For years, real estate has been a preferred investment in India. This was driven by favourable demographics, shortage of housing, a move to nuclear families, easy credit and increase in black money that required storage. The RBI released excess liquidity into the system during 2009-12, as part of stimulus. This found its way into real estate via various transmission channels and aided a bull run in the sector.
This was supported by factors like high inflation, negative real returns on financial instruments such as fixed deposits, and choppy equity markets. Today, residential real estate is now priced at an average yield of 2%. This is indicative of a huge bubble in the sector. After a decade, many factors are converging, setting the stage for a deep correction in the Indian real estate sector. Today, the rupee has depreciated considerably from year-ago levels.
The RBI has also tightened monetary policy. Tighter monetary conditions will force Indian banks to start deleveraging: today, they are running a high investment-to-deposit ratio of 108%, instead of the usual range of 95-100%. The direct real estate-related lending — including mortgages, construction loans and loans against property — amounts to $235 billion, or 25% of the outstanding loans in the banking sector, up from $20 billion, or 12%, in 2004.
The period from 1997 to 2003 witnessed deleveraging by Indian banks and overleveraged companies. In that period, property prices corrected by more than 50% in the Mumbai metro region (MMR).
Foreign flows into India are drying up. Foreign private equity funds invested over $20 billion into Indian real estate during 2006-13. The developers were supposed to make housing affordable but, instead, fuelled real estate prices across the country by hoarding finished inventory, diverting money to other projects and investing in land banks for future use. After 7-8 years, these funds are reaching their end of term and, so, would have to sell their holdings.
Towering Elections Soon
Real estate has been a store for illicit funds. The need for funds in upcoming central and state polls will accentuate the outflow of money from this sector over the next 18 months. The fiscal deficit funds consumption with policies like farm loan waivers, pay hikes for government staff, NREGA and food security schemes.
Subsidies remain high and all attempts towards fiscal consolidation remain a distant dream. Today, subsidies account for 42% of gross fiscal deficit, exactly double the size of a decade ago.
The transmission of fiscal deficit will move in the following way: from corporates to banks to government, and finally landing to people in the form of increased direct and indirect taxes. We are in an era of low growth, accompanied by lower investments by the private sector.
The slower growth of real personal disposable income per capita over the last few years is a factor slowing demand. NSSO surveys indicate that India is witnessing jobless growth in the formal sector for the last 10 years. Given all this, the ability of the average Indian to afford real estate in our cities is already under serious threat.
Government records suggest that there are only 35 million taxpayers, about 3% of the population. Only 1.5 million declare annual earnings of more than a million rupees. A recent report by Cushman & Wakefield suggests that more than 30% of apartments under construction in Mumbai are priced at more than Rs1 crore per apartment.
This was supported by factors like high inflation, negative real returns on financial instruments such as fixed deposits, and choppy equity markets. Today, residential real estate is now priced at an average yield of 2%. This is indicative of a huge bubble in the sector. After a decade, many factors are converging, setting the stage for a deep correction in the Indian real estate sector. Today, the rupee has depreciated considerably from year-ago levels.
The RBI has also tightened monetary policy. Tighter monetary conditions will force Indian banks to start deleveraging: today, they are running a high investment-to-deposit ratio of 108%, instead of the usual range of 95-100%. The direct real estate-related lending — including mortgages, construction loans and loans against property — amounts to $235 billion, or 25% of the outstanding loans in the banking sector, up from $20 billion, or 12%, in 2004.
The period from 1997 to 2003 witnessed deleveraging by Indian banks and overleveraged companies. In that period, property prices corrected by more than 50% in the Mumbai metro region (MMR).
Foreign flows into India are drying up. Foreign private equity funds invested over $20 billion into Indian real estate during 2006-13. The developers were supposed to make housing affordable but, instead, fuelled real estate prices across the country by hoarding finished inventory, diverting money to other projects and investing in land banks for future use. After 7-8 years, these funds are reaching their end of term and, so, would have to sell their holdings.
Towering Elections Soon
Real estate has been a store for illicit funds. The need for funds in upcoming central and state polls will accentuate the outflow of money from this sector over the next 18 months. The fiscal deficit funds consumption with policies like farm loan waivers, pay hikes for government staff, NREGA and food security schemes.
Subsidies remain high and all attempts towards fiscal consolidation remain a distant dream. Today, subsidies account for 42% of gross fiscal deficit, exactly double the size of a decade ago.
The transmission of fiscal deficit will move in the following way: from corporates to banks to government, and finally landing to people in the form of increased direct and indirect taxes. We are in an era of low growth, accompanied by lower investments by the private sector.
The slower growth of real personal disposable income per capita over the last few years is a factor slowing demand. NSSO surveys indicate that India is witnessing jobless growth in the formal sector for the last 10 years. Given all this, the ability of the average Indian to afford real estate in our cities is already under serious threat.
Government records suggest that there are only 35 million taxpayers, about 3% of the population. Only 1.5 million declare annual earnings of more than a million rupees. A recent report by Cushman & Wakefield suggests that more than 30% of apartments under construction in Mumbai are priced at more than Rs1 crore per apartment.
Caution, Correction Ahead
These things together show that wealth is concentrated and tax evasion is rampant in India. The current real estate prices represent affordability for very few. Today, common man has to shell out 20 years of his savings to afford a house. All these factors are setting the stage for a deep correction in real estate prices. Asset price bubbles have occurred and burst across asset classes, countries and times. Japan witnessed its lost decades on the back of a real estate bust; the US has still not recovered from its subprime mortgage crisis.
Indian policymakers need to seriously think about an approach to make housing truly affordable. Both the RBI and government have to collaborate in this. The recent measure by the RBI, to caution banks on 20:80 scheme, is welcome. But much more needs to be done.
Measures taken by the Chinese and Singapore governments, to restrict price expansion in the housing sector — like reducing loan-to-value ratio and differential taxation on profit and interest rates for second home loans — point the way for India. The time has come to deflate the real estate bubble in an orderly manner to save financial institutions and households, and to channelise public resources for productive purposes, failing which the financial consequences can be disastrous.
The writer is CEO and managing partner, Vallum Capital Advisors
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