The RBI cannot revive Indian real estate

Vivek Kaul

Raghuram Rajan took over as the governor of the Reserve Bank of India (RBI) in September 2013. Since then, real estate companies and associations that represent these companies have been asking (i.e. putting it politely) for a repo rate cut. The repo rate is the interest rate at which RBI lends to banks and acts as a benchmark for the interest rate at which banks borrow money and in turn, the interest rate at which they lend. Every time Rajan did not cut the repo rate, real estate companies and associations representing them, put out statements in the media saying how high interest rates were hurting the sector and were the main reason why people were not buying homes that were being built. Hence, when the RBI decided to cut the repo rate last week, the real estate companies had a reason to rejoice. Take a look at this statement made by Rohit Raj Modi, President of the Confederation of Real Estate Developers’ Associations of India (CREDAI) in the National Capital Region: “We have been raising the concerns of developers over higher rates from the government. We are happy that RBI has taken a step by cutting the rates. We expect that this will encourage banks to ease their home loan rates…This will help developers to expedite their projects which were otherwise facing fund crunch. Home buyers’ dreams of owning a home would also get a boost as we expect an accelerated purchase cycle(The emphasis is mine).” The most important part of the statement is the last sentence which I have italicized. Modi, who represents the real estate developers in and around Delhi feels that a 25 basis cut in the repo rate by the RBI will lead to more people buying homes. This is a sentiment echoed by Rajiv Talwar, DLF group executive director. As Talwar told the PTI: “The move would definitely encourage buyers now to invest in new homes.” [interestingly, Talwar uses the word invest and not buy]. I wonder where this confidence comes from. The real estate story has gone beyond interest rates and EMIs for a while now. People are not buying real estate simply because it is too expensive. It has been priced way beyond what they can afford. Take a look at the following table. The weighted average price of a flat in Mumbai is Rs 1.34 crore. The average per capita income of a Mumbaikar is Rs 1.97 lakh. This means that it takes 68 years of average per capita income to buy a flat in the Mumbai Metropolitan Region. For Bangalore, the number is at 81.5 years. This is a little difficult to believe. The average income of Bangalore is Rs 1.08 lakh. The number is very low in comparison to the average income of other cities considered in the table. The reason for it is that I have used the per capita income of Bangalore division (which is what I could find in the Karnataka Economic Survey of 2013-2014) and Bangalore division includes not just Bangalore but also other places like Kolar, Shimoga, Tumkur etc., where per capita incomes are lower than that in Bangalore and hence, drag down the overall number.

Source: Liases Foras and state government documents

What this table clearly tells us is that Indians are not buying homes to live in primarily because homes are priced way beyond what is affordable. This becomes clear at the massive inventory numbers being reported (as can be seen from the table). “Months inventory denotes the months required to clear the stock at the existing absorption pace. A healthy market maintains 8 months of inventory,” points out Liases Foras, a real estate rating and research firm in a report.
The following table shows very clearly that the months inventory across major cities is way over the healthy level of eight months and high price is the only possible explanation for it. 

One criticism of this piece of analysis which I can immediately see coming is that the average income of a city hides all kinds of variations. So, for a city like Mumbai it would also take into account the incomes of people who live in slums. And these people should not be considered because they cannot afford the flats being built. The point is that no one stays in a slum by choice. People stay in a slum because they cannot afford proper housing. Another point that I would like to make here is that when such analysis is carried out in developed countries they consider the ratio of weighted average price of a home and disposable income. I had to make do with average income primarily because I could not find any disposable income data for Indian cities (I would be grateful to anyone who could lead me to such data, if it exists). Nevertheless we can make an assumption that around 40% of income is disposable income (I guess that is on the higher side, but let’s just go with it and see how the numbers work out. Also, I am leaving Bangalore out of the calculation for reasons already explained). The following table shows how crazy the situation actually is. 

Assuming that disposable income is 40% of average income it would take 170 years of disposable income to buy a flat in Mumbai. Hyderabad comes in second at 128.4 years. In fact, in a recent article in the Business Standard columnist Bhupesh Bhandari made a similar point when he wrote: “According to one study, it will take an Indian with the average per capita income 580 years to buy a top-end property in Mumbai, compared to 65 years in Hong Kong, 62 years in Paris and 47 years in New York.” So, the real estate companies and media reports may keep blaming high interest rates for people not buying homes, but that isn’t really the case. Edelweiss Capital expects the RBI to cut the repo rate by further 100-125 basis points by March 2016. I can say this with confidence that unless real estate prices fall, even with such a massive cut in the repo rate (which is likely to lead to lower home loan rates) home sales won’t pick up. I can also say with confidence that the real estate companies will continue blaming the RBI. But RBI clearly does not have a solution to this problem.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 19, 2015