Tag: Ambit | Page 2 | Vivek Kaul

We all know that real estate in India is terribly expensive and is now selling at prices making it practically unaffordable for almost everybody who wants to buy a home to live in. But how expensive is expensive? This is an important question that needs to be answered.

One way of looking at this problem is through the rental yield available on houses at any point of time. Rental yield is the annual return that can be earned by renting out a house. The number is obtained by dividing the annual rent of the house by its market price.

And what is the rental yield in India? As Ashwinder Raj Singh is CEO – Residential Services of JLL India points out in a June 2015 column in The Indian Express: “Rental yields vary across the globe, but an average of 2 per cent of rental yield is considered a good deal for residential properties in India.”

Singh goes on to write: “In India, the cities which currently offer a higher rental yield are Mumbai, Pune, NCR-Delhi, Bengaluru, Kolkata, Chennai, Hyderabad, Ahmedabad. All these cities offer a rental yield of 2 per cent and above, and you can be assured that the average is not going down anytime soon. Investing in these cities will offer you the maximum returns on investment in properties bought for generating rental income.”

Why would anyone invest for a return of 2 percent is a question that only perhaps Singh can answer? And at 2 percent the rental yield is already very low. We will leave this argument for another day.

Hence, we have an expert telling us that an average rental yield of 2 percent is considered good in India at this point of time. But is it enough? In a recent research report titled Real Estate: The Unwind and its Side Effects analysts Saurabh Mukherjea and Sumit Shekhar of Ambit provide the answer.

As they write: “In a fairly-priced real estate market, the rental yield tends to be somewhere close to the cost of borrowing. Instead, Mumbai has a rental yield of close to 2% (this is gross of tax and maintenance charges) whilst the lending rate hovers around 10%. The difference between lending rates and rental yields is one of the highest.”

What Mukherjea and Shekhar are essentially saying is that the rental yields in India are totally out of whack.

As the chart (Exhibit 11) shows us, even China which has had a huge real estate bubble going has a rental yield better than that of India. In fact as the next chart (Exhibit 12) shows the difference between the interest rate at which money can be borrowed and the rental yield is one of the highest in the world, in India. At this point of time a home loan can be borrowed at 10 percent whereas the rental yield is 2 percent, a difference of 8 percent.

What does this tell us? The rental yield as explained above has two inputs: the annual rent and the market price of the house. A rental yield of 2 percent means that the market price of homes in India has risen at a much faster rate than the rents.

And why is this the case? As Mukhejea and Shekhar write: “Rental yields in property markets in India have remained extremely low as compared to its other Asian peers thereby pointing to the over-valuation of this asset class mainly because it can absorb black money.”

The rental yield cannot continue to remain out of whack. For it to come to the right level, the rents need to rise or the market prices of homes need to fall. Given the surfeit of homes available right now, it is highly unlikely that rents will rise. The chances of property prices falling are significantly higher.

As the Firstpost editor R Jagannathan wrote in a column in November 2014: “In India, borrowing costs for home loans are around 10.5-11 percent currently – when rental yields are a fourth of that level. If rental yields in India have to catch up with those in New York and London, Indian property rates have to fall by a third to a half.”

Mukherjea and Shekhar of Ambit make the same point when the say: “Even if one assumes that buyers are willing to live with only 5% rental yields (as they might have an extremely bullish view of capital gains arising from real estate in India), this would imply halving of real estate prices in Mumbai.” What is true about Mumbai is also true about other parts of the country.

Let me explain the maths through an example. Let’s say an individual buys a home for Rs 50 lakh. The rent that he can earn on this is Rs 1 lakh, meaning a rental yield of 2 percent (Rs 1 lakh expressed as a percentage of Rs 50 lakh).

For the rental yield to rise to 5 percent, what has to happen? One option is that the rent needs to rise to Rs 2.5 lakh. This would mean a rental yield of 5 percent (Rs 2.5 lakh expressed as a percentage of Rs 50 lakh). But as I explained above, the chances of rents going up at this dramatic rate are simply not there.

Hence, what needs to happen for the rental yield to be around 5 percent? Market price of homes needs to fall. A rent of Rs 1 lakh would lead to a rental yield of 5 percent, if the market price of the home is Rs 20 lakh (Rs 1 lakh expressed as a percentage of Rs 20 lakh). This means that the price of the home needs to fall from Rs 50 lakh to Rs 20 lakh or a fall of 60 percent. At a 50 percent fall, for a rental yield of 5 percent, the rent needs to rise to Rs 1.25 lakh (Rs 1.25 lakh expressed as a percentage of Rs 25 lakh).

This is the point that Mukherjea and Shekhar are trying to make.

While the maths looks all fine, the question is will this happen and how soon will this happen? The only way this will happen is if the black money going into real estate slows down to a trickle so that only genuine buyers are left in the market. This is easier said than done. The Modi government has had some focus on black money and let’s hope that continues and improves in the days to come, with the government focussing on domestic black money as well. A point worth repeating here is that ultimately almost all the black money is domestic given that it is generated within the country.

Also, it is worth remembering here that real estate prices don’t fall as rapidly as stock markets do. So, the right answer here is that real estate prices will fall and they will fall dramatically, but only over a period of time.

Stay tuned. The massacre has just started.

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

The column originally appeared on Firstpost on July 21, 2015

One of the points that I have made over and over again in the columns that I have written on black money is that theNarendra Modi government needs to concentrate on domestic black money as well.

Since coming to power in May last year, the Modi government has made a lot of noise and come up with legislation on trying to curb the black money leaving the shores of this country. Black money is essentially money which has been earned but on which tax has not been paid.

Nevertheless, it is important to realise that ultimately almost all the black money is domestic i.e. it is generated within the country when people earn money (through legal or illegal means) and do not pay any tax on it.

Given this, it is more important to concentrate on trying to bring down the total amount of black money being generated instead of trying to get back the black money that has already left India. One way to do this is to get more people under the income tax net. Efforts are being made on this front.

A PTI report points out that: “The income tax department has launched an ambitious drive to bring under its net 10 million new taxpayers, after the government recently asked the official to achieve the target within the current financial year.”

Region wise targets have been set. Pune leads the list with a target of more than 10 lakh new assesses. This is an interesting move and if it is successful this will lead to more people paying income tax and hence, the total amount of black money within the system will come down.

When the total amount of black money comes down, lesser black money will go into real estate. And this will help in ensuring that only those who really want homes to live in,will buy. This will help in controlling real estate prices.

Other than getting more people to pay income tax, the government also needs to concentrate on blocking leakages on the subsidy front. In 2004-2005, the total subsidies offered by the government stood at Rs 47,432 crore. By 2013-2014, this number had ballooned to Rs 2,54,632 crore. The total subsidies of the government had jumped by 5.4 times during the period. In comparison, the total expenditure of the government had jumped by only 3.15 times.

Only if the subsidies were reaching those for whom they were intended for, it would not have been a problem. In October 2009, Montek Singh Ahluwalia, the then deputy chairman of the Planning Commission had said: “a Plan panel study on PDS [public distribution system] found that only 16 paise out of a rupee was reaching the targeted poor.”

So where did the remaining 84 paise go? It was stolen in between. Obviously people who stole the subsidies would neither be declaring this money as income and nor be paying any income tax on it.

As Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research titled Real Estate: The unwind and its side effects: “Subsidies under the UPA regime grew at a staggeringCAGR[compounded annual growth rate] of 19% per annum…A substantial portion of these subsidies(30-50%) was pilfered by the political class and used by them to fund investment in gold and real estate.”

In comparison to Ahluwalia’s estimate, Mukherjee and Shekhar are being extremely conservative. Nevertheless, the point being made is the same—that government subsidies are terribly leaky. The politicians who stole this money obviously did not declare this as income. This black money then found its way into real estate and drove up real estate prices.

As a FICCI report on black money published in February 2015 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.”

So what has happened since the UPA was voted out of power? In 2015-2016, the total amount of subsidies have been budgeted at Rs2,43,811 crore, which is lower than the Rs 2,54,632 crore that had been spent in 2013-2014. One reason for this is obviously a fall in oil prices. The number in 2014-2015 had stood at Rs 2,66,692 crore.

This cut in subsidies along with the fact that some subsidies are now directly being paid into bank accounts is likely to help bring down both black money as well as real estate prices. As Mukherjea and Shekhar write: “The NDA has cut subsidies sharply (down 9% in 2015-2016) and is shifting subsidies to Direct Benefit Transfer (DBT); at least 10% of the overall subsidies have already been moved to the DBT. As a result, the ability ofthe politician-and-builder to pilfer subsidies to fund real estate construction has been checked.”

While cutting down on subsidies further may not be politically possible, if more and more of subsidies are paid directly into the bank account of the beneficiaries, the total amount of black money within the system is likely to come down.

Taking these steps rather than chasing black money that has left the shores of this country makes more sense and will have a greater impact on bringing down real estate prices in India. This will go a long way in making homes affordable for those who want to buy homes to live in rather than to invest.

As Mukherjea and Shekhar put it: “the NDA Government is engineering a clamp down on black money in India. The 2015-2016 Union Budget explicitly aimed to disincentivise the black economy and curb the demand for physical assets. With the new Black Money Bill (which was passed by the Parliament on May 26) and with the Cabinet approving the Benami Transactions Bill in May this year, the crackdown on blackmoney will continue further.”

These steps need to continue.

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

The column originally appeared on Firstpost on July 20, 2015

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