Month: July 2015

Are real estate builders getting desperate for money?

India-Real-Estate-MarketVivek Kaul

One of things that I have maintained in my columns on real estate is that for real estate prices to fall, the funding of builders needs to dry up. And that seems to have started to happen.

Let me share two recent examples that I came across (I request The Daily Reckoning readers to share more examples, if they know of any).

A real estate company is running an advertisement for homes they are selling in a central suburb of Mumbai. This advertisement essentially talks about giving only 20% of the price of the home at the time of booking.  It also talks about no income eligibility and no bank formalities.

What does this mean? It means that as long as you are willing to pay the company 20% of the price of the home at the time of booking, they will not ask any more questions. They will not try and check whether you have the capability of paying the remaining 80%.

What does this tell us? One the company is unable to sell the flats and raise the money upfront. And two, it is now so desperate for money that even 20% of the price is fine with them.

So, this was the first example. The second example is slightly more detailed. A friend forwarded an email he got from a housing finance company. The housing finance company assured him a return of 48.5% over a period of two years, if he invested in a new project in the National Capital Region.

The proposal is as follows. The investor needs to pay the builder a total of Rs 1.27 crore. Of this, the housing finance company is willing to finance around Rs 1.1 crore through a home loan. The remaining Rs 17 lakh has to come from the investor’s pocket.

Since the property is still under construction, the investor taking on the home loan will not have to pay an EMI but a pre-EMI. A pre-EMI essentially means paying only the interest on the home loan. The principal repayment kicks in only after the investor/buyer takes the possession of the home.

In this case, the housing finance company has promised that the builder will keep paying the pre-EMI for a period of two years.

What happens at the end of two years? If the investor does not want to take a possession of the home, the builder will buy back the home and close the home loan. He will also pay the investor Rs 8.25 lakh, over and above the Rs 17 lakh that the investor had initially put in.

This means a return of 48.5% over a two year period, which is not a bad deal at all, from the investor’s point of view. At least, prima facie that is what seems to be the case.

But what is really happening here? The housing finance company is helping the builder indirectly borrow home loans at a significantly lower rate of interest. Why is it doing that? I can only make a guess here. And I feel that builder is actually in a mess and the conventional borrowing channels (of banks/HFCs etc.) are not ready to lend to him anymore.

Other than paying Rs 8.25 lakh to the investor at the end of two years, the builder is also paying the pre-EMI on the home loan. At 10% interest, the pre-EMI will work out to around Rs 11 lakh per year (10% of Rs 1.1 crore) or around Rs 91,667 per month. The internal rate of return on this loan works out at a little over 14%, which is much better than the 30-40% interest that builders have to pay when the borrow from informal channels. Hence, in that sense borrowing at 14% is a steal, even though it seems to be on the higher side. Further, the builder may already have been borrowing from informal channels, and may have been looking to limit that borrowing.

It is also possible that the builder needs to repay an earlier loan that he had taken from the housing finance company and is not in a position to repay the loan. The housing finance company instead of recognising it as a bad loan and going after the assets of the builder is essentially bailing him out and postponing the problem.

The HFC and the builder are both buying time. Who knows what will happen two years down the line?

As far as the investor is concerned, he is being taken for a royal ride with the housing finance company telling him that this is an “assured buy back scheme”. The disclaimer at the bottom of the proposal clearly states that: “The information/product(s)/service(s)/offer(s)…as contained herein are provided /offered by third party and are subject to their respective terms and conditions and not intended to create any rights or obligations.”

So there is no guarantee that the builder will buyback the home and close the home loan two years down the loan. Further, the home loan is in the name of the investor. And the housing finance company will then go after him to ensure that he keeps paying the EMIs or the pre-EMIs. If he chooses to default, then the housing finance companies can go after his other assets as well.

Also, it is worth asking why is the builder borrowing one at a time through what is basically a complicated route for him? The only answer here is that the conventional sources of finance have totally rejected him. And he has no other way out of this mess.

I would request The Daily Reckoning readers to be careful of such investment schemes which sound too good to be true. Any scheme promising a return of greater than 9-10% a year, needs to be closely examined.

To conclude, what the two examples I have shared today clearly tell us is that builders are getting desperate for funding. And their situation is only going to get messier in the days to come.

Stay tuned.

The column originally appeared on The Daily Reckoning on July 23, 2015

How black money hurts the entire idea of a happy family

rupee
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

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

India-Real-Estate-Market
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

How real estate consultants are trying to confuse home-buyers

India-Real-Estate-MarketVivek Kaul

One of the bigger problems with Indian real estate is that there is almost no independent data available for consumers to trust.  For instance, you may want to buy a home in a particular locality, how do you find out what the going price is?

Till very recently you would have had to call up a relative who has some idea of these things. Or you would call up a real estate broker. The real estate broker does not always have the best interest of the buyer on his mind simply because for him it is a one-time transaction.  He is unlikely to be dealing with the buyer ever again. With the advent of websites one can get some idea of what the price scene is in a particular locality.

The point being that the insiders who are a part of the real estate sector in India have no incentive in making things easy for the end consumer. And on most occasions they are bound to mislead.

Take the case of real estate consultants who are the major source of data when it comes to the real estate sector in India. Here is one instance where an attempt has been made to mislead prospective buyers. As Ashwinder Raj Singh is CEO – Residential Services of JLL India points out in a June 2015 column in The Indian Express: “Rental yields vary across the globe, but an average of 2 per cent of rental yield is considered a good deal for residential properties in India.”

Rental yield is essentially the annual rent that can be earned by renting out a home divided by its market price. Singh goes on to write: “In India, the cities which currently offer a higher rental yield are Mumbai, Pune, NCR-Delhi, Bengaluru, Kolkata, Chennai, Hyderabad, Ahmedabad. All these cities offer a rental yield of 2 per cent and above, and you can be assured that the average is not going down anytime soon. Investing in these cities will offer you the maximum returns on investment in properties bought for generating rental income.”

What is Singh saying here? You can hope to earn a return of 2% or a little more, by renting out a home, almost all across metropolitan India. The question is why would anyone in their right mind invest when the prospective return is 2%? That Singh does not tell us. And this when most savings bank accounts pay an assured return of 4%. There are banks which even pay 7% interest on their savings bank accounts.

Further, earning a return by depositing money in a savings bank account is a very easy of making money in comparison to earning a rent by buying a home. Real estate investment comes with its share of hassles. And earning a 2% return for those troubles is simply not go enough.

Singh of JLL India then goes on to say that the rental yield of 2% is not going to go down any time soon. Well, hasn’t it gone down enough already?
The second question is why have real estate consultants now started recommending real estate as a mode of earning a rental income. As anyone who has ever invested in real estate will tell you, investors buy real estate in the hope of making capital gains. Very few investors buy real estate in the hope of earning a rental income. There are easier ways of earning a regular income than through renting out real estate.

The problem is that real estate prices have not gone anywhere in the recent past. As Atul Tiwari and Rishi Iyer of Citi Research point out: “Different data points continue to suggest broad-based deceleration in residential prices across India. Residential prices grew just ~0.5% year on year as on March 31, 2015.”
The Citi analysts have used data from Prop Equity. They further point out that prices had been rising at double digit rates before this.

Data from Liases Foras, a real estate research and rating company, shows a similar trend. The average price in six cities (Mumbai Metropolitan Region, National Capital Region, Hyderabad, Chennai, Bangalore and Pune) went up by around 1%, for a one year period ending on March 31, 2015.

So, the insiders are telling us that the real estate prices have stayed almost flat over the last one year. And this explains why Singh of JLL India had to write a column pitching rental income of 2% that can be earned from investing in real estate.

In fact, there is enough anecdotal evidence to suggest that prices have fallen by almost 20% in many parts of the country. Given that there is no neutral agency putting this data together, there is no way of knowing how bad the scene is at the aggregated level. My guess is that it is much worse than what the real estate consultants are telling us.

All the price and sales data that is currently available comes from real estate consultants. And they have an incentive in the real estate prices continuing to go up. Their incomes depend on it.

Hence, there is a clear need for an independent agency which collates real estate data in the country. This will be a huge help to genuine real estate buyers who want to buy a home to live in. Hope the Modi government is listening.

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

The column originally appeared on Yahoo India on July 22, 2015

Why companies fire employees

boss
Vivek Kaul

In the aftermath of the financial crisis that started in September 2008, after the investment bank Lehman Brothers went bust, the news regarding companies firing employees in order to cut costs, is regularly published in the media. The global information technology firms have fired a lot of people over the last few years in order to stay competitive.
In an economic environment where business is dull, the companies try to maintain profit levels by cutting costs. There are various ways in which this is done. An organisation I worked for in the past tried to cut costs by getting rid of toilet paper in the restrooms. This move was met with immediate protests and sometime later the status quo was restored.
Jokes apart, a major way in which companies cut costs is by firing employees. This is a painful process which typically leads to people working at the middle and lower levels suddenly finding themselves without a job. Normally, those at the top levels of management as well as those who work in the HR department, carry on with their jobs.
What makes the situation worse is the fact that people who are fired are in no way prepared for it and are told one fine day that they would no longer be needed. In this day and age when almost everybody has EMIs to pay and the joint family system has completely broken down in cities (in the Indian context), it is a very difficult situation to be in.
What I have always wondered is why do companies fire employees? Why don’t they reduce salaries across the board and ensure that everyone has a job. In fact, those at the upper levels should forego more, given that they are more responsible for the good or bad performance of the company. Those at the middle and junior levels typically do what they are told to. Further, cutting salaries across the board can’t be very difficult to implement, I guess.
I have put this question to a few HR people I happen to know. The answer I typically get from them is that when the economy is not doing very well, it is a good time to get rid of the “deadwood” (essentially employees who are not very productive) and make the company leaner. This I guess is a part of the answer but not a complete answer to my question.
To get a complete answer we need to know a little about a famous American economist Irving Fisher. In the latter part of his career, Fisher had turned into an entrepreneur and hence, ended up employing people.
One of the interesting things that he did was to index the salaries of his employees to the rate of inflation. So if inflation went up salaries went up as well and vice versa. As Sylvia Nasar writes in Grand Pursuit—The Story of Economic Genius: “He [i.e. Fisher] was probably the first employer to ever grant an explicit, annual, automatic “cost of living” adjustment.”
Nevertheless, Fisher’s experience with this experiment wasn’t very smooth. As long as the salaries were going up his employees were fine with the situation. But the moment salaries started to fall the employees resented it.
As Fisher would later recount in Stable Money—A History of the Movement: “As long as cost of living was getting higher…employees welcomed the swelling contents of their…pay envelopes…But as soon as cost of living fell they resented the “reduction” in their wages.”
The point being that employees do not like salaries being cut and it typically leads to a lot of resentment. Hence, it is just easier for organisations to fire people, rather than cut salaries across the board.
As Richard Thaler writes in Misbehaving—The Making of Behavioural Economics: “Cutting wage makes workers so angry that firms find it better to keep pay levels fixed and just lay off surplus employees(who are not around to complain).”
This behavioural problem essentially leads to people being fired.
(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared in the Bangalore Mirror on July 22, 2015