Are banks finally pulling the plug on real estate?

The Reserve Bank of India (RBI) puts out the sectoral deployment of credit data every month.  These numbers tell us how much banks have lent to different sectors.

The latest set of numbers released by the RBI point out that lending to commercial real estate grew by just Rs 7,153 crore or 4.5% between August 22, 2014 and August 21, 2015. Commercial real estate includes loans to builders.

This, when the overall lending by banks grew by Rs 4,67,509 crore or 8.2%. Hence, the lending to real estate by banks grew at a much slower rate than the overall lending carried out by banks, over the last one year.

How did things stand in August 2014? Between August 23, 2013 and August 22, 2014, the overall lending of banks had grown by Rs 5,28,173 crore or 10.2%. In comparison the lending to commercial real estate by banks had grown by 17.3% or Rs 23,318 crore during the period. Hence, the lending to real estate banks between August 2013 and August 2014 had grown at a much faster rate than the overall lending by banks. That is clearly not the case now.

In fact, between August 2013 and August 2014, banks lent Rs 23,318 crore or nearly 3.3 times the Rs 7,153 crore that they have lent between August 2014 and August 2015. Hence, new lending to commercial real estate by banks has slowed down considerably.

What is interesting is that during the course of this financial year the overall lending to commercial real estate by banks has actually gone down. Between March 20, 2015 and August 21, 2015, the lending to commercial real estate has fallen by Rs 975 crore or 0.6%.

This should put further pressure on builders as far as their finances are concerned and push them more towards lowering prices of unsold homes.

In the recent past a spate of private equity/venture capital funds have invested in real estate companies as well as projects. This is now being offered as one of the reasons as to why the real estate prices won’t fall in the time to come. It is being said that money from private equity/venture capital funds will keep real estate companies going for a while.

There are multiple questions that needs to be answered here. The first question is, why are these funds investing in Indian real estate? John Kay explains this in his book Other People’s Money—Masters of the Universe or Servants of the People?

In the aftermath of the financial crisis, the central banks of the Western world have printed a huge amount of money. Some of this money has been diverted into asset markets and financial markets all around the world, driving up their values. At the same time, the markets have been going up and down in the same direction at the same time. They have become highly correlated in comparison to the past.

As Kay writes: “The resulting common volatility of security prices has provoked a search for ‘alternative assets’ which would not be correlated with existing portfolios. Traditionally ‘alternatives’ were investments such as gold, art, vintage cars and fine wines: but these exist only in limited quantities. And as investor interest in them grew, their prices became increasingly correlated with those of mainstream assets.”

This, perhaps explains why private equity and venture capital funds are interested in investing in Indian real estate. They believe that returns are not highly correlated to other asset classes.

The next question is how many real estate companies have got money from these funds? The answer is not many. It is worth remembering here that thousands of companies operate in the Indian real estate space all over the country. And once this is taken into account, the number of companies getting venture capital/private equity funding is essentially insignificant.

Further, at what prices are these funds buying into real estate companies or real estate projects. There is not much clarity on this front. It is safe saying here that the prices at which they are buying projects must be at a significant discount to the so called “market price” of real estate. So, in that sense there has been a price correction. The question is at what price will these companies sell these homes?

Meanwhile, the simplistic belief that a cut in home loan interest rates will revive the sector continues. As Sumeet Abrol of Grant Thorton India told The New Indian Express: “High interest rates and inflated prices were the major problems. Now one is resolved.” Really? The RBI cut the repo rate or the rate at which it lends to banks by 50 basis points (one basis point is one hundredth of a percentage) to 6.75%. In response the country’s largest bank, the State Bank of India, cut its base rate or the minimum interest rate a bank charges its customers, by 40 basis points to 9.3%.

This meant that the interest rate on home loans should have fallen by 40 basis points as well. Nevertheless, the interest rate on an SBI home loan will fall by only 20 basis points. Why is that? Earlier, the bank gave out home loans to men at five basis points above its base rate. To women, it gave out home loans at the base rate. Now it has decided to give out home loans to men at 25 basis points above the base rate. In case of women it is 20 basis points.

Hence, interest rate on a man taking an SBI home loan will be now be 9.55% (9.3% base rate plus 25 basis points). Earlier, the interest rate was 9.75%. This means a fall in interest rate of 20 basis points.

This means a fall in EMI of a little over Rs 13 per lakh of a home loan. Data from the National Housing Bank shows that in 2013-14, the average home loan size in India was Rs 18-19 lakh. I couldn’t find more recent data. Hence, we can assume that the average home loan size for banks would be around Rs 20 lakh now.

The housing finance company, HDFC, gives out average home loan size data every three months, along with its quarterly results. As on June 30, 2015, the average home loan size of HDFC stood at Rs 23.4 lakh.

Given this, an average home loan of Rs 20 lakh for the Indian banking system is a good number to work with. This means that the EMI on an average Indian home loan would fall by Rs 260 (Rs 13 multiplied by 20). So, will that lead to more people buying homes? Or was that stopping people from buying homes in the first place? I don’t think I need to answer that.

As Abrol of Grant Thorton India put it: “Real growth will be triggered only when builders are ready to cut property prices. If a revival is to happen in the sector, prices which were artificially moved up in the recent past in some areas, should come down to realistic levels.”


(The column originally appeared on The Daily Reckoning on October 6, 2015)