Care ratings expects lower liquidity to impact the construction progress, secondary market transactions and lead to lower land deals in the short and medium term.
Demonetization is expected to further dampen demand and negatively impact prices in the real estate sector, which has been lacklustre the past three-four years due to various factors, said Care Ratings in a report.
On November 8, Prime Minister Narendra Modi in an attempt to curb black money and turn the economy cashless, announced the decomposing of Rs 500 and Rs 1,000 notes as legal tender. The ratings agency stated that demand is expected to decline as the Centre's move would lead to lower liquidity in the hands of potential buyers of the sector which is infamous for hoarding unaccounted money.
Lower liquidity likely to impact demand, construction progress and secondary market transactions:
The construction progress is likely to get hampered as buyers of under-construction properties, who pay in instalments or stage payments to builders as per contractual Builder Buyer Agreements, may now have lower liquidity leading to lower collections by developers. “The routing of black money into real estate sector which was creating demand and supporting property prices is largely going to dry up,” said Care Ratings.
The agency said that demonetization will lead to lower collections in the form of customer advances as projects in early stages of construction are mostly dependent on these advances for construction progress and debt servicing. This impact will be greater for small and marginal developers rather than large developers who have access to multiple financing sources. Care Ratings stated that the problem will aggravate if banks and financial institutions do not interfere to support the sector and provide the required liquidity.
The agency said that purchases of the under-construction properties generally took place at the initial launch stages or at early stages of construction, where buyers have enough cash flow to pay the first few instalments and sell it in the secondary market much before the full completion of the project. These speculators make a gain from the likely price rise in the projects as they near completion. Such buyers are struggling due to the prolonged slow down and a stagnant or falling price situation over the demonetization move. Care Ratings said, “Prices in the secondary market are still supported by a high component of black money, which will no longer be available. The secondary market transactions built on a speculative view will clearly be significantly lower.”
Expected decline in prices:
Selling an existing property and using the proceeds of the sale at prevailing prices to buy a new property often supported the property prices. The ratings agency stated said that such transactions had two components- one, the legitimate part where stamp duty was paid and second, the ‘cash’ component which constitutes 35-40% of the transaction value and does not entail any taxes or stamp duty. The Centre’s move to curb black money has restricted liquidity and will thus have two implications- one, the price support from the ‘cash’ component will no longer be there and prices will drop. Two, since the tax proceeds will now be charged on the entire transaction value, instead of the 60-65% value charged earlier, the post-tax receipt with the seller will be lower. Hence the seller will then offer a lower price for his purchases.
Lower land deals in short and medium term:
Care Ratings said that there will be fewer land deals in the interim period before all the transactions enter the formal system. Once they do enter the formal system, the developers will bear the transaction costs which will impact their profitability margins as an increase in real estate prices would not be possible.
Property prices are headed for a drop by atleast 10-15% due to demonetization, stated the agency. It expects that the increased liquidity in the banking system will attract genuine buyers to invest in property. “In the long term, demonetization along with implementation of Real Estate Regulation Act and single-window clearance system will be positive for the sector leading to higher transparency and investor’s confidence.”
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