Month: July 2017 | Page 3

17 July, 2017

The Real Returns from Real Estate Have Been Very Low

250px-Underconstruction_Building

The best way to challenge myths is to look at data. The trouble is that India’s real estate sector is very opaque and does not give us enough data points to do a proper job of analysing it. In the process, the myth that any real estate investment yields massive amounts of returns at all points of time, continues to persist.

Thankfully, now we have some data which we can use. Sometime back, the National Housing Bank (NHB), the regulator of housing finance companies, launched a revamped RESIDEX, a housing price index. The index claims to offer home prices of 50 cities across the nation though I could find data for only 49. In this column, I look at data referred to as HPI@Assessment Prices based on the information furnished by banks and other lending agencies regarding home prices.

This should help us get some idea about which way the real estate prices have gone over the last few years. And for the first time we should be able to calculate the actual city wise returns. This should give all the real estate bhakts out there some idea of how their investments have done over the years.

As I said at the beginning, the NHB RESIDEX has price data for 50 cities. Let’s take a look at Table 1. It shows the per year returns of these cities between June 2013 and March 2017. It also shows the one-year return between March 2016 and March 2017. While the NHB RESIDEX claims to have data from 50 cities, I could find data only for 49 cities.

Also, even though it has data from 50 cities, it can’t claim to be a pan India index given that many of the cities represented separately are essentially the satellite cities of some of the bigger cities like Mumbai, Delhi and Kolkata. Further, some of the bigger cities in states haven’t found representation in the index. These include Jamshedpur in Jharkhand, Madurai in Tamil Nadu, Jalandhar in Punjab, Allahabad and Varanasi in Uttar Pradesh.

Nevertheless, the index is a good start which can give us a good sense which way the real estate market in India is headed. Also, it will give us a good idea of how well or badly has the real estate market in India performed, over the last few years. Typically, this sort of information is rarely available in the public domain and will allow us to settle once and for all, how good an investment real estate has been over the last few years.

Table 1:

	Name of the city	Return per year between June 2013 and March 2017 (in %)	One-year return between March 2016 and March 2017 (in %)
1	Mumbai	6.7	2.8
2	Delhi	-2.6	5.8
3	Bengaluru	7.3	7.5
4	Kolkata	6.5	2.9
5	Chennai	7.1	10
6	Pune	7.2	9.5
7	Nagpur	5.6	11.2
8	Nashik	2.5	-0.25
9	Kalyan Dombivali	8.6	7.4
10	Mira Road-Bhayander	5.11	2.9
11	Navi Mumbai	3.4	-8.9
12	Panvel	2.9	-7.1
13	Thane	7.1	2
14	Vasai Virar	3.2	2.3
15	Chakan	6	0.7
16	Pimpri Chinchwad	5.2	3.5
17	Coimbatore	-0.8	-10.5
18	Ahmedabad	0.5	6.8
19	Surat	3.5	3.6
20	Vadodra	1.6	7.9
21	Rajkot	2.5	0.3
22	Gandhinagar	-7.8	-11.1
23	Kanpur	8.3	11.3
24	Lucknow	4.7	1.9
25	Meerut	13.5	6
26	Ghaziabad	2.9	9.7
27	Greater Noida	4.3	0
28	Noida	2.7	0
29	Howrah	10.5	15.6
30	New Town Kolkata	4.2	-7.8
31	Bidhanagar excluding Rajarhat	5.4	-1.8
32	Chandigarah(Tricity)	2.1	-5.4
33	Ludhiana	4.8	0
34	Faridabad	3.7	12.3
35	Gurugram	4.8	7.4
36	Jaipur	5.2	-1.5
37	Bhiwadi	1.6	-14
38	Indore	6.2	6.9
39	Bhopal	3.2	0.4
40	Vizag	10.3	24.7
41	Vijaywada	8.8	1.2
42	Kochi	6.8	4.1
43	Thiruvananthapuram	7.7	-0.5
44	Hyderabad	4.1	2.2
45	Patna	2.6	-7.1
46	Guwahati	4	8.2
47	Dehradun	0	4.8
48	Ranchi	-2.6	-17.7
49	Bhubaneswar	1.5	7.5

Source: Author calculations on data obtained from https://residex.nhbonline.org.in/NHB_Residex.aspx

Table 1 makes for a very interesting reading. If we look at returns per year across different cities from June 2013 onwards, very few cities have given a return of greater than 10 per cent year, which is what is needed, in order to meet the regular expenses for upkeep of real estate, along with beating the rate of inflation. Regular expenses would include the maintenance charge that needs to be paid to the housing society every month and a property tax that needs to be paid every year. Of course, the home could be put on rent, the rental yield would work out to around 2 per cent per year. (rental yield is essentially annual rent divided by the market price of the home). If you had bought the home on a loan, then interest would have to be paid on the loan. But a tax deduction would also be available.There are only three cities which have given a return of greater than 10 per cent per year (Meerut, Howrah and Vizag), since June 2013.

In fact, the median rate of return on real estate investment across the 49 cities is 4.3 per cent per year. As John Allen Paulos writes in Beyond Numeracy: “The median of a set of numbers is the middle number in the set.”

Hence, it is easy to see that unless a massive amount of black money has been invested in real estate, the returns have been meagre across the country since June 2013. This is the point from which the NHB RESIDEX data is available, in case you are wondering, dear reader, as to why have we taken this as a cut off.

The situation has gotten worse in the one-year period between March 2016 and March 2017. The median rate of return has fallen to 2.8 per cent. In fact, if we remove Vizag where one year return has been close to 25 per cent return during this period, the median rate of return falls to 2.55 per cent. Money in a savings bank account would have yielded more.

This basically means that real estate returns across the country have been subdued lately. In fact, between March 2016 and March 2017 prices have fallen in 13 out of the 49 cities under consideration. This is if we just look at prices. If we take other expenses into account (maintenance charges, property tax, interest paid on a home loan after adjusting for the tax benefit and inflation etc.) into account, the real returns would be negative in many other cases.

Of course, this logic works on weighted average prices for cities and individual experiences may have been different. Also, the logic could have been completely different if black money was being invested to buy real estate.

Hence, real estate as an investment hasn’t gone anywhere in the last four years and the situation has only worsened in the last one year. Having said that prices are not falling. This, despite the sales crashing in the aftermath of demonetisation.

Recently, the real estate consulting firm PropEquity released some interesting data. As per the data, for the period between January and May 2017, the housing sales fell by 41 per cent to 1.1 lakhs, across 42 major cities. During the same period in 2016, the housing sales had stood at 1.87 lakh.

But as we have seen the median price hasn’t really fallen between March 2016 and March 2017. While, real estate hasn’t made for a great investment for a while now, it hasn’t reached a stage where those actually wanting a home to live in, can buy one, in most cities. What are the reasons for the same?

a) Those who have already invested in real estate have a substantial amount of black money invested in it. The trouble is that if they sell right now, there isn’t much they can do with the black money that they will get in the form of cash after the sale. This is because black money generated by real estate finds its way into real estate all over again. But given the very low returns that real estate has given over the last few years, there is no point in doing that.

b) In some cases, the investors are sitting on losses and they are waiting for prices to rise before they will sell. As Richard Thaler writes in Misbehaving-The Making of Behavioural Economics: “Roughly speaking, losses hurt about twice as much as gains make you feel good.” This basically leads to a tendency among investors who are facing losses on their investment to continue to hold on to the losses, until they reach the positive territory again. This leads to a slow correction in prices.

c) In some other cases, investors are anchored on to the high returns that their friends, relatives and acquaintances, had made during the go go years of real estate between 2002 and 2011. They are waiting for that era to return. We wish them luck.

d) Up until last year, home loans taken to finance self-occupied homes, were allowed a deduction of up to Rs 2 lakh for the interest paid on the home loan against taxable income.

For home loans taken to finance non-self-occupied homes, any amount of interest on the home loan could be deducted to arrive at taxable income. This was allowed as long as the real rent (if the home was rented out) or the notional rent (if the home wasn’t rented out, but the rent the home owner was likely to earn if he would rent it out), was adjusted against it.

Typically, given the high home prices, the interest paid on a home loan these days, is many times the rent a home is likely to earn, if rented out. This essentially ensures that by buying a second home (or a third or a fourth or fifth home…), individuals could create a massive tax deduction and bring down their taxable income dramatically. The corporate crowd used this anomaly with great success by buying second and third homes, as they went up the hierarchy.

This basically ensured that even if the investment was not yielding any returns in terms of price increase, the tax arbitrage available was good enough to stay invested.

In his budget speech, the finance minister Arun Jaitley limited all such deductions (for self-occupied as well as other homes financed through home loans) to Rs 2 lakh. This has basically ensured that the market for homes to be create a tax deduction has now effectively come to an end. Whether this has an impact on prices remains to be seen.

To conclude, without a genuine price correction the mess in the real estate sector is likely to continue. Investors have sustained the sector for many many years now. It’s time the real estate companies realised this. If they want to continue to make money in the years to come, it’s time they addressed the genuine home buyers as well.

Until that happens, we don’t see any acche din for this sector.

Note: This originally appeared as a part of the Vivek Kaul Letter on July 14, 2017.

The column originally appeared on July 17, 2017, on Equitymaster.

13 July, 2017

The Other Side of GST

There is a difference between making things simple and making them simplistic. In the zeal to make things simple a significant chunk of media’s coverage on the recently introduced Goods and Services Tax (GST) has turned out to be simplistic.

Here’s how.

There are two basic concepts at the heart of the GST. It has a self-policing feature built into it and it allows for an input tax credit. And both are linked.

Let’s start with the second feature first. What is input tax credit? Let’s say you are a manufacturer. The product you make needs different kinds of raw material. You buy this raw material from other suppliers. When you buy this raw material from other suppliers, they have already paid some indirect taxes on it and these indirect taxes are built into the price that you pay.

In the pre-GST era, you could not deduct for the taxes already paid down the value chain, while you paid your share of indirect taxes. In this way, you ended up paying a tax on tax and hence there was a cascading effect on the final price of the product.
GST subsumes many indirect taxes both at the level of the state governments as well as the central government. And that is a good thing because it actually reduces the number of taxes.

With the introduction of the GST, you can deduct the GST already paid as a part of your value chain, while paying your share of the GST. This is referred to as input tax credit.
And how do you get this input tax credit? As Section 16(2a) of the Central Goods and Services Tax Act, 2017, points out: “Notwithstanding anything contained in this section, no registered person shall be entitled to the credit of any input tax in respect of any supply of goods or services or both to him unless,–– (a) he is in possession of a tax invoice or debit note issued by a supplier registered under this Act, or such other tax paying documents as may be prescribed.”

What does this mean in simple English? It basically means that anyone claiming an input tax credit for the GST already paid down his value chain, needs to ensure that his suppliers have registered under this Act (i.e. they have a Goods and Services Tax Identification Number (GSTIN)). The individual also needs to ensure that he is in possession of an invoice from his suppliers.

This is the self-policing feature built into the GST. Anyone claiming an input tax credit needs to ensure that all his suppliers are a part of the GST as well. This basically ensures that if any supplier was operating in the informal economy, he now has to become a part of the formal economy by getting a GSTIN. Wherever this chain breaks, the government knows that somebody is not paying his fair share of taxes. So far so good.

Norman Loayza, an economist with the Development Research Group of the World Bank defines informality as “a term used to describe the collection of firms, workers, and activities that operate outside the legal and regulatory frameworks or outside the modern economy.” And given this, governments are not able to collect tax from firms operating in the informal economy. The GST is a way of ensuring that these firms become a part of the formal economy and they pay taxes.

Much of the writing in the media has focused on this and passed it as a good effect of the GST, which it is. But saying that it is only a good effect and does not have any negative sides to it, is making things simplistic instead of simple.

Let me explain.

Loayza estimates that in a typical developing country the informal economy employs 70 per cent of the labour force and produces around 35 per cent of the GDP. India has multiple estimates of the size of the informal economy.

Take a look at the following figure.

Source: Boosting Growth and Employment in the BRICS’ Prepared by ILO and VV Giri National Labour Institute, INDIA. September 15, 2016.

As per Figure 1, nearly 67 per cent of India’s labour force works in the informal economy. This touches nearly 85 per cent, if we take the informal workers in the formal economy into account as well. Many formal firms under declare the total number of people they employ.

The India Employment and Labour Report of 2014 states: “An overwhelmingly large percentage of workers (about 92 per cent) are engaged in informal employment and a large majority of them have low earnings with limited or no social protection.”

There are other estimates as well. Nevertheless, most of these estimates put the size of the labour force working in the informal economy at around 75 per cent or more of the total labour force. Also, depending on which estimate you believe the informal economy contributes 35 to 45 per cent of the GDP, which is huge.

The question is why are the firms operating in the informal economy, and not formal? The simplistic answer is that they want to avoid paying tax. And GST will make them compliant on that front.

Many Indian firms operating in the informal economy do so because going formal means following a whole host of rules and regulations, which they simply do not have the wherewithal to follow. The National Manufacturing Policy of 2011 estimates that, on an average, a manufacturing unit needs to comply with nearly 70 laws and regulations. At the same time, these units sometimes need to file as many as 100 returns a year.

Furthermore, India has 150 state level-labour laws and 44 central-level labour laws.
GST will force informal firms to go formal, the question is, will they? It really depends on whether it will be viable for them to do so. Instead of going formal, they may simply decide to shutdown. This is also a possibility, which the media seems to have taken great care not to talk about. How this will play out, no one really knows and only time will tell.

If GST has to be a real success then the ease of doing business in India needs to start improving as well. Nothing much has happened on that front.

If the informal firms shutdown, how is the situation likely to play out? Many people will end up losing jobs and this will have an impact on consumption and economic growth.
Will the smaller formal firms cash in on the situation by expanding their production and recruiting more people? Again, it’s not so easy. The average Indian manufacturing firm is very small. In many cases, it employs even less than ten people.

Many formal firms continue to want to stay small so that they don’t come under the ambit of labour laws. As Jagidsh Bhagwati and Arvind Panagariya write in India’s Tryst with Destiny: “The costs due to labour legislations rise progressively in discrete steps at seven, ten, twenty, fifty and 100 workers. As the firm size rises from six regular workers towards 100, at no point between the two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra costs of satisfying these laws.” Panagariya is currently the Vice Chairman of the NITI Aayog.

The situation will end up benefitting the larger firms who will end up capturing a larger portion of the market. And this will give them pricing power as well. Of course, it will mean more taxes for the government, which can then continue with its many boondoggles or create newer ones.

Also, it is worth mentioning here that while the owners of firms working in the informal economy don’t pay taxes, those working in these firms do pay their share. Most of these workers earn lesser than Rs 2.5 lakh. Hence, they don’t come under the ambit of income tax. When they spend the money that they earn they pay indirect taxes. Also, the money they spend is income for firms operating in the formal economy, which then pay their share of income tax.

Given this, simply arguing that all informal economy is bad, is basically a very simplistic way of looking at things. Ultimately, it provides jobs to three-fourths of the labour force and that can’t be ignored. Hence, it is important that the media, economists and analysts, try to explore this other side of the GST as well.

The article originally appeared on Newslaundry on July 12, 2017.

11 July, 2017

The Rise of the Robots

robot

Euphemisms and corporates go together.

Vishal Sikka, the bossman at Infosys, in a recent letter to the stakeholders said: “Automation itself released about 11,000 FTE [Fulltime Employee] worth of effort through the year, a clear demonstration of how software is going to play a crucial role in our business model.”

Sikka did not specify what he meant by the phrase “released about 11,000 FTE [Fulltime Employee] worth of effort through the year”. Nevertheless, the broader point is that automation or the rise of the robots, will destroy many human jobs in the years to come.

This is not the first time that the rise of the robots or automation or mechanisation has been seen as a threat to human jobs. Similar concerns were also raised at the start of the industrial revolution in the Western world, a couple of centuries back.

The industrial revolution destroyed jobs, but it created many more new jobs, which finally led to economic growth and economic progress, the world had never seen before. What has changed this time around? If at all, it has.

Human beings essentially have two kinds of abilities: a) physical ability b) cognitive abilities i.e., the ability to think, understand, reason, analyse, remember, etc. As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “As long as machines competed with us merely in physical abilities, you could always find cognitive tasks that humans do better. So machines took over purely manual jobs, while humans focussed on jobs requiring at least some cognitive skills. Yet what will happen once algorithms [another name for robots] outperform us in remembering, analysing and recognising patterns?”

The trouble is that the rise of the robots hits at the heart of the model that has created economic growth world over, for the last two centuries. Companies employed individuals, and paid them a salary. The individuals then spent this salary to meet their needs. One man’s spending was someone else’s income. This benefitted other individuals and companies and so the cycle worked.

Henry Ford, the automobile pioneer understood this and paid his workers very well. As Edward Luce writes in The Retreat of Western Liberalism: “Henry Ford… raised the wage he paid to factory employees to $5 a day, a sum that in the 1920s would afford a comfortable middle-class lifestyle.”

By the time the 1950s came around, Ford started to invest in automation and at this point of time a very interesting incident took place. The auto union leader Walter Reuther was being given a tour of a new factory which had robots. And he was asked: “How will you get union dues from them?”

To which, Reuther replied: “How will you get them to buy your cars?” The point being that only when businessmen paid their employees did they go out and spend that money. This spending benefitted the businessmen they worked for, as well as other businessmen. Many employees of Ford, went out and bought Ford cars because they were well paid.

Once companies start employing more and mor robots instead of human beings, this model of economic growth and progress will go for a complete toss. As Luce writes: “The new economy requires consumers with spending power – just as the old one did. Yet much, like the farmer who eats his seed corn, Big Data is gobbling up its source of future revenue.”

The rise of the robots or Big Data or increased automation and mechanisation, will take away human jobs. As Luce writes: “Whether you listen to utopians or dystopians, all agree the share of jobs at risk of elimination is rising. McKinsey says almost half of existing jobs are vulnerable to robots.”

If robots take over, then humans don’t earn. If they don’t earn, how will they spend money. And if they don’t have money to spend, the question is, how will the companies run by robots, make money.

This is a question that nobody seems to have an answer for.

The column originally appeared in the Bangalore Mirror on July 5, 2017.

11 July, 2017

Post Demonetisation Real Estate Sales Have Collapsed, But Prices Haven’t

250px-Underconstruction_Building

It has been a while since I wrote anything on real estate and the only reason for it is the sheer lack of data on the sector.

Recently, the real estate consulting firm PropEquity released some interesting data and that gave me sufficient reason to write one more piece on real estate.

As per the data, f or the period between January and May 2017, the housing sales fell by 41 per cent to 1.1 lakhs, across 42 major cities. During the same period in 2016, the housing sales had stood at 1.87 lakh.

The interesting thing is that the launch of new homes has also come down considerably. For the first five months of the current year, which are under consideration here, the launch of new homes fell by 62 per cent to 70,450 units. During the same period in 2016, the launch of new homes had stood at around 1.86 lakh.

The new home launches are a good indicator of the appetite investors have for real estate. And that has clearly come down big time. So, what is happening here? One, people are not buying ready to move in homes from builders. And two, they aren’t interested in under-construction property, where investment returns tend to be very high, either.

Why has that been the case? Typically, a significant portion in any real estate deal tends to be carried out in black. When going about a real estate deal, a significant part of the transaction is in the form of cash which changes hands, and for which there is no record. This cash may be black money where no taxes have been paid. Or it could even be white money, where taxes have been paid, but which is now becoming black.

For most of the period January to May 2017, there wasn’t enough sufficient cash going around in the financial system. This was because of the demonetisation announced on November 8, 2016, by the prime minister Narendra Modi.

Take a look at Figure 1. It plots the gap between the currency under circulation as on November 4, 2016 (a few days before demonetisation) and at the end every week between January and May 2017.

Figure 1:

What does Figure 1 tell us? On January 6, 2017, the currency in circulation was around 50 per cent of the currency in circulation as on November 4, 2016. This meant that the gap was also around 50 per cent. Since then, the currency in circulation has kept increasing every week, as the RBI has printed and pumped money into the financial system, and this has led to the gap coming down. Hence, as on May 26, 2017, the currency in circulation was at around 83 per cent of the currency in circulation as on November 4, 2016. Given this, the gap had come down to around 17 per cent.

So, what does this tell us? It tells us that there wasn’t enough cash going around in the financial system for people to carry out transactions in cash. Given this, people were not in a position to pay the black part of any real estate transaction in cash. This essentially meant that real estate transactions collapsed and were down by 41 per cent during the first five months of the year.

It also tells us that many of those who wanted to sell real estate just sat on it, instead of carrying out the transaction in 100 per cent white amount, as was the hope post demonetisation.

By the end of March 2017, the financial system had nearly 75 per cent of the currency in circulation as on November 4, 2016. The point being that there was enough money to go back to making black payments as a part of real estate transactions. But that doesn’t seem to have happened, with new home launches down by a whopping 62 per cent during the period.

One answer for that might lie in a change that finance minister Arun Jaitley made in this year’s budget. Up until last year, home loans taken to finance self-occupied homes, were allowed a deduction of up to Rs 2 lakh for the interest paid on the home loan against taxable income.

For home loans taken to finance non-self-occupied homes, any amount of interest on the home loan could be deducted to arrive at taxable income. This was allowed as long as the real rent (if the home was rented out) or the notional rent(if the home wasn’t rented out, but the rent the home owner was likely to earn if he would rent it out), was adjusted against it.

Typically, given the high home prices, the interest paid on a home loan these days, is many times the rent a home is likely to earn, if rented out. This essentially ensures that by buying a second home, individuals could create a massive tax deduction and bring down their taxable income dramatically. The corporate crowd used this anomaly with great success by buying second and third homes, as they went up the hierarchy. And after buying these homes, they kept it locked, thus creating a shortage for homes available for rent.

In his budget speech, the finance minister Arun Jaitley limited all such deductions (for self occupied as well as other homes financed through home loans) to Rs 2 lakh. This has basically ensured that the market for homes to be create a tax deduction has now effectively come to an end.

This is another factor which has basically ensured that the demand for finished homes as well as under-construction property has come down dramatically during the first five months of this year.

Regular readers would know that I have been recommending this for a few years now. In an era of exceptionally high home prices, why should the government be encouraging people to buy homes in order to benefit from a massive tax deduction. Also, those who buy more than one home, aren’t exactly poor. Hence, why pander them like this? So, finally after many years this anomaly has thankfully been done away with.

This brings us to the last and the most important point of the piece. While, the sales and prospective sales of real estate have come down dramatically, what has the impact been on the prices front?

The National Housing Bank relaunched its real estate index RESIDEX yesterday. As per the press release: “NHB RESIDEX for January-March,2017 revealed that price indices for residential properties based on actual market prices for ongoing construction prices have increased over the previous quarter in 24 of the 47 cities covered in the Index including in Jaipur, Chennai, Lucknow, Guwahati, Howrah, Hyderabad, Bidhannagar etc. In Delhi, Faridabad, Chandigarh, Patna and Nashik etc, prices have come down.”

What this tells us is that the broader trend in prices across India hasn’t gone anywhere post demonetisation. On the whole prices haven’t changed much What does this tell us? It tells us that builders have great staying power. The amount of money that they have made and stashed away in the real estate bull run between 2002 and 2011, allows them a tremendous staying power.

Also, many real estate companies are fronts for politicians and there is no point for them in annoying politicians by cutting prices and selling homes. Instead of selling homes at lower prices, the builders would rather sit on it, and which is what they are doing.

The trouble with this is that the longer they do this, the longer the time correction of prices will last i.e. the prices may not go down in nominal terms, but if we take inflation into account over the years, they would have gone down substantially.

The thing is that this time correction is not enough. If the real estate market has to revive, actual real estate prices need to fall. Yeah, I know I have been repeating this like a cuckoo clock over the years, but that is the only way out of the mess that prevails.

Postscript: In the next edition of the Vivek Kaul Letter, I will be discussing the newly launched NHB RESIDEX index in detail. For the first time, there is some detailed price data that has been made available across multiple cities. And that should make for an interesting piece of analysis and reading. Do keep a lookout.

The column originally appeared on Equitymaster on July 11, 2017.