When it comes to reviving real estate, Jaitley needs to look beyond RBI

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

Arun Jaitley is at it again. On Sunday (September 20, 2015) the finance minister said in Hong Kong: “RBI historically has been a very responsible institution.
Now, as somebody who wants India’s economy to grow and who wants domestic demand to grow, I will want the rates to come down…Real estate, for example, can give a big push to India’s growth and this is a sector which is impacted by high policy rates. Therefore, if the policy rates come down over the next year or so, certainly this is one sector which has a huge potential to grow.”

This is not the first time Jaitley has said something like this. In December 2014 he had said: “Now time has come with moderate inflation to bring down the rates. If you bring down the rates, people will start borrowing from banks to pay for their flats and houses. The EMIs will go down.”

As I have often said in The Daily Reckoning in the past, homes are not selling because prices are high. It has got nothing to do with high EMIs. A fall in interest rates will not make such a huge difference in EMIs so as to get people all excited about buying homes to live in.

The finance minister has regularly talked about high interest rates and the fact that the Reserve Bank of India (RBI) needs to cut interest rates, so that people start buying homes again. Given that he talks to the media almost every week, why can’t the finance minister also talk about high real estate prices? Why doesn’t he talk about the real estate companies sitting on a huge amount of inventory and still not cutting prices?

Further, public sector banks can be encouraged to go after real estate companies which owe them money. Such real estate companies should be forced to liquidate the inventory of unsold homes they are sitting on. If this is happening, the finance minister needs to talk about it, instead of just asking the RBI to cut interest rates.

Real estate prices can also be brought down if the stamp duty charged by state governments on real estate sales is brought down. The Bhartiya Janata Party (BJP) is in power in many big states, and these governments can be encouraged to bring down the stamp duty. The chances are that as home prices fall, with a lower stamp duty, home sales will pick up, and the total amount of stamp duty collected by the government will go up or at least remain the same.

Media reports suggest that in a few states the market price of homes is lower than the circle rate. This has brought the transactions to a complete stand still. Why can’t this anomaly be corrected? I agree this is something that the state governments need to do, but the finance minister, given that he talks so much, can set the agenda by talking about this as well.

Along similar lines, why can’t the finance minister and other senior BJP leaders encourage the states where the BJP is in power, to have better and more transparent FSI laws? The way these laws are currently structured, they allow the nexus between the builders and the politicians to flourish. I am no expert on this, but what is stopping the central government from coming up with a model FSI law, which states can follow, with their own tweaks.

Further, Jaitley can also perhaps explain to us why is his government opposing the move to bring political parties under the ambit of the Right to Information (RTI) Act? In an affidavit submitted to the Supreme Court in August 2015, the government said: “If political parties are held to be public authorities under RTI Act, it would hamper their smooth internal working, which is not the objective of the RTI Act and was not envisaged by Parliament. Further, it is apprehended that political rivals might file RTI applications with malicious intentions, adversely affecting their political functioning.”

If the political parties are brought under the ambit of RTI they will have to function in a much more transparent way in comparison to what they do now. This would mean keeping proper records of where the funds to finance them are coming from. Real estate companies are major financiers of political parties, at least at the state level.

If the political parties are brought under the ambit of RTI, the nexus between politicians and builders will come under proper scrutiny. And this is something that no political party can afford. This, perhaps explains why the Narendra Modi government does not want political parties to be brought under the ambit of RTI.

Nevertheless, if this were to happen, it would go a long way in ensuring that real estate prices in India at any point of time are a reflection of the underlying demand and supply of homes.

Also, as any builder will tell you off the record, the construction cost is only a small part of getting a real estate project going. Fees to politicians and bureaucrats form a major cost of a project, and are passed on to the buyer. The finance minister Arun Jaitley cannot do much about this, but at least he can talk about it. The first step in tackling a problem is acknowledging that it exists.

Finally, Jaitley can also explain to us why the Real Estate (Regulation and Development) Bill, which promises to bring some regulation to what has been a totally unregulated sector, up until now, has more or less been put on the backburner?

The government has shown a lot of aggression when it came to bills pertaining to land acquisition and goods and services tax. The same aggression has been missing when it came to the Real Estate bill. The bill provides for penalties to be paid by the builder, if a project is not delivered within a time bound period. It also stops builders from making arbitrary changes to project plans without the consent of home-buyers. It also has a provision for state level real estate regulators.

Long story short – why doesn’t Jaitley talk about all these factors as well. What is the point in blaming the RBI over and over again for a slowdown in the real estate sector?

The column originally appeared in The Daily Reckoning on Sep 23, 2015

How state governments are supporting high real estate prices

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)

High price not EMIs: Dear Jaitley, here is why Indians are not buying homes

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010Sometimes I wonder if the finance minister Arun Jaitley has ever heard of Abraham Maslow. Maslow was an American psychologist who among other things also came up with the law of the instrument, which is better known as Maslow’s hammer.
As Maslow put it: “I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.”
The idea was also put forward by the American philosopher Abraham Kaplan, when he said: “Give a small boy a hammer, and he will find that everything he encounters needs pounding.”
What the idea essentially tries to communicate is the habit of using the one tool for all purposes. In Jaitley’s case this tool seems to be a cut in the “repo rate”, or the rate at which the Reserve Bank of India (RBI) lends to banks.
In the recent past, he has asked the RBI to cut the repo rate time and again. Once the RBI starts cutting the repo rate, banks will start cutting the interest rates at which they give loans, the belief is.
At lower rates people will borrow and spend more and the Indian economy will grow at a much faster rate. For Jaitley its all about lower interest rates. “Now time has come with moderate inflation to bring down the rates. If you bring down the rates, people will start borrowing from banks to pay for their flats and houses. The EMIs will go down,” he
said yesterday.
The statement was essentially a continuation of the pressure that Jaitley has been trying to build on the RBI to cut the repo rate. But will it make any difference?
Let’s try and understand this through an example of an individual trying to buy a home in Mumbai. In a recent research report the real estate research firm Liases Foras had pointed out that the weighted average price of a flat in Mumbai was Rs 1.34 crore.
I had written a piece around this data in early November showing how expensive flats in Mumbai and other cities were vis a vis the average income of people in living in those cities. One criticism that came in was that the weighted average price arrived at was on a higher side because the data had taken only premium projects into account.
There is enough anecdotal evidence to suggest that is not the case. Nevertheless let’s take that into account and assume that the actual weighted average price of a flat in Mumbai is 75% of the price that Liases Foras had arrived at.
This works out to around Rs 1 crore. Let’s say an individual decides to buy such a flat and takes on a home loan to do so. A bank would normally give around 80% of the market price of a house as a home loan. So, the individual takes a loan of Rs 80 lakh (80% of Rs 1 crore) to be repaid over a period of 20 years. The remaining Rs 20 lakh he puts from his savings.
The RBI governor Raghuram Rajan in a recent speech said that the average interest rate on a home loan these days was 10.7%. Let’s assume that the individual borrows at the average interest rate. The EMI on this loan works out to Rs 80,948.
Let’s say the interest rate on the home loan comes down by 50 basis points (one basis point is one hundredth of a percentage) to 10.2%. The EMI on this loan works out to Rs 78,265 or Rs 2,683 lower.
If the interest rates are cut by 100 basis points and the interest rate on the home loan falls to 9.7%, the EMI will fall by around Rs 5,330. So, will an individual who has the ability of making a downpayment of Rs 20 lakh and taking on a home loan of Rs 80 lakh, buy a home simply because the EMI is Rs 2,683-5,330 lower?
An individual who has the ability to take on a home loan of Rs 80 lakh must be making around Rs 1.65 lakh per month(
as per the home loan eligiblity calculator available on www.hdfc.com). And that is clearly a lot of money. Only a small set of individuals make that kind of money, even in a city like Mumbai.
The same exercise can be repeated for other cities as well, and the results will remain the same. The larger point is that the fact that Indians are not buying homes has got nothing to do with high interest rates and EMIs and everything to do with the fact that homes are atrociously expensive. And instead of asking the RBI to cut interest rates, Jaitely should be looking at ways through which home prices can be brought down to more reasonable levels.
He could start with ensuring that better data on real state is available to the people of this country.
Currently, t
he National Housing Bank has the Residex index, which gives some idea of the prevailing price trends across various cities. But the information is not up-to-date enough to be of much use. As of now, the data is available only up to June 2014. Also, the data is declared every three months. Something of this sort should be declared on a monthly basis.
Further, anyone trying to buy a home essentially has no data that he can look at to figure out what the prevailing price trend is. Typically, he has to go with what the brokers tell him. And brokers are not normally thinking about the best interests of the individual trying to buy a home.
For starters, the government could try and aggregate the stamp duty data from the twenty biggest cities in India. This will tell us the average price at which “homes” are “supposedly” being sold. Along with that the number of transactions being registered will give us some idea of what the demand situation is.
Of course, given the black money transactions that happen in real estate, the average price that we get through this route may not be totally correct. Nevertheless, this is not a bad starting point. Further, in order to cut down on black money transactions the government needs to ensure that the circle rate is close to the prevailing market value in any area.
A property when it is sold needs to be registered at the actual transaction value or the prevailing circle rate, whichever is higher. The stamp duty needs to paid on this value. Typically, the market rate tends to be much higher than the prevailing circles rate. This essentially leads to a situation where transactions are declared at the circle rate and not the market rate, ensuring that a significant part of the transaction happens in black. It also leads to lower tax collections for the government.
Further, in areas where the difference between the market rate and the circle rate is high attract a lot of black money. As Anuj Puri chairman and country head, Jones Lang LaSalle India,
told Mint in September 2014, “Reduction in the gap between circle and market rates means that the region becomes less attractive for those who are seeking to offload unaccounted-for funds, and more attractive for genuine buyers.”
These are the steps that Jaitley should be thinking about instead of asking the RBI to cut interest rates almost every time he speaks.

The article appeared originally on www.FirstBiz.com on Dec 12, 2014

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