Home Prices, And Not Buyers, Are Unrealistic

India-Real-Estate-MarketVivek Kaul

Columnist Gautam Mukherjee wrote an article on real estate published on this website on August 3, 2015. In this column Mukherjee had this to say about prospective buyers looking to buy a home to live-in: “These worthies [i.e. the prospective buyers], expecting a crash in prices as the crisis deepens, are gleefully seeking ever more unrealistic bargains before committing themselves. To them, the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.”

I really wonder why prospective buyers have been called “worthies” here. And what is wrong about hoping to find a home to live in at a price which one can afford? Further, are the prospective buyers really seeking “unrealistic bargains” or are home prices at unrealistic levels? From all the data that is available it seems to be the latter.

Data put out by real estate research and rating firm Liases Foras tells us that the weighted average price of a flat in a city like Mumbai was Rs 1.3 crore as of March 2015. In the National Capital Region it is Rs 74 lakh. In Bangalore the price is Rs 86 lakh. And so is the situation almost all over the country.
I would like to ask Mr Mukherjee, among the people who he calls “worthies”, how many make the kind of money that is needed to be able to afford these homes? Let’s do some back calculation and see.

The weighted average price of a flat in Mumbai is Rs 1.3 crore. A bank would finance 80% of this. This means that the bank would give a home loan of up to Rs 1.04 crore. The remaining Rs 26 lakh the prospective buyer would have to arrange as a down-payment. This assuming that the builder does not ask for any payment to be made in black. I know that this is an unrealistic assumption, but just humour me for a bit.

The State Bank of India currently charges an interest of 10% on home loans above Rs 1 crore. For a twenty year loan the EMI works out to Rs 96,502. Typically, while lending banks ensure that up to 40% of the salary goes towards the EMI. Hence, to get a loan of around Rs 1.04 crore and to be able to pay an EMI of Rs 96,502, the salary of the borrower has to be around Rs 2.41 lakh per month(Rs 96,502 divided by 40%) or around Rs 29 lakh per year (Rs 2.41 lakh multiplied by 12).

Even in Mumbai how many people make that kind of money? The Maharashtra State Economic Survey for the year 2014-2015 points out that the average per capita income in Mumbai during 2013-2014 stood at Rs 1.88 lakh. So it’s not the “prospective buyers” who are being unrealistic, it’s the prices that builders want to be paid for the homes that they have built, which are unrealistic.

Given this, it is not surprising that, as the latest Economic Survey points out: “At present urban housing shortage is 18.8 million units [i.e. homes].”

As mentioned earlier Mukherjee writes: “To them [prospective buyers], the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.”

What is wrong with this thinking? As analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled Real Estate: The unwind and its side effects: “Another big source of generation of black money is the real estate sector which has witnessed an unprecedented boom in the past ten years or so. 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.” In Mumbai, they put the ratio of black money to total value at between 10-30%. The Ambit analysts were quoting from data put out by National Institute of Public Finance and Policy in July 2014.

I guess Mukherjee may not want to believe this. So here is something out of a report on black money published by the business lobby FICCI in February 2015. As the report points out: “The Real Estate sector in India constitutes for about 11 % of the GDP of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.” FICCI is a business lobby and not an association of buyers looking to buy homes to live-in. Given these things Mukherjee’s sarcasm towards prospective buyers who cannot afford homes at their current prices, was really uncalled for.

In the example considered above the weighted average price of a flat in Mumbai is Rs 1.3 crore. If the builder asks 20% of this in black (and I am being fairly conservative here), the prospective buyer has to arrange for Rs 26 lakh.

This leaves Rs 1.04 crore, which becomes the price of the flat on which the bank will give a home loan. Now remember, the bank gives a home loan of up to only 80% of the price of the flat. Hence, the bank will give a loan of up to only Rs 83.2 lakh. The remaining Rs 20.8 lakh would have to be paid by the buyer as a down-payment. This means that the buyer needs savings of at least Rs 46.8 lakh(Rs 26 lakh paid in black plus Rs 20.8 lakh to be paid as a down-payment) to buy a flat. How many people have savings of this kind?

And Mumbai has low levels of black money required to buy a home in comparison to other cities. So, if prospective buyers see builders as profiteers who are bloated on black money, there is absolutely nothing wrong with that. Further, many builders have just taken money from buyers and disappeared. There are many others who have endlessly delayed projects. Hence, if other buyers look at them in a negative light, you can’t blame them for it.
Mukherjee further asks: “But what is the government, specifically the RBI and Finance Ministry doing about the high interest rates, the recapitalisation of banks, and renegotiation of all the stressed loans to builders/ industry, which are about to become irretrievable NPAs?.”

He also suggests: “Also, in the interim, the assumption is that the construction industry will receive new lines of credit/ rescheduled debts from the banks and lending institutions to finish their half-built projects.”

The tone is that the government and the banks should come to the rescue of the real estate companies which are in a mess. There are multiple points that need to be made here. First and foremost why can’t builders cut home prices and sell the massive number of unsold homes that they are sitting on.

Second, why should banks lend more to a borrower who is unable to repay his past debt? It is important to understand the main purpose of a bank, which is to ensure that the money deposited by individuals with it, remains safe and earns some return in the process. What Mukherjee is suggesting is that banks throw good money after bad. Why? Just because a few builders are going to go bust?

Also, it is worth asking where did all the money that the builders raise for building projects go? They took money from prospective buyers. They took money from banks. Where did all this money go? Guess Mukherjee can give us an answer for that.

Further, the builders have made potloads of money between 2002 and 2013, when the bull run in real estate drove home-prices to the current unrealistic level. So how is it fair that prices were allowed to rise, but now when the prices are falling (or should be falling), they should not be allowed to fall?

John Kenneth Galbraith, who was probably the most read economist in the mass media in the twentieth century, once said: “In America, the only respectable type of socialism is socialism for the rich.” Mukherjee along these lines wants the government to bailout the builders. I am no capitalist but socialism for the rich, is socialism of the worst kind.

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

The column originally appeared on SwarajyaMag on Aug 5, 2015