Yesterday I spent an hour talking to a friend who wants to buy a two BHK apartment for Rs 55 lakh in Mira Road, a distant western suburb of Mumbai. I was trying to explain to him that Rs 55 lakh is too much money to spend for living in Mira Road. Also, given that I know the financial position he is in, I knew if he went ahead and bought the apartment, he would really be stretching himself.
His logic is very simple: “I need something of my own. The rent I am paying is essentially getting wasted.” I tried telling him that he was paying rent to live in a decent locality from where he could reach most parts of Mumbai in under an hour, on a good day. The same wouldn’t be true after he moves to Mira Road, with his family. He currently pays a rent of around Rs 16,000 for a one BHK apartment, somewhere in the Central suburbs.
But his need to ‘own’ a house is so strong that he did not see it that way. So, for an hour we kept going round and round and he kept coming to the same thing of the rent being ‘wasted’. I guess he basically wanted me to tell him that he is making the right decision, which I wouldn’t. And so we kept talking.
As is the case with these things, social pressure to buy a home must have been at play as well—parents and relatives, whose experience is of a bygone era, wanting to see their kids settled and putting pressure on them to do things, which they think are right.
First they want you to get married. Then they want you to buy a few Life Insurance Corporation of India policies, because they have always done that. Then they want you to buy a house. Then they want you to produce kids. These wants never come to an end. And so the story goes.
The trouble is that all of this is not possible at once given how things stand these days. And one reason for this revolves around the huge amount of black money that keeps finding its way into Indian real estate. Black money is essentially money which has been earned and on which taxes have not been paid.
With a massive amount of black money finding its way into real estate, the prices of homes have gone way beyond what most people can afford. When you can’t afford a home to live in, the decision to have children also becomes a tricky one. A child needs some stability in life. If you are living on rent, you will have to keep changing your home every few years. And once a child starts going to school, this becomes very difficult.
Other than going to school there are other activities with which a child is involved as well. So, marriage, home, children, school and other activities are all closely linked. And the massive amount of black money in the Indian financial system is essentially threatening this very important “link,” which is a very important part of leading a happy family life.
Further, black money also leads to higher interest rate on loans. How is that? As I said earlier in the column, black money is essentially money which has been earned, legally or illegally, and on which taxes have not been paid. Lower taxes mean that the government has to borrow more in order to meet its expenditure.
When the government borrows more, it leads to crowding out, and leaves lesser money for the private sector to borrow. This leads to the private sector having to pay a higher rate of interest when they have to borrow. The private sector also includes banks. Hence, banks borrow at a higher rate of interest, they lend at an even higher rate of interest.
This hurts the honest tax payers as they end up paying higher EMIs. This is another way in which black money ends up hurting those who need homes to live in.
There is a third way in which black money hurts which a lot of people find out only while buying a home. During the course of buying a home a certain amount of payment has to be made in black.
As analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled Real Estate: The unwind and its side effects: “Whilst official figures are not available that quantify the size of the black money percolating through the real estate sector, research suggests that more than 30% of India’s real estate sector is funded by black. Our channel checks suggest that individuals who are involved in real estate transactions for their personal needs in Mumbai are routinely asked for black money payments ranging from 10% to 30% of the transaction value.”
The proportion of black money can be even higher in other cities. As Mukherjea and Shekhar point out citing a July 2014 report of the National Institute of Public Finance and Policy: “In Delhi, the ratio of unaccounted value of real estate transactions to the total value is as high as 78%. The same ratio is 50% in Kolkata and Bangalore. In smaller towns and semi urban centres, nearly 100% of property transactions are conducted in cash.”
And how does this impact genuine buyers? Let’s say an individual buys a property with a market price of Rs 50 lakh. The deal is 80:20, where 20% of the market price is to be handed over in cash to the seller. Hence, Rs 10 lakh (20% of Rs 50 lakh) gets handed over to the seller in cash.
Then the individual goes to the bank for a loan. The bank gives a loan against the remaining Rs 40 lakh (Rs 50 lakh minus Rs 10 lakh that has been handed over in cash), which is deemed to be the official value of the home. Further, the bank also follows an 80:20 ratio i.e. it gives a loan of Rs 32 lakh (80% of Rs 40 lakh) against the value of Rs 40 lakh. The remaining Rs 8 lakh the individual has to offer as a downpayment. It is his contribution to buying the home.
Many people realise this basic point only during the process of buying a home. Some of them get stuck because they have already handed over the cash they had to fulfil the black portion of the deal. And then they have a hard time trying to raise money for the downpayment.
To conclude, black money makes things difficult for people wanting to buy a home to live in at multiple levels and stops them from living a happy life.
The column originally appeared on The Daily Reckoning on July 22, 2015