions

In the near term demonetisation is likely to impact an already muted buyer sentiment across most major markets. This will be reflected across both velocity and pricing, albeit in a more limited way for Tier 1 cities and end user affordable housing when compared to the smaller towns and cities and the luxury segment.

Real estate tends to be an asymmetric market with regional and local nuances being of primary importance — hence even in this environment we continue to witness sales taking place, perhaps at a slower pace than before. So, sales are most certainly not absent as is being widely reported. In terms of pricing, we are seeing a slight discount to the clearing price of most recent transactions — somewhere in the order of magnitude of around 5-8 per cent and definitely not the 30 per cent figures that are widely being reported.

Consolidation in progress

Before dwelling on the medium and long-term impact of this move, it is necessary to set the context for the environment we find ourselves operating in. Over the past two years, there has already been a fundamental shift in the way real estate is transacted.

First, end user demand has been largely brand-elastic rather than being price elastic i.e. there is a ‘trust premium’ that is driving sales of Tier 1 developers where the buyer is assured of quality, execution and delivery timelines — while others are finding velocity to be challenging despite resorting to both discounts and other marketing gimmicks.

Second, the industry is witnessing a massive degree of consolidation, with smaller developers entering into joint projects with the larger names to muster sales or aid in project execution or completion.

Demonetisation will merely quicken the pace of such consolidation — and as markets will likely normalise over a three to six month period, Tier 1 developers and those that had already embraced institutional grade processes and governance standards will emerge stronger. The average, smaller or speculative developers will be weeded out quicker than otherwise expected.

Primary and secondary market

Let us talk of the secondary market next, as there have been widely reported ‘statistics’ on pricing having come off by as much as 30 per cent in some metros. While historically the incidence of cash has been higher in secondary transactions, the community of ‘first time home buyers’ or those that wish to upgrade their homes normally transact in the secondary market through a mortgage.

Therefore, those that hold real estate purely as an investment will then adopt a ‘wait and watch’ approach and merely defer the selling decision, rather than sell for lesser value. And others that have a need to buy or upgrade will either remain unaffected, given the incidence of mortgages are higher, or gravitate towards the primary market instead. Therefore I feel that the pricing ‘gap’ that typically exists between the secondary and primary market in any particular locality will be bridged quicker than expected.

It is also important to speak of the developers’ plight in ensuring minimal disruption to the construction process as well as site management. Typically, temporary labour as well as some construction materials and transport tends to be transacted on a cash basis and this will be impacted — we see a natural delay emerge in the construction cycle which will normalise as time passes. More importantly, it is heartening to see many developers, including our partners, ensuring that the daily needs of such labourers (in terms of basic food, shelter, and schooling) are being met at a corporate level to help them tide over the currency crisis.

Legislative impact

As for pricing in the primary market, developer margins have been largely contracting over the past few years and real estate does not afford the supernormal profits that the industry was blamed for in previous vintage years. Therefore, there is a natural barrier to the price correction that can be absorbed by the operating cash flows of a project.

I do not see much room for a further discount to pricing as margins have already been under pressure. Also notwithstanding demonetisation, a more important regulation that will shape the future of the real estate industry is, in fact, the Real Estate (Development and Regulation) Act (RERA). RERA will accelerate the maturing of this sector and force developers to further embrace institutional processes and governance standards.

With RERA on the horizon and given that demonetisation has impacted an already muted buyer sentiment, the industry eagerly awaits some impetus for sentiment to turn and demand to return.

Falling interest rates are an eventuality today. Further, beneficial changes in the tax regime are also being widely anticipated. These will fuel demand for real estate yet again and pave the way for renewed interest and growth in the sector, albeit for those developers that have already adopted the mantra of ‘institutionalisation’.

The writer is MD of Piramal Fund Management