Looking back: Real estate crash of 1997 reminds us prices can fall by 50%

Vivek Kaul

In response to a column I wrote yesterday many people wrote in saying that real estate prices never fall. Some others said that real estate prices cannot fall in India because India has a huge population, there is scarcity of land, and there is inflation and a lot of black money.

Fair enough.

Another logic that was offered was that real estate prices will not fall because they have only gone up in the past. Alan S Blinder explains this logic in his book After the Music Stopped:  “A survey of San Francisco homebuyers[sometime in the mid 2000s]… found that the average price increase expected over the next decade was 14 percent per annum…The Economist reported a survey of Los Angeles homebuyers who expected gains of 22 percent per annum over the same time span.” At an average price increase of 14% per year, a home that cost $500,000 in 2005 would have cost $1.85 million by 2015. At 22% it would have cost $3.65 million.

Now replace San Francisco with Mumbai or Delhi or Bangalore, and you get the drift of how people who believe that real estate prices can never fall, tend to think. This, if anything is a classic sign of a bubble. We all know what happened to American real estate starting in 2007-2008.
The naysayers might turn around and tell me, but this happened in the United States and not in India, and given that something like this is not possible in India.

So, let me tackle this by offering evidence from the real estate bubble of the 1990s, which started to run out of air sometime in the mid 1990s. As Manish Bhandari of Vallum Capital wrote in a report titled The End game of speculation in Indian Real Estate has begun: “The previous deleveraging cycle in year 1997-2003 witnessed price correction by more than 50% in Mumbai Metro Region (MMR) property.”

Yes, you read it right. Prices fell by 50% in Mumbai, where the population is huge and there is huge land scarcity. And the city had a lot of black money then. It has a lot of black money now.

Real estate prices also fell in other parts of the country. As an August 1997 newsreport in the India Today magazine points out: “Be it Mumbai’s ‘golden mile’, Nariman Point – the most expensive stretch of real estate in the world – or Somajiguda in Hyderabad; Delhi’s commercial hub Connaught Place or Koregaon Park in Pune; Bangalore’s pulsing heart M.G. Road or the sedate T. Nagar in Chennai. Each of these upmarket addresses, the most sought – after in their respective cities, are now dotted with unoccupied apartment blocks, unwanted commercial complexes and office space purchased at rates too hot to handle today.”

The point being that home prices had fallen by a huge amount across the country. “For the country’s over Rs 1,00,000 crore real estate business-one-twelfth the size of the GDP – it has been a crash without precedent. Between mid-1995, when the real estate boom peaked, and mid-1997, prices have fallen a bruising 40 per cent,” the India Today report newsreport further pointed out.

So what is the learning here? That real estate prices fall. And that they may not fall as quickly as stock markets do, but they do fall. Further, the fall can pretty much be all across the country, instead of only certain pockets. This despite, all the reasons offered in favour of “real estate prices can never fall” argument.
What this also tells us is that people have very weak memories and they tend to remember only things that have happened over the last few years. I guess up until late 2013, the real estate sector did reasonably well. And that is what people remember.

Actually, this is like information technology is the best sector to work in, argument (and Infosys is the best company). It may have been true a decade back, but clearly is not true today. Nevertheless, a whole new crop of parents forcing their children to become engineers continue to believe in it.

Getting back to the point, what those who still believe in the real estate story have not yet started to realise is that over the last one year, real estate prices have more or less been flat. And this as per data provided by real estate consultants, who have an incentive in ensuring that real estate prices continue to go up. There is enough anecdotal evidence to suggest that real estate prices have been falling at double digit rates in large parts of the country. It is just that no independent agency or organisation collates such data real time to give us a true state of the real estate prices in the country.

Also, from data that is available it can clearly be seen that real estate builders are sitting on a huge number of unsold homes. The bank funding to the sector has slowed down considerably over the last one year. The number of new launches, another source of funding for real estate companies, has collapsed, as real estate companies have not been able to deliver on their earlier projects. And investors are getting restless.

Further, those who believe in still buying real estate have no memory of the real estate crash of the late 1990s and the early 2000s. Hence, for them real estate prices can never fall. But that as I have shown is a stupid argument to make.

Also, the land-population argument is not a new one. It has been made over a very long period of time and despite that many real estate busts have happened all over the world. As Noble Prize winning economists George A. Akerlof and Robert J Shiller point out in Animal Spirits: “In a computer search of old newspapers, we found a newspaper articles from 1887-published during the real estate boom in some U.S. cities including New York-which used the idea to justify the boom amid a rising chorus of skeptics: “With the increase in population, the demand for land increases. As land cannot be stretched within a given area, only two ways remain to meet demands. One way is to build high in the air; the other is to raise price of land…Because it is perfectly plain to everyone that land must always be valuable, this form of investment has become permanently strong and popular.”

So, the land-population argument has always been offered by those who want you to buy real estate all the time. For those who are still not convinced, I suggest that you read the India Today story that I have mentioned earlier in the column. If you continue to remain a believer even after that, then best of luck from my side.

To conclude, let me reproduce an example from the India Today article: “At Himgiri, a typical multi-storeyed residential block on Mumbai’s arterial Peddar Road, the IT Department acquired a 624 sq ft flat for Rs 72 lakh in 1994. A year later, a similar flat went for Rs 60 lakh. And in June this year, a 622 sq ft flat was bought at a little under Rs 50 lakh. The list is endless.”

Pedder Road, as you would know is where Lata Mangeshkar lives and it is located in South Mumbai. And if real estate prices can crash in South Mumbai, they can crash anywhere else. Meanwhile, let me hear a few more arguments in favour of investing in real estate. Bring it on! But do remember that the one investment lesson that people learn over and over again is that, this time is not different.  

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on July 22, 2015