Real Estate

With rising inventories oil prices are falling, but real estate prices are not: Here’s why

India-Real-Estate-Market
A major reason for the price of crude oil falling has been the accumulation of oil inventories all over the world. Inventories in any commodity are a result of supply being more than demand. The trouble is that in case of oil there is only a limited amount of storage space available and this can lead to rapid decline in price, once the inventories start to build.
As the analysts at Bank of America-Merrill Lynch point out in a research note dated January 16 and titled Oil price undershoot; Compelling value emerging: “Inventories all over the world are building at a very fast rate. In fact, we have moved up our storage numbers and now expect OECD (Organisation for Economic Co-operation and Development) inventory levels to reach 2,830 million barrels in 2Q15, 180 million barrels above last year.”
Even in the United States, there has been huge build up in oil inventories. Numbers released by the Energy Information Administration(EIA) of the United States suggest that on January 16, 2015, the oil inventories in the country stood at 397.853 million barrels. Thus the oil inventories “are at the highest level for this time of the year in at least the last 80 years,” the EIA said in the release.
Hence, this huge build up in oil inventories has led to the oil price crashing.
This led to one of the editors at Firstpost to tweet that despite huge inventories in the real estate sector in India, why are prices not falling, like they have in case of oil. In this piece published on Firstpost I discuss why real estate in India remains unaffordable. One of the tables in the piece shows the huge amount of home inventory in various cities. There are huge amounts of unsold flats which have been built but have not been sold.
A simple straight forward answer too high inventory not leading to falling prices is that there is too much black money in the country. And that black money keeps finding its way into real estate, keeping prices high. An article in The Caravan magazine a few years back captured this point beautifully when it said: “There isn’t a bubble of real homes…If all these apartments were actually built, and built fairly to schedule, I guarantee you that they would find real buyers. The demand is out there. But there is a huge bubble in imaginary homes.”
The reason for this is that the ill-gotten wealth of politicians has been invested in real estate through the “benami” route over the years. In fact, the government or rather governments (the central government as well as state governments all over India) can do a few basic things to try and reverse the situation.
One straight forward way is to start selling land that they own and push down land prices. The consultancy KPMG in a report titled Affordable Housing – A key growth driver in the real estate sector points out: “The government holds substantial amount of urban land under ownership of port trusts, the Railways, the Ministry of Defence, land acquired under the Urban Land (Ceiling and Regulation) Act, the Airports Authority of India and other government departments.”
But this hasn’t happened despite being a very obvious solution primarily because the ill-gotten wealth of politicians is in real estate and any fall in land prices will push down home prices and in the process lead to the value of the “real” wealth of the politicians falling as well.
As Bombay First points out in a report titled My Bombay My Dream: “Government and the land mafia in fact do not want more land on the market: after all, you make more money out of the spiralling prices resulting from scarcities than you could out of the hard work that goes into more construction.”
Further, banks are also playing an important role in ensuring that real estate prices continue to remain high. As India Ratings and Research points out in a recent report FY16 Outlook: Real Estate Sector: “Bank credit to the sector grew by double digits yoy in 2014. This, when coupled with declining sales, indicates bank funding is being used to build up inventory, which may further deteriorate the credit profile of the sector.”
The report further goes on to point out that: “Any fall in property prices will require steps for reduction of land costs, shortening of the approval process and removal of red tape and also pressure from lenders on such companies to liquidate inventory to reduce debt.”
What this means in simple English is that banks need to pressurize real estate companies to repay their loans instead of giving them fresh loans to repay their older loans.
But that is just one part of the story. To understand the other part of the story we need to understand an economic theory called “a market for lemons” put forward by Noble prize winning economist George Akerlof (these days more famous as Mr Janet Yellen). Akerlof wrote a research paper titled The Market for “Lemons”: Quality Uncertainty and the Market Mechanism in 1970.
In this rather unusual paper Akerlof discussed the second hand car market in the United States. He pointed out that there are essentially four types of cars. “There are new cars and used cars. There are good cars and bad cars [which in the United States are known as “lemons”]. A new car may be a good car or a lemon, and of course the same is true of used cars.”
An owner of a car has a good idea about whether his car is a good car or a lemon. This leads to what economists call an “information asymmetry”. As Akerlof put it in his research paper: “After owning a specific car, however, for a length of time, the car owner can form a good idea of the quality of this machine…An asymmetry in available information has developed: for the sellers now have more knowledge about the quality of a car than the buyers.”
This leads to a problem where the buyer of the car has no idea as to how good or bad the car is. Hence, as Akerlof put it: “The bad cars sell at the same price as good cars since it is impossible for a buyer to tell the difference between a good and a bad car; only the seller knows.”
And given that the buyer has no way to differentiate between a good car or a lemon it is ultimately reflected in the price of the car. Tim Harford explains this phenomenon in his book The Undercover Economist. As he writes: “Anyone who has ever tried to buy a second-hand car will appreciate that Akerlof was on to something. The market doesn’t work nearly as well as it should; second-hand cards tend to be cheap and of poor quality. Sellers with good cars want to hold out for a good price, but because they cannot prove that a good car is really a peach, they cannot get that price and prefer to keep the car for themselves.”
Information asymmetry essentially ensures that the market does not work well. As Nate Silver writes in The Signal and the Noise –The Art and the Science of Prediction: “In a market plagued by asymmetries of information, the quality of goods will decrease and the market will be dominated by crooked sellers and gullible and desperate buyers.”
If this sentence strikes a chord then you have perhaps been trying to buy a home somewhere in India. The Indian real estate market is totally rigged one way. The information asymmetry totally works in favour of real estate companies, builders and brokers who are a part of this industry.
Something as straightforward as what is the going price of a flat or house in any given area is very difficult to figure out. The only source of information on this are the brokers or the builders themselves. And the world that they live in, real estate prices only go one way and that is up. This helps sustain the myth that real estate prices only go up. Given that there are no other sources of information, people end up believing everything that their broker tells them.
Also, what the buyer does not know is the volume of transactions that have happened at the price being offered by the brokers (This is visible in the miles and miles of built and unsold homes all over the country). So, there is no way of verifying anything. The buyers have no way of figuring out whether deals are actually happening or not and hence, need to either believe the broker or play mind games with him.
As Jeff Madrick writes in Seven Bad Ideas—How Mainstream Economists Have Damaged America and the World: “Almost all homebuyers…enter into such transactions only two or three times in their lives. How can they possibly be knowledgeable and informed?”
Given these reasons, even with a huge inventory, real estate prices in India are not falling. And this has led to a situation where sales have fallen dramatically. “Sales of fresh residential units (in sq.ft.) by listed real estate companies continued to decline during 2014, falling 25.6% yoy for the 12 months ended September 2014,” the India Ratings and Research report points out. In fact, this is also reflected in the fall in home loan disburals between April and September 2014.
The question is will home prices fall during the next financial year (i.e. April 2015 to March 2016)? “While economic growth is likely to improve in FY16, property prices might not correct. This could lead to endcustomers postponing purchase decisions,” feel the India Ratings and Research analysts.

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

The article originally appeared on www.firstpost.com on Jan 30, 2015

Busting a few more real estate myths

India-Real-Estate-MarketVivek Kaul

The last column on real estate which appeared on January 19, 2015, stuck a chord with a lot of readers. Given that, I thought it made sense to dwell a little more on this topic and the “spin” that real estate wallahs try to give it.
One logic that I have heard being given over and over again is that India has too little land and too many people. Given this, real estate prices can never fall. They will only keep going up ad infinitum and hence, you need to invest in real estate and earn a perpetual return. This is the most widely used logic to justify high real estate prices in the country. But a little bit of number crunching basically tells us that there is nothing right about this theory.
Let’s look at India has “too many people” theory first. As per the 2011 census, India has an average of 382 people living per square kilometre. When it comes to density of population India is ranked 33rd in the world. Let’s compare this with Japan. The country has 336 people living per square kilometre and is ranked 39th in the world.
Japan had a huge real estate boom in the 1980s. The boom came to an end towards the end of the 1980s and prices fell big time after that. As George Akerlof and Robert Shiller point out in Animal Spirits: “Urban land prices…in Japan (where land is every bit as scarce as it is in other countries)…fell 68% in real terms in major Japanese cities from 1991 to 2006.” And if real estate prices could fall in Japan, which has a slightly lower population density than that of India, they can in India as well.
Even in India real estate prices have fallen in the past. It’s just that people don’t rememember about it anymore. As Manish Bhandari of Vallum Capital wrorte 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.” And this was just a little over a decade back. Bull markets lead to bad memories and theories justifying high prices.
In fact, real estate prices have been falling in some parts of the country. A December 2014 newsreport in The Economic Times suggested that “secondary market prices of properties in posh South Delhi localities have fallen 25-30 per cent over the last one year as a pileup of inventory and need for money turn many investors into desperate sellers.” “Compared with peak prices, the discount is as much as 40 per cent, say brokers,” the report added.
Another important point here is that the consumer sentiment seems to be turning against real estate. Recently a buyer sentiment survey was carried out by IIM Bangalore and Magicbricks. A report on the survey in The Economic Times said that: “[The survey] orecasts that the homebuyers expect real estate prices to drop over the next six months. In fact, the aggregate Housing Sentiment Index (HSI), measured across the 10 cities, dropped sharply by 29% in the 3rd quarter of 2014-15 to 81. (An HSI score of 100 suggests the prices would remain static).”
Now compare this with another survey that the business lobby ASSOCHAM had got done in June 2013, which said: “Over 85 per cent of urban working class prefer to invest in real estate saying it is likely to fetch them guaranteed and higher returns.” So, the sentiment clearly seems to be changing. And there is no greater danger to the price of an asset class than changing sentiment of those who want to invest in it.
The second theory offered is that India has very little land to house its huge population. Again a little number crunching tells us that this is not correct. The Indian Institute for Human Settlements in a report titled Urban India 2011 esimates that “the top 10 cities are estimated to produce about 15% of the GDP, with 8% of the population and just 0.1% of the land area.”
Economist Ajay Shah in a May 2013 column in The Economic Times did some number crunching to show that India has enough land to house its millions. As he wrote “A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI(floor space index) of 1. There is absolutely no shortage of land to house the great Indian population.”
One corollary of this theory is that as cities expand they will take away land from agriculture and that will create a problem as well. Again this is a specious argument. Data from World Bank shows that around 60.3% of India’s land area is agricultural land. The bank defines agricultural land as “share of land area that is arable, under permanent crops, and under permanent pastures.”
In fact, only the United States has more agriculural land than India. As India Brand Equity Foundation, a trust established by the Ministry of Commerce and Industry points out: “At 157.35 million hectares, India holds the second largest agricultural land globally.” Only, the United States has more agricultural land than India. Take the case of China. India has more arable land than China. This, despite the fact its total area is only a little over 34% that of China.
Hence, agricultural land near the cities can easily be diverted towards construction of more housing without it having any signficant impact on agricultural production.
The basic problem lies in the fact that too much black money has gone into real estate and has driven up prices ( as I wrote in the last column) to previously unimaginable levels. This has led to builders and politicians who back these builders to sit on a huge amount of unsold inventory instead of cutting prices to clear it. They have got used to these high prices. Also, so much money has already been made that sitting on inventory till prices start to recover, doesn’t seem like a bad idea at all to them.
As an article in The Caravan magazine pointed out few years back: “There isn’t a bubble of real homes…If all these apartments were actually built, and built fairly to schedule, I guarantee you that they would find real buyers. The demand is out there. But there is a huge bubble in imaginary homes.”
And this is because the ill-gotten wealth of politicians and their cronies has found its way into the sector through “benami” means over the years. However, there continues to be demand for reasonably priced property even in big cities. Only if there was someone trying to fulfill this unmet consumer demand.
To conclude, it is worth sharing this example that Ruchir Sharma talks about in his book Breakout Nations: “Lately Indian businessmen have been regaling one another with accounts of a leading politician from Mumbai who is known to have amassed a huge wealth through property deals. At a private screening of a new Bollywood movie, this politician asked the producer to replay a particular song-and-dance number, over and over. When the producer asked if he was taken with the leading lady, the politician said no, he was eyeing the location and wondering where the producer had found such an attractive stretch of open space in Mumbai.”
And this is where the real problem lies. 

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 21, 2015

Trump’s wrong: How the Big Mac burger tells us Mumbai real estate ain’t cheap

donald trumpVivek Kaul

In a recent interview to the Forbes India magazine, Donald Trump the billionaire American investor and business tycoon said “Your real estate is unbelievably cheap…Mumbai is a great city and yet it is not priced like other comparable cities. It is priced lower than cities that are less important. That gives investors a tremendous amount of growth potential.” He made similar statements in interviews to several other publications.
This statement needs closer examination. Let’s do that by comparing prices in Mumbai and New York, the largest city in the United States. A July 2014 report in The Times of India quotes Pankaj Kapoor of property research firm Liases Foras as saying “In Mumbai, the average cost of a flat is Rs 1.2 crore.”
In comparison, the price of a median home in New York in July 2014 stood at $524,500. For most of July 2014, one dollar was worth Rs 60. Hence, in rupee terms the price of a median home in New York stood at around Rs 3.15 crore ($524,500 multiplied by Rs 60). While Trump did not go into these details, this is the logic he must have used to say that the real estate prices in Mumbai are cheap, in comparison to other big cities around the world.
The trouble with this calculation is that it has been carried out at the market exchange rate. It doesn’t take the purchasing power of the currencies into account. Purchasing power is essentially a concept which takes into account the fact that how many “units of a country’s currency [are] required to buy the same amount of goods and services in the domestic market[in this case India and the rupee] as a U.S. dollar would buy in the United States.” This is necessary because foreign exchange market determined exchange rates do not always take this into account.
There are several ways of taking purchasing power into account. A quick and dirty way is to consider The Economist’s Big Mac Index. This index compares the price of McDonald’s Big Mac hamburger in various countries around the world. In July 2014, the Big Mac had an average price of $4.80 in the United States. In India it was sold at an average price of $1.75.
Hence, what could be bought at $1.75 in India would need $4.8 in the United States. This means Rs 105 (Rs 60 multiplied by 1.75) is worth $4.8. Or in other words one dollar is worth Rs 21.9 (Rs 105/$4.8), in purchasing power terms.
If one dollar is worth Rs 21.9, then the price of a New York city median home in rupee terms works out to Rs 1.15 crore ($524,500 multiplied by Rs 21.9). In comparison the average cost of a flat in Mumbai is Rs 1.2 crore. Hence, the real estate prices in New York are slightly cheaper than Mumbai once we take the purchasing power into account.
As mentioned earlier, using the Big Mac index was a quick and dirty way of taking purchasing power into account. Data from the World Bank can be used to carry out a more reliable calculation. In case of the Big Mac index we are just taking the price of one particular brand of burger for taking purchasing power into account. As per World Bank data one dollar is worth Rs 16.8, once we take purchasing power into account.
This means that the price of a New York median home in rupee terms is around Rs 88.1 lakh ($524,500 multiplied by Rs 16.8). This is almost 32% cheaper than the price of an average home in Mumbai.
These calculations clearly tell us that real estate in Mumbai is not cheap by any stretch of imagination, irrespective of what Trump would like us to believe. In a recent report brought out by UBS Investment Research analyst Ashish Jagnani estimated that Mumbai had 50 months of unsold inventory of homes. This is the highest among all major cities in India. Gurgaon comes in next with 30 months of unsold inventory.
Another recent research report titled India Real Estate Outlook brought out by real estate consultants Knight Frank points out that the unsold inventory of residential apartments in Mumbai stands at 2,13,742 units. In June 2014, the quarters-to-sell ratio stood at 12.
“Quarters-to-sell(QTS) can be explained as 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,” the report points out.
Further, the “inventory level in the South Mumbai market will take the maximum time of 18 quarters (4.5 years) to sell,” the report points out. Donald Trump had come to India for the launch of the Trump Tower, located in Worli, South Mumbai.
The enormous level of inventory in Mumbai is because people are not buying homes. This has led to an inventory of unsold homes which is at a seven year high across different cities., the UBS report points out. People are not buying homes, because homes have become too expensive. As Jagnani of UBS mildly puts it, there are “affordability concerns amid property prices” going “up 13-30% in key cities over last 2-years.”
The article originally appeared on www.firstbiz.com on Sep 14, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)