Real Estate

How state governments are supporting high real estate prices

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For any market to work efficiently to arrive at a right price, transactions need to happen. Buyers need to buy and sellers need to sell. Take the case of the real estate market in the country currently. Transactions have slowed down. In many places they have come to an absolute standstill.

Those who own real estate are not selling it. Those who want to buy real estate are in no mood to buy it. A simple reason for this lies in the fact that the real estate prices all over the country are way beyond what most people can afford. Nevertheless, the reasoning is not as simple as that.

The area where real estate is bought or sold has a circle rate decided by the state government. The circle rate is the minimum value at which the actual transfer of a property between a seller and a buyer should take place. Hence, the buyer of the property pays stamp duty to the state government on the circle rate.

Over the years the market price of real estate in India has usually been higher than the prevailing circle rate. This has essentially led to a situation where the transaction is registered at the circle rate or a little higher, and the remaining transaction is carried out in black money.

Nevertheless, in the recent past the situation has reversed. In many parts of the country the prevailing circle rate is now higher than the market price. And this has led to the transactions in the real estate market coming to a complete standstill. People are not buying and selling homes because of this.

TN Ninan made this point recently in the Business Standard where he said that the circle rates at which stamp duty is collected had been raised three or four times by the Delhi government in the last four years. “The scuttlebutt is that the market rates for property have fallen in the ballpark region of 30-40 per cent. Consequently, the circle rates are now about 50-75 per cent higher than the real rates in the market,” he wrote.

A similar point was made S Murlidharan on Firstpost, where he wrote about circle rates in Sriperembudur near Chennai. The going circle rate in the area for residential land is Rs 600 per square foot. But, as he writes, there are no buyers even for Rs 400 per square foot.

This marked disconnect between the circle rates and the market price has brought transactions to a standstill.

As Muralidharan explains: “Suppose a transaction is done at Rs 350, the consequence for the buyer would be he would have to pay stamp duty on Rs 600 even though he bought for Rs 350 and for the seller capital gains on Rs 600 less cost even though he got only Rs 350.”

A buyer does not want to pay stamp duty on Rs 600 per square foot when he is actually paying only Rs 350 per foot to the seller. Along similar lines, the seller does not want to pay capital gains tax on Rs 600 per square foot when he is getting paid only Rs 350 per square foot. Hence, no transaction happens.

A similar situation prevails in parts of Kolkata as well, as this column points out. As mentioned earlier, the situation used to be exactly opposite in the past when the circle rate was lower than the market price. This used to allow a part of the transaction to be carried out in black.

Now that the circle rate is higher than the actual market price, it doesn’t make any sense for those who have black money to invest in real estate in many parts of the country.

The question is why aren’t state governments cutting the circle rates in parts of the country where this situation prevails? One reason lies in the fact that taxing property is seen as an easy way to fill the state government coffers. But with transactions slowing down that won’t remain true anymore. As an official told the Daily News and Analysis, recently in the context of Mumbai: “A majority of registration is lease and leave and licence. Actual buying is quite low. As a result, our revenue is decreasing. We should be generating Rs 6,000 crore to Rs 8,000 crore revenue a year in Mumbai; the current is Rs4,000 crore and below.”

Secondly, the black money of most politicians is invested in real estate. If state governments start bringing down circle rates, this would lead to the unofficial “wealth” of politicians coming down as well. This would happen primarily because transactions will start happening at lower prices. Currently, transactions where circle rates are higher than the market price, transactions have come to a standstill.

What does this mean? If state governments do not allow real estate prices to fall by maintaining high circle rates, then the mess in real estate will continue for a longer period of time. Transactions will not happen and the market will go through a longer “time” correction. And this can’t be good for anyone—buyers won’t be able to buy, sellers won’t be able to sell. The builders will continue holding on to the excessive inventory of unsold homes that they have accumulated over a period of time.
The column originally appeared on Yahoo India on August 18, 2015

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

Banks have lent no new money to real estate this financial year

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It is very difficult to get hold of numbers when it concerns the real estate sector in India. The numbers usually put out are by organisations and institutions close to the real estate companies. The one genuine set of numbers that are put out every month is related to the total amount of lending carried out by scheduled commercial banks to the real estate sector in India. These numbers are put out by the Reserve Bank of India (RBI) as a part of the sectoral deployment of credit data, which is released once every month.

The latest set of numbers were released by the RBI on July 31, 2015, and make for a very interesting reading, especially if you have had a long(and perhaps lost) dream of buying a home to live in. Why do I say that? Allow me to explain.

As on June 26, 2015, the total amount of lending carried out by banks to the commercial real estate sector stood at Rs 1,66,900 crore. As on March 20, 2015, three months earlier, the number had stood at Rs 1,68,000 crore. Hence, the total amount of lending by banks to real estate companies has actually come down by around 0.7%. What can safely be said is that in the current financial year (which started on April 1, 2015) on an aggregate basis, the banks haven’t lent a single rupee to real estate companies.

How did the scene look like last year? As on March 21, 2014, the total amount of lending by banks to real estate companies had stood at Rs 1,54,400 crore. By June 27, 2014, the total lending had gone up by 1.7% to Rs 1,57,000 crore. This year the total lending has fallen by 0.7% during a similar period.

How do the numbers look over a longer horizon of one year? The lending to commercial real estate by banks has slowed down considerably. As mentioned earlier, as on June 26, 2015, the total amount of lending to commercial real estate by banks stood at Rs 1,66,900 crore. Over a period of one year, it has grown by just 6.3%. The overall lending by banks grew by 7.3% during the same period.

This is the third month in a row when the lending to real estate by banks has grown at a much slower pace than the overall lending. In fact, we need to look at numbers in June 2014 to realise how much the situation has changed over the last one year.

As on June 27, 2014, the total lending by banks to real estate companies had stood at Rs 1,57,000 crore. It had grown by 17.2% over a one year period. The overall lending by banks had grown 12.8%. Hence, the lending to real estate companies by banks had grown at a much faster rate than overall lending.
Further, lending to real estate companies by banks had grown by 17.2% last year. This year it has grown by only 6.3%. Also, as mentioned earlier, since the beginning of this financial year, the lending to real estate companies by banks has actually fallen.

And all this should be good news for buyers.  Why? For the simple reason that the funding source of real estate companies is drying out. Real estate companies have to repay the interest on the loans they had taken on previously. They also need to pay interest on it. Over and above this, there are projects that are still being built and need to be delivered by a certain date. Money will be needed for all these things.

All these reasons will ensure that the companies will have to get around to selling the unsold apartments that they have built and have been unable to sell. The number of unsold homes in cities across the country is huge. As per an estimate made by the real estate consultant Knight Frank the number of unsold homes in National Capital Region stands at around 1.89 lakhs. In Mumbai Metropolitan Region it stands at 1.94 lakh. In Ahmedabad the number is at 42,000. In Bangalore the number is at 1.05 lakh. And so the situation is all across the country.

The only way these unsold homes can be sold is by cutting prices. While the real estate companies have resisted this so far, with the funding from banks almost coming to a standstill, they really have no more options left in the days to come.

Finally, acche din should be on their way for those looking to buy homes to live in.

The column originally appeared on Yahoo India on Aug 4, 2015

The Delhi/NCR real estate market is dead

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The real estate consultant Knight Frank has released a research report on the real estate market in Delhi and the National Capital Region (NCR). The most important point in the report is that home sales in Delhi and NCR have crashed by 50% to 14,250 units, during the period January and June 2015, in comparison to the same period last year.

The launch of new homes has also crashed dramatically by 68% to 11,360 units, during the period January and June 20115, in comparison to the same period last year. The total number of unsold homes in Delhi and NCR currently stands at around 1.89 lakh units as per Knight Frank.

Hence, the quarters to sell unsold inventory has jumped dramatically. As of June 30, 2015, the quarters to sell unsold inventory number was at 19 quarters. What does this mean? Knight Frank defines quarters to sell unsold inventory as: “The quarters to sell unsold inventory (QTS) is the number of quarters required to exhaust the existing unsold inventory in the market. The existing unsold inventory is divided by the average sales velocity of the preceding eight quarters in order to arrive at the QTS number for that particular quarter.”

Hence, quarters to sell unsold inventory is derived by dividing the total number of unsold homes currently, by the average rate at which homes have been selling over the past eight quarters.

Given that the average sales over eight quarters or two years is considered, the current average sales rate is lower than the overall average sales rate. Hence, if the quarters to sell unsold inventory were to be calculated using the latest average sales rate, the number would be even higher than 19 quarters.

Let’s do some basic maths and try and understand this. The total unsold inventory of homes in Delhi and National Capital Region stands at 1,89,678 units. The quarters to sell unsold inventory is 19 quarters. This means that the average sales rate for the last eight quarters thus stands at 9,988 units (1,89,768 divided by 19).
What is the latest sales rate? For the first six months of 2015 the total number of homes sold in Delhi were 14,250 units. This means a sales rate of 7,125 units (14,250 divided by 2) on an average, over the last two quarters.

If this number were to be considered as the average sales rate, then the quarters to sell unsold inventory would jump to 26.6 quarters (1,89,678 divided by 7,125) . What does this mean? If the total number of unsold homes continue to sell at the rate that they are currently selling at, it would take more than six and half years (26.6 quarters divided by 4), to sell them totally. And this, if no new homes were to be built in the days to come.

As can be seen from the accompanying graph, the quarters to sell unsold inventory has jumped big time over the last one year.

Quarters To Sell (QTS) Unsold Inventory Analysis

As Knight Frank points out: “NCR has moved from a quarters to sell unsold inventory of 14 to 19 in a six-month period. Though January to June 2015 was the leanest half in terms of new launches, the absence of sales velocity has pushed the quarters to sell unsold inventory to nearly 5 years.”

In fact, as the earlier calculation shows the actual quarters to unsold inventory might be more than six and a half years. This is the kind of mess that the real estate sector in the Delhi and National Capital Region is in. Some of the unsold inventory is more than three years old, as can be seen from the following graph.

Micro-Market-Wise QTS vs Age Of Inventory

Data Source: Knight Frank Research.
In fact, to realise how quickly the situation is deteriorating we need to look at how things stood at as on June 30, 2014, a year earlier. The total unsold inventory one year back stood at 1,67,000, data from Knight Frank tells us. The quarters to sell unsold inventory stood at 9. One year later it is at 19.

Also, the average sales rate was at 18,556 units (1,67,000 divided by 9). Currently it is at 9,987 units, which is a fall of more than 46%, during the course of one year. As Knight Frank points out: “The opening up of new land parcels for development while the existing ones were still not fully utilised is seen as one of the reasons behind the inventory pileup in NCR.”

What makes the situation worse is that new supply (despite falling) will keep hitting the market. As of December 2014, 1,92,568 units were under various stages of construction in Delhi and National Capital Region. The latest report of Knight Frank does not provide an updated number. But given that only 11,360 new homes hit the market, the under-construction number as on June 30, 2015, cannot be significantly different from the December 2014 number.

To conclude, the real estate market in Delhi and the National Capital Region is dead. It will take many years for this market to recover. Your money will be better invested somewhere else.
Postscript: Hopefully, next week I won’t write on real estate.

The column originally appeared on The Daily Reckoning on July 31, 2015

Buyers can’t be fooled all the time: Lessons from a 50% fall in home sales in Delhi

India-Real-Estate-MarketVivek Kaul

If you are still in denial that all is well with the real estate sector, this should wake you up. The real estate consultant Knight Frank has released a research report in which it points out the depressing state of the real estate sector in Delhi and the National Capital Region.

As analyst Ankita Sood writing for Knight Frank points out: “The market registered a year on year dip of 50%, with 14,250 units sold.” Hence, home sales in the National Capital Region for the period January to June 2015 dropped by 50% in comparison to the same period last year.

At the same time the number of new launches also fell dramatically by 68% in January to June 2015 in comparison to the same period last year. The new project launches stood at 11,360 units.

There are a number of lessons that can be drawn from these numbers:

1) Investors do not have endless patience: The real estate market in and around Delhi has primarily been investor driven. This is primarily because of the massive amount of black money that the city manages to generate. Black money is money which has been earned but on which taxes have not been paid.
Falling home sales clearly indicate that investors are no longer interested in buying more new homes, given that they are still sitting on the ones they had bought over the last few years. And the returns on these apartments have been negative or next to nothing. Hence, investors are looking to sell out the homes they had bought.

As Sood writes: “The growth rate of the weighted average price has been witnessing a downward trend since 2013, and has slowed down considerably…Long-term investors who were with the developers over the 3–4 year construction period are now looking for an exit, owing to the depressed market sentiments. Stagnant prices and delayed project deliveries have contributed towards investors entering into a ‘distressed resale’ mode, as they are now offering to exit at a 15% to 20% discount than the primary market price.”

This “offer to exit” at 15 to 20% discount tells us very clearly that real estate prices do fall. And as more and more investors hit the market to sell what they have been sitting on, prices will fall further.

2) The total amount of black money coming into real estate has been coming down: As far as the metropolitan cities in India is concerned, the maximum amount of black money goes into real estate in Delhi. As analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled Real Estate: The unwind and its side effects: “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%.

Hence, among the bigger cities, the maximum amount of black money goes into real estate in Delhi and the National Capital Region. And this has been coming down. How can we conclude that? The Delhi and the National Capital Region have approximately 189,678 unsold units, Knight Frank data suggests.
If black money were coming into real estate at the same pace as before, this number would have been much lower. A fall in new launches by 68% is another good indicator that black money coming into the sector has been coming down.

3) You can’t fool all the people all the time: The Delhi and the National Capital Region has had too many instances of builders disappearing as well as not delivering homes on time. As Santhosh Kumar, CEO – Operations & International Director, JLL India, wrote in a recent research note: “The National Capital Region (NCR) has some locations that buyers are best advised to avoid. Various issues like delays in delivery, oversupply, speculation and infrastructure deficit have been plaguing these markets, rendering them unsuitable for first-time home purchase.”

Kumar gives the example of the Greater Faridabad area. As he writes: “Many instances of fly-by-night operators (and even some established developers) reneging on their commitments to buyers have been evident in Greater Faridabad. There have even been cases of developers absconding altogether after selling as many flats as they could without finishing the projects.”

Obviously, such fraud cannot go on forever. Buyers have come to know about these things over a period of time and have decided to stay away from buying real estate. In fact, Kumar even warns people to stay away from under-construction property, such is the state of real estate in Delhi and National Capital Region.
As he writes: “Keep away from pre-launches. Instead, look for bargain buys when investors exit. At that point of time, construction will be closer to completion or completed, and Gurgaon is witnessing distress sales from investors.”

A real estate consultant asking people not to invest in pre-launches needs to be taken very seriously.

4) An end user market:  With investors staying away and the total amount of black money finding its way into real estate coming down, if things continue in this way, Delhi and the National Capital Region real estate market, will become a market which is driven by those people who are looking for a home to live in, rather than invest. In fact, Sood of Knight Frank suggests that is already the case: “NCR is now an end user-driven market – developers restrict new launches, while buyers carefully select clean projects.”

5) You can’t keep making a product which the consumer does not want: The main reason why the real estate sector is in a mess is because prices have gone way beyond what most people can afford. This is a fundamental reason that most people associated with real estate refuse to acknowledge. On being given this reason, they come up with reasons like there is corruption in the government, laws are complicated, so on and so forth.

These might be genuine reasons but that does not negate the point that real estate prices have gone way beyond what most people can afford. Even the “rich” that real estate companies were building for cannot afford real estate at current prices. A product cannot be endlessly priced above what people are willing to pay for it.

As Knight Frank points out: “Policy fallacies such as the opening up of new land for development, allotment of group housing licences in areas with no infrastructure, project delays due to litigations and the liquidity crunch, and stagnant incomes[emphasis is mine] have affected NCR’s real estate appetite adversely.”

It is nice to see a real estate consultant acknowledge stagnant incomes as one of the reasons for one of the mess in the real estate sector. What it means in simple English is that incomes haven’t been able to keep pace with real estate prices i.e. prices are now way beyond what people can afford. And this cannot go on forever.

The column first appeared on Firstpost on July 30, 2015

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

Taking a home loan? This is how dual financing by banks might hurt you

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Paul Volcker, the Chairman of the Federal Reserve of the United States, the American central bank, is once said to have remarked: “the only thing useful banks have invented is the ATM”. I would like to add “home-loans” to the list as well.

Home loans allow people to buy a home at a point of time in life when they are really not in a financial position to buy a home by making the entire payment upfront from their savings. Home loans allow individuals to buy a home and repay the loan over a period of time.

This essentially ensures that an individual can enjoy the benefits of owning a home much earlier in life than if he would have had to simply depend on accumulating enough money to buy a home.

But what if the home loan turns into a nightmare? And believe me it can. How, you may ask?

In the recent past, there have been many cases of builders collecting the money from prospective buyers and disappearing. This, other than leading to a situation where a buyer does not get the home he has already paid for, also leads to other problems.

Let’s try and understand this through an example. A builder wants to build apartments on a piece of land that he owns. He offers this land as a collateral to a bank and takes on a loan. After he has taken on the loan from the bank he starts marketing the project and starts collecting money from the prospective buyers as well. The buyers who want a home to live in, obviously take on home loans to pay the builder.

The builder is supposed to complete the project by a certain date, but doesn’t complete the project. At the same time he defaults on the loan he had taken on from the bank. The buyers are stuck because their homes are nowhere near completion. And there is another problem.

The builder before marketing the project had taken on a loan from the bank against the land on which apartments were to be built. What happens after that? The buyers take on home loans offering the apartments that are being built on that land as a collateral.

What is happening here? Basically the same asset has been offered as a collateral twice. But given that the builder took the loan first, the first charge is created in favour of the bank which gave the loan to the builder. A first charge ensures that the loan given by the bank to the builder takes precedence over the home loans that have been taken on against the same collateral.

What happens next? The bank which gave the loan to the builder goes after the collateral following the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFESAI Act).

What happens to the buyers? They will have to fight a legal battle trying to establish their ownership over the apartments. Meanwhile, they will have to continue paying their EMIs on the home loans that they had taken on. If they stop paying their EMIs, their banks will come after their other assets. In India, home loans are recourse i.e. the banks can go after the other assets of the borrower as well, other than the asset offered as a collateral, in order to recover their loan.

This situation is referred to as “dual-finance”, where multiple loans have been taken against the same collateral. This leaves the home-buyers in a total mess. The Reserve Bank of India (RBI) does not allow primary urban cooperative banks (UCBs) to carry out this kind of lending. As the Master Circular- Finance for Housing Schemes – UCBs points out: “The builders / contractors generally require huge funds, take advance payments from the prospective buyers or from those on whose behalf construction is undertaken and, therefore, they may not normally require bank finance for the purpose. Any financial assistance extended to them by primary (urban) co-operative banks may result in dual financing. The banks should, therefore, normally refrain from sanctioning loans and advances to this category of borrowers.”

The term to mark here is “dual financing”. The situation is exactly similar to the example that I took earlier in the column. The problem is that while the urban cooperative banks are not allowed to carry out dual financing, there is nothing that stops scheduled commercial banks from doing the same.

As the Master Circular—Housing Finance for scheduled commercial banks points out: “In view of the important role played by professional builders as providers of construction services in the housing field, especially where land is acquired and developed by State Housing Boards and other public agencies, commercial banks may extend credit to private builders on commercial terms by way of loans linked to each specific project. However, the banks are not permitted to extend fund based or non-fund based facilities to private builders for acquisition of land even as part of a housing project.”
The phrase to mark in the above paragraph is that: “commercial banks may extend credit to private builders on commercial terms by way of loans linked to each specific project.” This is something that the RBI does not allow urban cooperative banks to do. The moment a bank is lending against a specific project, the collateral offered by the builder to take on the loan is the same as the collateral that will be offered by prospective buyers who will borrow home loans from banks in the days to come.

And this creates the problem of dual financing. In the recent past, there have been many cases of builders disappearing and leaving buyers in a lurch. Interestingly, the RBI Master Circular on housing finance points out: “In a case which came up before the Hon’ble High Court of Judicature at Bombay, the Hon’ble Court observed that the bank granting finance to housing / development projects should insist on disclosure of the charge / or any other liability on the plot, in the brochure, pamphlets etc., which may be published by developer / owner inviting public at large to purchase flats and properties.”

Hence, banks need to make sure that builder tells the prospective buyers very clearly that he has already borrowed money against the land on which apartments are being built. Further the circular also points out: “While granting finance to specific housing / development projects, banks are advised to stipulate as a part of the terms and conditions that: (i) the builder / developer / company would disclose in the Pamphlets / Brochures etc., the name(s) of the bank(s) to which the property is mortgaged. (ii) the builder / developer / company would append the information relating to mortgage while publishing advertisement of a particular scheme in newspapers / magazines etc.”

The point being that the builder has to communicate very clearly that he has borrowed money against the project from a bank(s). As the Master Circular points out: “Banks are also advised to ensure compliance of the above terms and conditions and funds should not be released unless the builder/developer/company fulfils the above requirements.”

While, this sounds very good on paper, such disclosures are rarely made. And my guess is that even if they are made, there are not many buyers going around who have the wherewithal to understand these things. Further, at the point of buying a home there are so many terms and conditions that a buyer has to go through that it is worth asking whether it is possible to mentally process and understand everything.

In this scenario, it is important that the RBI works towards stopping this practice of dual financing and making life slightly easier for a prospective home buyer.

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

The column originally appeared on Firstpost on July 28, 2015