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| Edited By: Raghvendra Nath |Source: DNA |Updated: Jan 03, 2019, 06:25 AM IST
Property prices have been stable in majority parts of India since 2013. While investors are fretting over it, for end users it is a very good state. In real estate industry pricing cycle is 12-14 years long, unlike other asset categories like gold or equities, where it is much shorter. The longer duration of the pricing cycle makes it less volatile in short term, leading to a feeling of safety amongst real estate investors.
Unlike other asset classes, real estate sector is driven primarily by high leverage as most people rely on home loans to meet their housing needs. Hence, when prices are surging, people make exceptional profits. For instance, if an investor made a down payment of 20% and took the rest as loan, even a 20% rise in prices would result in a 100% profit for him. Such exceptional profits drive greed and rush for investments. But the same leverage can really hurt when prices stop growing or declining.
For the last three to four years prices have stabilised and in many markets have declined. Noida and Gurgaon are the classic examples of the buying frenzy and the resultant glut that has now driven prices 20-30% from their peaks. Mumbai is a little better as prices have been marginally down. Liquidity has dried out and builders are sitting on large inventories.
This trend is unlikely to change in the next three to five years. As mentioned earlier, real estate cycles are very long in nature. If the upward cycle lasted for almost 12 years, the downward cycle is unlikely to end soon. The reasons are many.
First is the unaffordability factor in Tier 1 and Tier 2 cities, because of which end-user demand, the primary driver for real estate, is low. For instance, in Mumbai, a two-bedroom hall kitchen (BHK) in a suburb like Mira road, may cost around Rs 70 lakh. At an 80% loan level for 25 years, it would mean an EMI of Rs 50,000. This implies that only a person earning an annual salary of Rs 20 lakh can afford to buy a home. If we go by income tax data, there are less than 1% people earning salary in that range.
Second is the poor past returns that has impacted the investment demand. Most investors have a recency bias. That means that their investment decisions are driven by the recent returns. If returns are good in the recent past, investors get the confidence to invest more. And vice-versa. Since the last few years have been sluggish and most investors are stuck with their real estate investments, fresh demand is low.
The third factor is the change in regulations. The Real Estate Regulatory Authority (RERA) has brought in a slew of regulations for the sector implying better compliance from builders, timely execution and proper use of funds received from home buyers. This has resulted in reduced margins for builders. Introduction of GST has also resulted in higher prices for the buyers resulting in sluggish demand.
Fourth factor is the diversion of funds towards equity markets that has given superior returns since 2013. After all, every investor looks at his asset allocation and wants to allocate money in asset classes where the probability of returns is higher.
The new cycle can only start when conditions are benign. This would first require that inflation stays moderate for the next few years, as it would help returning purchasing power in the hands of investors. Unsold inventories are sold off and new inventories do not pile up, helping restore the demand supply balance. GDP growth rates should stay strong, leading to better salaries for people prompting them to buy houses. And finally, interest rates should come down substantially so that housing loans can become affordable. And this would naturally lead to a general conclusion that the fresh real estate rally is still quite far away.
The writer is managing director at Ladderup Wealth Managment
