Every second investment report on India sees housing as the most promising sector and yet we see defaults, slowdown in launches and declining sales dominating the industry. On the surface, the problem is, “Home prices are not affordable.” But a more economically correct definition of the current situation would be : “At prices that buyers can afford homes, developers are unable to find land that can give developers economic return.”
To understand the root cause of a developer’s inability to find appropriate land parcels, one needs to go back to September 11, 2001.
After the Twin Towers were felled, the US government feared that crashing consumer confidence could take the slowing economy into a recession. It therefore, adopted the easy money route. But even at low interest rates, there weren’t enough opportunities for investment.
Darling Of American Financial Markets
Owing to the onslaught of cheap imports of Chinese manufactured goods and shift of services to low-cost Asian and EEC (European Economic Community) countries, the capacity buildup in the US manufacturing and service sectors was minimal. Housing, as a result, became the darling of American financial markets. Homebuyers too were happy borrowing as low-interest rates meant buying was cheaper than renting.
As soon as banks were able to find a wiling homebuyer, re-financing institutions were more than happy to refinance banks, creating an extremely efficient channel for the flow of newly printed dollars into US real estate.
With the US following easy money policy, few nations could follow a tight money policy. Money became easily available across the globe. Indian real estate would have probably been left isolated but with the Indian government permitting foreign direct investment (FDI) in real estate in 2004, the excess global liquidity also found its way into India.
Having raised money from the international market, real estate funds were under pressure to invest in India. The problem wasn't just this. It was much severe.
All real estate funds were looking at the same kind of investment opportunity – large land parcels in urban areas with clear titles. But such avenues were few. As a result, valuations of clear title, large land parcels in urban areas reached stratospheric levels.
Indian real estate market took the prices of these marquee properties as benchmarks and real estate boom started spreading to smaller cities, towns and villages.
A crash in the housing market can cause a bigger emotional trauma than any stock market crash as most homebuyers are leveraged. So in 2008 when the housing market crashed in the US, its government was quick to realise the impending public distress. It pumped in money and saved the day.
Real Estate In India
The Indian market, however, had a different story. In 2008, responding to the US market, the Indian housing market dipped for a while mainly because of liquidity issues with some developers. But a large number of individual investors, who had missed the bus during 2004-08, were waiting to have a piece of estate. These were small investors but larger in numbers.
Banks and housing finance companies (HFCs) found them promising customers. So the real estate boom continued for another five years. But by 2013-14, developers had realised that the momentum had slowed. They were now looking at reducing their cost of land in new acquisitions.
And this is where Indian land market exhibited its uniqueness. Market inefficiency in land markets came to the fore.
The land sale typically involves decision-making by multiple-owners (joint families, trusts, companies, societies, tenants etc.) and due to the psychological phenomenon called ‘Group Think’, rationality does not prevail in such decision-making and the group is unable to accept the market reality (slowdown in sales).
The land prices, therefore, do not come down. Moreover, in India, buying of land is seen as a sign of prosperity and selling land is associated with a stigma. Even in distress, few would consider selling land and among them, very few would agree to sell at less than the original purchase price.
Thus, developers looking at buying land at discount to earlier prices are hardly able to any crack deal. Land prices, in India, are truly downward sticky.
To make matters worse, during the past 8-10 years, state governments have started to look at housing as a key source of revenue. Circle rates were increased across the country. Service tax and now GST made a further dent into housing sales. Thus, the money left with developers for payment to landlord shrunk significantly. The offer from developers now appears to be a raw deal to landlords.
Circle rates and income tax laws further inhibit landlords from selling at lower prices. Market inefficiencies have thus created a big quagmire.
Correcting market inefficiencies involve unpopular and difficult decisions; these are neither easy nor quick in a federal democracy like India.
Deepesh Salgia is director at Shapoorji Pallonji Real Estate.