Builders

Ten Things to Remember While Buying a Home

This piece emerged out of a couple of WhatsApp conversations I had over this weekend, along with a few emails that I have received over the last few months.

From these conversations and in trying to answer the emails, I have tried to develop a sort of checklist of things to keep in mind, while buying a home. Of course, as I have said in the past, when it comes to personal finance, each person’s situation is unique, and which is why it’s called personal finance.

Nevertheless, there are a few general principles that can be kept in mind. Also, this list like all checklists, is complete to the extent of things I can think of.

So, let this not limit your thinking and the points that you need to keep in mind.

Here we go.

1) If you are buying the house as an investment (not in my scheme of things, but nonetheless), please learn how to calculate the internal rate of return on an investment. Believe me, you will thank me for the rest of your life.

Also, keep track of the cost of maintaining a house and other costs that come with it. Only then will you be able to know the real rate of return from investing in a house.

Otherwise, you will talk like others do, I bought it at x and I sold it at 2x, and get lost in the big numbers, thinking you have made huge returns. While this sort of conversation sounds impressive, it doesn’t mean anything.

2) Don’t buy a house to generate a regular income. The home rentals in the bigger cities have come down post covid. Even if they haven’t, the rental yields (rent divided by market price) continue to be lower than what you would earn if you had that money invested in a fixed deposit (despite such low interest rates).

Of course, the corollary here is that as a landlord you choose to declare your rental income and pay an income tax on it. Many landlords prefer to be totally or partially paid in cash and choose not to pay any income tax. 

3) From what I have been able to gather from my conversations, people in a few cities are still flipping houses. In fact, the trick is to invest before a project gets a RERA approval and then sell out as soon as the approval comes through. This reminds me of the old days when the builder never really knew the people who ended up living in the homes that had been built.

Anyway, if you are flipping homes, do remember that many people caught in the real estate shenanigans of 2009 to 2011, are still waiting for their homes. Many of them are investors. So, if you are flipping homes, do take some basic precautions like not betting your life on any one deal. As the old cliche goes, don’t put all your eggs in one basket. 

4) Also, do remember that you are an individual and the builder is a builder. While many stories of David beating the Goliath have come out in the media, many more stories of Goliaths having crushed Davids, never made it to the media.

It was, is and will remain, an unequal fight. Do remember that. For a builder this is the life that he leads, you, dear reader, on the other hand, have many other things to do. And you are looking for a home to live in, not a builder to take on. So, be careful.

5) One question that I often get is, which bank/housing finance company should I take a loan from. I don’t think this should matter much. Most big banks and housing finance companies charge similar interest rates. As we say in Hindi, bus unees bees ka farak hai.

So, go to the financial institution which seems to be the most convenient to you.

6) One story being pushed in the media is that you should buy a home now because interest rates are low. Among many dumb reasons for buying a home, this is by far the dumbest. Interest rates on home loans are not fixed but floating interest rate loans. If the cost of borrowing for banks and housing finance companies goes up, so will the interest rate on floating rate home loans.

No one can predict which way interest rates will go in the medium to long-term (That doesn’t stop people from trying. Many economists build careers around this). So, currently, the interest rate on a home loan is around 7% per year or thereabouts. If you are buying a home, make sure that you have the capacity to keep repaying the EMI even at an interest rate of 10% per year. This is very important.

7) How do you structure the amount you pay for the home? What portion of the home price should be a downpayment? What portion of the home price should be your home loan? These are very important questions. The answer varies from person to person. Nevertheless, the one general principle I would like to state here is that don’t dip into your retirement savings as far as possible to pay for the downpayment.

It might seem like a good idea with retirement far away and your parents encouraging you to do so because they did the same and it worked out fine for them. Nevertheless, do remember that on an average the current generation will live longer than its parents, and the family support that your parents had or will have in their old age, you may never have.

8) Also, from the point of diversification, it makes sense not to bet all your savings on making the downpayment for a home. Do remember, no job or source of income is safe these days. Further, do ensure that at any point of time you have the ability to pay six to 12 EMIs, without having a regular source of income.

Other than being able to continue repaying your EMI, it will also help you have some time to look for a job or another source of income, if the current one goes kaput.  Money in the bank, buys you time, which helps you make better decisions in life.

And most importantly, if your EMI is more than a third of your take home salary or monthly income, rest assured you are in for trouble on the financial front.

9) If you want to buy a home to live in, go for a ready to move in home. I have seen completion dates for RERA approved projects going beyond 2025 in Mumbai.

The other advantage with a ready to move in home is that some people are already living there and if there is some problem with the building (not a huge deal in India) then there are many more people who have a stake in solving the problem (as convoluted as this might sound). As always there is strength in numbers. 

10) Finally, be sure why you are buying a home. You want to live close to your place of work. You want your child to have some stability in life. You don’t like the idea of moving homes, every couple of years. And so on.

But please don’t buy a home because your parents, in-laws, extended family or relatives, expect you to do so and it gives them something to chat up on or some meaning to their lives. These are financially difficult times and making the biggest financial decision of your life to impress others, isn’t the smartest thing to do possibly.

To conclude, as I said in the beginning this isn’t a complete list by any stretch of imagination. Each person’s situation is unique. Also, you may not end up with a tick mark on all these points mentioned above and you may still end up buying a home. But the advantage will be that you will know clearly where you are placed in the financial scheme of things.

The points essentially help you think in a structured way to arrive at a decision. They do not make the decision for you. That you will have to do.

PS: Don’t know if you noticed that the terms house and home, have been used at different places. Hope you appreciate the difference between the two. 

10 Things You Need to Know About Indian Real Estate in 2021

If you are the kind who follows the business media closely, you would probably be thinking that for the last few months all people have done across India is buy homes to live in. But is that really true? The short answer is no, though sales did pick up during October to December 2020, in comparison to the three month period before that. But whether that was pent up demand or genuine demand coming back, only time will tell.

A thriving real estate sector really helps the overall economy grow at a fast pace. But given the mess that the Indian real estate sector has been in for many years, and the fact that the deep state of Indian real estate won’t allow market forces to work to help clean it up, that isn’t really going to happen.

Let’s look at the issue in more detail.

1) As per the annual roundup of residential real estate published by PropTiger Research, sales in 2020 contracted by 47% to 1.83 lakhs across eight large cities (Delhi NCR, Mumbai, Pune, Ahmedabad, Chennai, Bengaluru, Hyderabad, Kolkata).

In short, 2020 was a bad year for real estate. Having said that, sales during October to December 2020 picked up and 58,914 units were sold, which was 68% more in comparison to the number of units sold during July to September 2020. In comparison to October to December 2019, sales were down 27%, during the period.

Of course, the real estate sector wants us to believe that demand is back and all is well with the sector. Nevertheless, this jump in sales can be because of pent up demand. Whether it sustains in the months to come remains to be seen. This is an important caveat to keep in mind.

2) More than half of these sales have happened in Mumbai and Pune. The reason offered for this is the cut in stamp duty carried out by the state government. The Maharashtra government cut the stamp duty applicable on real estate transactions from 5% to 2%. This was applicable until December 31, 2020.

The stamp duty cut driving up builder sales, is true to some extent. Given that the price of an apartment in a city like Mumbai runs into crores, even a 3% saving on the price runs into a decent amount of money. But more than the stamp duty cut, a substantial drop in prices, especially for homes priced at more than Rs 2 crore, is the main reason for the sales in the city picking up.

Independent real estate expert Vishal Bhargava has pointed this out in the past in his columns (Those who like to follow Mumbai’s real estate scene, should seriously read all that Vishal writes).

Of course, you haven’t read about this in the mainstream media simply because the mainstream media depends on advertisements from real estate companies and needs to keep driving the notion that real estate prices don’t fall, over and over again. (Another reason you need to support my work).

One reason for a fall in prices is the fact that businessmen who run small and medium enterprises have been facing a tough time since covid broke out. And they are looking at alternate avenues to raise money to keep their businesses going. This includes selling the real estate assets they have accumulated in the past. There is some distress sale as well.

Also, other than Mumbai and Pune, the other six cities account for less than half the sales. This tells us clearly that real estate sales in these cities are at best sluggish.

3) The clearest trend in the PropTiger data is that 48% of the sales have been for apartments selling at a price of less than Rs 45 lakh. What this tells us is that high prices remain the biggest challenge of owning a home in India. It also tells us that while home prices haven’t really fallen, on the whole across India, despite the lower demand, the demand that remains is primarily at the lower end of the price spectrum. Hence, the market has corrected itself in its own way, despite home prices not coming down in absolute terms. This is an important lesson that the real estate industry needs to learn.

Also, 74% of the sales have happened for home prices of less than Rs 75 lakh.

4) As far as prices are concerned, the PropTiger report points out: “Weighted average prices for new launched projects across the top-eight cities remained stagnant in the past few quarters, with prices moving in close ranges.”

This is something that is also reflected in Reserve Bank of India’s 10 city house index, though the cities tracked by this index are not the same as the cities tracked by PropTiger.

Source: Centre for Monitoring Indian Economy.

The cities tracked by the RBI’s 10-city house index are Mumbai, Delhi, Chennai, Kolkata, Bengaluru, Ahmedabad, Lucknow, Kanpur, Jaipur and Kochi. The index tells us that the average one-year return of owning real estate in India during the period July to September 2020, stood at 1.13%. This is the lowest since the index came into existence. The index also tells us that the return on real estate during 2020 has been marginally negative.

What this means is, and as I have often said in the past, Indian real estate is going through a time correction and not a price correction. The inflation seen over the last two years has been around 6% per year on an average. This means in real terms, the prices have already corrected by more than 12%, over a two year period.

5) This trend is likely to continue given the huge amount of inventory that remains piled up with builders. The overall inventory stock is at 7.18 lakh units across eight cities as per PropTiger. It has come down from 7.91 lakh units in 2019, simply because builders aren’t launching as many new projects as they used to.

Having said that, with the sales slowing down, at the current sales pace it will take around 47 months to clear the remaining inventory. Even though all this inventory is not ready to move in, a significant portion is. Also, it is worth remembering that the prospective buyers have a choice when it comes to buying a home. Over the years, investors across the country have ended up buying a huge number of homes in the hope of a price appreciation. Many of these homes have remained locked and are available for sale.

As Bhargava wrote in a recent column: “Resale transactions are traditionally 2/3rd of the market.” Even if this proportion were to come down, resale transactions of locked homes will continue to form a significant chunk of the market, making it difficult for builders to cut down their inventory quickly. Also, even if builders don’t offer ready to move in homes, there is a significant supply that will keep coming in from individuals who have bought real estate as an investment over the years.

6) Homes priced below Rs 45 lakh form 48% of the inventory. What does this tell us? It tells us that the real demand for homes is at a price even below Rs 45 lakh, probably below Rs 25 lakh. This is something that the builders need to keep in mind. It may not work in a city like Mumbai, where land available is limited and expensive, but it will definitely work for the other seven cities that PropTiger tracks and other parts of India, where cities can expand in all directions and land is really not an issue.


7) It is worth remembering here that builders have benefitted because of the Reserve Bank of India allowing banks and non-banking finance companies, to restructure commercial real estate loans.

As former RBI governor Urjit Patel writes in Overdraft—Saving the Indian Saver:

“In February 2020, ‘living dead’ borrowers in the commercial real-estate sector – under a familiar guise (‘a ghost from the past’, if you will) viz., ad hoc ‘restructuring’ – have been given a lifeline. It is estimated that over one-third of loans to builders are under moratorium.”

Patel does know a thing or two about banks and lending and hence, needs to be taken seriously. It remains to be seen for how long will the RBI continue supporting the builders. The longer, the RBI supports the builders, the longer they can hold on to a significant price cut. This also means that inventory will take longer to clear and home prices will continue to stagnate. It is all linked.

8) At a macro level this means that the ability of real estate to create jobs for the unskilled and the semi-skilled, will continue to remain limited. It is also worth remembering that real estate as a sector can have a huge multiplier effect on the overall economy.

The real estate sector has forward and backward linkages with 250 ancillary industries. This basically means that when the real estate sector does well, many other sectors, right from steel and cement to furnishings, paints, etc., do well.

If this were to happen, the Indian economy would really benefit in the post-covid times. But sadly it won’t, given that the deep state of Indian real estate which includes, builders, banks and politicians, will make sure that the sector is continued to be treated with kids gloves and any problems which could lead to a price cut, are kicked down the road. Trying to maintain the status quo in the sector is not helping the Indian economy.

9) Dear reader, some of you by now must be like all this gyan is fine, but tell me one simple thing, should I buy home or should I hold on to my money. The answer as always is, it depends. It is worth remembering here, that what we can possibly do with our money is a very individual thing.

If you are looking to buy a home to live in and have the capacity to pay an EMI and arrange for a down-payment, then this is a good time as any to buy a home. Owning a house has its own set of advantages. Parents and in-laws feel you have settled in life. There is no danger of the landlord acting cranky. And once you have children it gives them some kind of stability with friends, activities as well as the school they go to. Of course, address proofs don’t need to change, every time you move house.

Having said that do keep in mind that we live in tough times and the negative economic impact of covid is yet to go away. Also, there can be further cycles of the spread of the virus. Before taking on a home loan, ensure that you have some money in the bank to be able to continue paying the EMI in case you lose your source of income.

When it comes to investing in a house, it continues to remain a bad idea on the whole. Of course, there will always be some good opportunities and some distress sales happening.

10) Finally, everyone who makes a living out of selling real estate will spend 2021 trying to tell us that demand is coming back, people are buying homes, new trends are springing up and all is well.

As PropTiger points out:

“By making bare the limitations involved in other investment assets, the pandemic has forced people to rethink their investment strategies, tilting it in favour of home ownership.”

This is basically rubbish which has been written well. Why would anyone in their right mind during tough economic times, invest a large part of their savings and/or take on a large loan to buy an illiquid asset?

Some people who can afford it, may have definitely bought new homes in order to adjust to the new reality of work from home, but beyond that the proposition that PropTiger is making, remains a difficult one to buy.

If it were true, some of the massive amount of easy money that is currently floating around in the financial system, would have gone into real estate as well. But given that sales have crashed 47% during 2020 tells us that it clearly hasn’t.

In fact, the outstanding home loans of banks between March 2020 and November 2020 have gone up by just Rs 44,463 crore. This is around two-fifths of the increase (38.7% to be precise) in outstanding home loans of Rs 1,14,636 crore seen between March 2019 and November 2019. This is despite the fact that home loan interest rates have come down to as low as 7%.

So, people are generally being careful when it comes to buying a home by taking on a loan and that is the right strategy to follow at this point of time.

Why Do Builders Overbuild

India-Real-Estate-Market

Conversations with friends who live in Delhi and the National Capital Region(NCR) inevitably turn towards the topic of real estate. Over the last two weeks, I met two friends and we ended up talking about the perils of the idea of owning real estate, among other things.

In case of one friend the builder has taken the money and is postponing building the apartments. Meanwhile, the housing finance company has turned a blind eye to this. At the same time, my friend is paying the EMI, though the promised home is nowhere in sight. He continues to pay rent as well. Not a happy situation to be in.

In case of the second friend, the builder ended up building more floors than he had initially promised. My friend was lucky to get possession and move in. But with more floors he is now sharing the infrastructure with more people than was initially planned and this has its own share of problems.

Other than sharing the infrastructure there is a bigger problem which most people don’t even realise. As Sushil Kumar Sayal writes in Inside Unreal Estate—A Journey Through India’s Most Controversial Sector: “When the builder builds a ten-floor block he digs the foundation to a certain depth; when the additional floors are added, does he ensure the foundation is deeper? He doesn’t. The authorities not only turn a blind eye to this safety hazard but are often hand in glove with errant builders.”

The question is why do builders overbuild? The builder-broker nexus essentially leads to overbuilding. As Sayal writes: “There is a close relationship between builders and brokers. Thus, very few builders in and around Delhi put their money into a project upfront. As soon as he wins land in an auction, he collects his band of brokers and sells the project to them. With that money, he pays for the land. The brokers, in return, are assured of space at a discount.”

What this clearly tells us is that the builder has very little of his own money (i.e. equity/capital) riding on the project at any point of time. Also, since he is giving a discount to the broker, he overbuilds. As Sayal writes: “Since he has given a discount to the brokers, the builder overbuilds in order to make money. The extra construction is frequently regularized. Even if it isn’t, nothing stops the builder and brokers from selling it. Often, the builder doesn’t even bother to get a completion certificate.”

The regularisation of the illegal floors happens in the days to come and is easy business for the builder. As Swati Ramanthan wrote in the Mint in June 2014: “State regularization initiatives unfortunately, have become tainted as tools for corruption, or political populism, or as a means to generate revenue for the state. Consider the following: in Kolkata, a meagre ex-parte penalty of Rs.500 per square foot allows regularization of illegal floors.”

In this scenario it is not surprising that the builder builds extra floors and gets away with it. Also, what explains the fact that the builders goes around selling a project which he hasn’t got a total clearance for? The simple answer is greed. But there is a more complicated answer as well. The economic incentive is at work.

As Sayal writes: “Under the law, a builder cannot sell his project unless he has secured all the clearances. These clearances can take up to two years to obtain. Given the high land prices all over the country, no builder can afford to let the investment sit idle for two years. He has no choice but to violate the law and pre-sell the project.”

In fact, this will be the single biggest impediment to the success of the Real Estate (Regulation and Development) Bill, 2013, which was recently passed. I had made this point on December 14, last year. Nevertheless, it is worth repeating here.

The Real Estate Act wants the real estate regulator (to be set up in every state) in order to facilitate the growth and promotion of a healthy, transparent, efficient and competitive real estate sector, to make recommendations to the appropriate state government on creation of a single window system ensuring time bound project approvals and clearances for timely completion of real estate projects.

I guess there is nothing beyond this the central government can really do. So it ultimately boils down to the state governments whether they are in the mood to give a single window clearance for real estate projects.

How good are the chances of something like that happening? The entire process of clearing a real estate project through the various stages is a good money making exercise for both state level politicians as well as bureaucrats.

So the economic incentive is clearly against a single window clearance. Also, much of the money thus raised is used to fight elections at the state level. The builder-political nexus is a huge source of finance to fight elections at the state level for politicians. Will this nexus break down?

You know what I think of it. Nevertheless, let’s wait and watch.

The column originally appeared on Vivek Kaul’s Diary on March 28, 2016

Are real estate builders getting desperate for money?

India-Real-Estate-MarketVivek Kaul

One of things that I have maintained in my columns on real estate is that for real estate prices to fall, the funding of builders needs to dry up. And that seems to have started to happen.

Let me share two recent examples that I came across (I request The Daily Reckoning readers to share more examples, if they know of any).

A real estate company is running an advertisement for homes they are selling in a central suburb of Mumbai. This advertisement essentially talks about giving only 20% of the price of the home at the time of booking.  It also talks about no income eligibility and no bank formalities.

What does this mean? It means that as long as you are willing to pay the company 20% of the price of the home at the time of booking, they will not ask any more questions. They will not try and check whether you have the capability of paying the remaining 80%.

What does this tell us? One the company is unable to sell the flats and raise the money upfront. And two, it is now so desperate for money that even 20% of the price is fine with them.

So, this was the first example. The second example is slightly more detailed. A friend forwarded an email he got from a housing finance company. The housing finance company assured him a return of 48.5% over a period of two years, if he invested in a new project in the National Capital Region.

The proposal is as follows. The investor needs to pay the builder a total of Rs 1.27 crore. Of this, the housing finance company is willing to finance around Rs 1.1 crore through a home loan. The remaining Rs 17 lakh has to come from the investor’s pocket.

Since the property is still under construction, the investor taking on the home loan will not have to pay an EMI but a pre-EMI. A pre-EMI essentially means paying only the interest on the home loan. The principal repayment kicks in only after the investor/buyer takes the possession of the home.

In this case, the housing finance company has promised that the builder will keep paying the pre-EMI for a period of two years.

What happens at the end of two years? If the investor does not want to take a possession of the home, the builder will buy back the home and close the home loan. He will also pay the investor Rs 8.25 lakh, over and above the Rs 17 lakh that the investor had initially put in.

This means a return of 48.5% over a two year period, which is not a bad deal at all, from the investor’s point of view. At least, prima facie that is what seems to be the case.

But what is really happening here? The housing finance company is helping the builder indirectly borrow home loans at a significantly lower rate of interest. Why is it doing that? I can only make a guess here. And I feel that builder is actually in a mess and the conventional borrowing channels (of banks/HFCs etc.) are not ready to lend to him anymore.

Other than paying Rs 8.25 lakh to the investor at the end of two years, the builder is also paying the pre-EMI on the home loan. At 10% interest, the pre-EMI will work out to around Rs 11 lakh per year (10% of Rs 1.1 crore) or around Rs 91,667 per month. The internal rate of return on this loan works out at a little over 14%, which is much better than the 30-40% interest that builders have to pay when the borrow from informal channels. Hence, in that sense borrowing at 14% is a steal, even though it seems to be on the higher side. Further, the builder may already have been borrowing from informal channels, and may have been looking to limit that borrowing.

It is also possible that the builder needs to repay an earlier loan that he had taken from the housing finance company and is not in a position to repay the loan. The housing finance company instead of recognising it as a bad loan and going after the assets of the builder is essentially bailing him out and postponing the problem.

The HFC and the builder are both buying time. Who knows what will happen two years down the line?

As far as the investor is concerned, he is being taken for a royal ride with the housing finance company telling him that this is an “assured buy back scheme”. The disclaimer at the bottom of the proposal clearly states that: “The information/product(s)/service(s)/offer(s)…as contained herein are provided /offered by third party and are subject to their respective terms and conditions and not intended to create any rights or obligations.”

So there is no guarantee that the builder will buyback the home and close the home loan two years down the loan. Further, the home loan is in the name of the investor. And the housing finance company will then go after him to ensure that he keeps paying the EMIs or the pre-EMIs. If he chooses to default, then the housing finance companies can go after his other assets as well.

Also, it is worth asking why is the builder borrowing one at a time through what is basically a complicated route for him? The only answer here is that the conventional sources of finance have totally rejected him. And he has no other way out of this mess.

I would request The Daily Reckoning readers to be careful of such investment schemes which sound too good to be true. Any scheme promising a return of greater than 9-10% a year, needs to be closely examined.

To conclude, what the two examples I have shared today clearly tell us is that builders are getting desperate for funding. And their situation is only going to get messier in the days to come.

Stay tuned.

The column originally appeared on The Daily Reckoning on July 23, 2015

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