CK Prahalad

In a Country of 10 crore Urban Households, Builders Sold 2.62 Lakh Homes Last Year  

I recently wrote a column in the Mint newspaper titled India and China: A tale of ghost towns in two gigantic countries. This piece is an extension of a small part in that column. Ideally, you should read the column before reading this piece, nevertheless, this piece stands on its own as well.

The real estate rating and research firm Liases Foras recently put out some interesting data in a report titled, Residential Real Estate Market Report. Let’s look at this pointwise.

1) The home sales in the top 60 cities in India in 2020 stood at 2.62 lakh units. This was down 31% from 2019, when it had stood at 3.77 lakh units.

2) The sales in tier I cities (Ahmedabad, Bengaluru, Chennai, Hyderabad, Kolkata, Mumbai Metropolitan Area, National Capital Region, Pune) stood at 1.85 lakh units in 2020, down 32% from sales in 2019 when 2.75 lakh units had been sold.

3) The sales in tier II cities in 2020 stood at 76,603 units down 25% from 2019 when 1.03 lakh units had been sold.

4) The overall unsold housing inventory was down 6% to 12.52 lakh units in 2020, against 13.32 lakh units in 2019. The value of homes sold in 2020 stood at Rs 1.73 lakh crore, whereas the value of the inventory outstanding is at around Rs 8.65 lakh crore. At this rate, it will take five years to sell the current inventory (Rs 8.65 lakh crore divided by Rs 1.73 lakh crore).

Of course, this does assume that no new construction will happen over the next five years, which is a wrong assumption to begin with. Hence, the current inventory will take longer than five years to sell, unless sales pick up at a dramatic rate, which as far as I see it is unlikely to happen, given the state of the economy and the general purchasing power of Indians, which the real estate industry never seems to take into account.

Let’s use this data and make some assumptions to explain all over again why the Indian real estate industry is in a mess and what can be possibly done to revive it.

1) In 2020, a total of 2,62,055 homes were sold across the top 60 cities in India with the total value of these sales being Rs 1,72,770 crore. This means that the average price of a home sold stood at Rs 65.92 lakh (Rs 1,72,770 crore of sales divided by 2,62,055 homes sold). In comparison to 2019, the average home price has barely fallen. In 2019, the average home price was Rs 65.96 lakh (Rs 2,48,861 crore of sales divided by 3,77,295 homes sold).

Let me not analyze this number further and make a few adjustments first.

2) Let’s consider the tier I and tier II cities separately. The average home price in tier I cities in 2020 was at Rs 74.37 lakh (Rs 1,37,921 crore of sales divided by 1,85,452 homes sold). The average home price in tier I cities in 2019 was Rs 73.57 lakh (Rs 2,02,089 crore of sales divided by 2,74,680 homes sold).  In tier I cities, despite home sales crashing by 32% in terms of number of units sold, the average home price has gone up marginally. There can be various local reasons for it which the overall average won’t reveal, but on the whole it is safe to say that real estate sales don’t seem to follow the basic law of demand in India. They never have and which is why the sector has been in a mess for more than half a decade now.

3) Within tier I cities, let’s make one more adjustment by first checking what was the average home price in Mumbai Metropolitan Region (MMR), which tends to be higher than other parts of the country, simply because prices in Mumbai city tend to be very high. The average home price in MMR in 2020 was Rs 94.98 lakh (Rs 46,043 crore of sales divided by 48,479 homes sold). The average home price in 2019 had stood at Rs 99.11 lakh (Rs 67,938 crore of sales divided by 68,543 homes sold). Hence, the price in MMR has come down by 4.2% on an average between 2019 and 2020.

4) Now let’s calculate the average price of a home in non MMR tier I cities. The average home price in a non MMR tier I city in 2020 stood at Rs 67.07 lakh (Rs 91,878 crore of sales divided by 1,36,973 homes sold). The average home price in a non MMR tier I city in 2019 had stood at Rs 65.08 lakh (Rs 1,34,151 crore of sales divided by 2,06,137 homes sold). Hence, the average home price in non MMR tier I city in 2020 has gone up by a little over 3%.

5) Now finally let’s look at the average home price in a tier II city. The average home price in a tier II city in 2020 stood at Rs 45.49 lakh (Rs 34,849 crore of sales divided by 76,603 homes sold). The average price in 2019 had stood at Rs 45.58 lakh (Rs 46,772 crore of sales divided by 1,02,615 homes sold). Given this, the average home price in tier II cities has barely moved between 2019 and 2020.

What does all this data tell us?

1) At the risk of sounding as cliched as I can sound and have been sounding for years, the price of real estate in India is too high. Of course, we are looking at average prices here, but do take into account the fact that even in tier II cities the average home price is close to Rs 50 lakh.

In a tier I city without Mumbai, the average home price is close to Rs 67 lakh. Of course, there are tier I cities, like Pune and Ahmedabad, where the average price is closer to Rs 50 lakh. But even that is very high when one takes into account the fact that the per capita gross national disposable income in 2020-21 is expected to be around Rs 1.46 lakh.

Thus, the per capita household disposable income amounts to Rs 7.3 lakh (given that there are five people in an average Indian household). What needs to be kept in mind here is that this is the mean income of a household or the average income of an Indian household and not the median income or the income of an average Indian household. Hence, the income of the an average Indian household must be much lower than Rs 7.3 lakh per year.

2) Clearly, the real estate builders are building homes only for a certain section of the population, the very rich. And that has limited their market. In 2001, the number of urban households had stood at 5.58 crore. In 2011, this had jumped by 41.3% to 7.89 crore. Looking at this data, it is safe to say that by 2021, the number of urban households would have crossed 10 crore. Let’s assume it is at 10 crore households, which I think is a reasonable assumption to make, given that the number of actual households should be much greater looking at the past trend and increasing urbanisation.

3) A bulk of these 10 crore households would be living in the top 60 cities of urban India. In these cities, in 2020, a total of 2.62 lakh new homes were sold by builders. In 2019, the number was at 3.77 lakh homes. Let’s further assume that Liases Foras probably does not capture all the new homes being sold by builders across these 60 cities. Even if the homes sold were double of this number, they are barely a very small fraction of less than 1% of the total number of households in urban India. And this is true not just about 2020, it is equally valid for 2019, a non-covid year.

Of course, not all homes sold are new homes. People who have bought homes as an investment in the past and are now selling them, also need to be considered. There is no data available for this, but even if there was, the prices at which these homes were sold couldn’t have been significantly different from the new homes being sold by builders, hence, limiting their affordability.

4) As I had said in my Mint piece earlier this week, India needs real affordable housing, homes which can be built and sold profitably in the range of Rs 5-20 lakh in Indian cities. Of course, these homes will be smaller in size, but they will be definitely much better and more humane than living in slums. And imagine if something like this takes off, what it could do to economic activity in a post covid world. Building of real estate leads to a lot of economic activity. Every apartment requires, cement, bricks, sand, steel, pipes etc. It also requires people to take on home loans.

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. The multiplier effect is huge.

Also, real estate is one sector which can create a lot of semi-skilled and unskilled jobs, very quickly, thus help people move away from agriculture, which tends to employ more people than is economically feasible.

5) Of course, this is easier said than done. First, it needs the real estate industry to consider the idea of doing business profitably at a much lower price, which it currently doesn’t seem to have got its head around to. Over the past few years, the real estate industry has maintained that it is difficult to cut prices given that input costs have gone up over the years.

It recently blamed the steel and the cement sector for driving up real estate prices. The cement industry has responded by saying: “only Rs 150/sq. ft of built up area constitutes cement costs. The amount being so low … is this not hoodwinking gullible consumers?”

I am no civil engineer and have absolutely no idea about what it costs to build a building, an apartment and so on. But what I do understand is that if real affordable housing has to become the order of the day, home prices need to come down and come down dramatically.

6) One thing holding back affordable housing is the cost of land in and around big cities. At the heart of this is the issue of Change in Land Usage (CLU). Agricultural land beyond a certain size cannot be owned, as per the land ceiling regulations. This limit varies from state to state. What this does is that it limits the amount of land available in cities unless the state government intervenes. And the moment that happens, the cost of the land starts to go up.

7) The central government and the state governments own a massive amount of land in Indian cities, which is lying unused. Over the years, some of it can be made available for real affordable housing. Of course, wherever there is land and there are politicians, there is scope for corruption (I really have no answer for this, honestly).

8) In a recent research report, IIFL securities looked at the cost of redevelopment projects in Mumbai. The figure that caught my eye is that the construction cost is 30.8% of the total cost. So, whatever the real estate industry might say, the construction costs forming less than a third of the overall cost, are really not the problem. I guess in non-redevelopment projects the construction cost as a proportion might be more, but even with that the problem is somewhere else.

It is the remaining charges that need to be brought down. Interestingly, charges related to the government in different ways (everything from floor space index charges to staircase premium to taxes to liaison cost) made up for around 40% of the overall cost. Clearly, the government is the problem here. The dependence on revenue from real estate for state governments needs to come down.

9) I am not an expert on this, but I do feel that this is an idea that needs to be made to work and there are experts out there who can look at it in a more detailed and feasible way.

To conclude, the problems holding back Indian real estate are huge and it will be very tough to sort them out. But as the corporates like to say in adversity there is opportunity. And real affordable housing is a huge opportunity, only if someone can figure out how to run a profitable business at lower costs. As the late Professor CK Prahalad would have said there is a fortune to be made at the bottom of the pyramid.

When It Comes to Taxes, the Fortune is at the Bottom of the Pyramid

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Sometime back the Income Tax department released some detailed data about the income tax returns filed during the assessment year 2012-2013. The income tax returns for the income earned during the financial year 2011-2012 were filed during the assessment year 2012-2013. The department released some other data points as well.

I had hoped I won’t write anymore columns around the data, but then that is not how things have turned out to be.

One of the interesting data points that I wrote extensively about was that in the assessment year 2012-2013, only around 2.88 crore individuals filed income tax returns. Of this number, around 1.62 crore did not pay any income tax. Only the remaining 1.26 crore individuals paid some amount of tax.

Of this number, around 1.11 crore paid a total amount of income tax upto Rs 1.5 lakh. The average income tax paid by these individuals was at around Rs 21,068. Of course, the median amount of income tax paid would be even lower.

The interesting thing is that even though the average income tax paid by these individuals was low, the total income tax paid, added up to a substantial Rs 23,446 crore. This was by far the highest amount paid by any category of taxpayers.

The next highest amount of tax was collected from individuals who paid income tax in the range of Rs 5.5 lakh to Rs 9.5 lakh. Around 1.79 lakh individuals fell in this category and paid a total income tax of Rs 12,580 crore. The average income tax paid worked out to around Rs 7.04 lakh. While at an average level this was substantially higher than the income tax paid by those paying tax of up to Rs 1.5 lakh, on the whole it was lower.

What does this mean? This essentially means that when it comes to income tax there is a fortune waiting for the government at the bottom of the pyramid. The term “fortune at the bottom of the pyramid” was coined by management guru CK Prahalad in a book of the same name.

In this book, Prahalad looked at the distribution of wealth and the capacity to generate incomes in the form of an economic pyramid. As he wrote: “At the top of the pyramid are the wealthy, with numerous opportunities for generating high levels of income. More than 4 billion people live at the bottom of the pyramid on less than $2 per day.”

Prahalad’s book was about these people and he felt that the “dominant assumption is that the poor have no purchasing power and, therefore, do not represent a viable market.” This he believed was incorrect and went on to show through various examples that even those earning less than $2 per day and can add up to substantial market size.

Along similar lines, those paying an income tax of less than Rs 1.5 lakh can also end up paying a substantial amount of income tax in total, though individually the income tax that they pay is low.

Hence, there is a lot of money that the government can collect at the lower end as income tax. This is a point that was made even in the most recent Economic Survey, released in February earlier this year. Take a look at the following chart.

05132016-Vivek-DRChart

What does this tell us? It shows very clearly that the basic tax exemption limit, only above which an income tax has to be paid, has risen at a much faster rate than the per capita income in India. As the Survey points out: “We can calculate in some sense the “missing taxpayers” in India—not those who are evading taxes altogether or under-reporting taxes but those who have legitimately gone under the tax radar due to “generous” government policy.”

What does this calculation tell us? Or to put it simply who are these missing taxpayers? These are those taxpayers who got left out because the basic exemption limit beyond which an income tax has to be paid has been raised from the level of Rs 1.5 lakh in 2008-2009. It currently stands at Rs 2.5 lakh.

If this threshold had not been raised as rapidly as it was, the government’s income tax collections would have gone up tremendously.

As the Economic Survey points out: “We ask how many taxpayers there would have been in 2012-13 if the threshold had been maintained at Rs. 1,50,000 (the threshold limit in 2008-09). We find that there would have been an additional 1.65 crore units incorporated within the taxation system (an addition of about 39.5 percent) and tax revenues would have been about R31,500 crores greater. India’s tax-GDP would have increased by 0.32 per cent just by not having raised the threshold so generously.”

In fact, the Survey also points out that there is a lot that India can learn from China on this front. As it points out: “[The] Chinese success in bringing more citizens into the individual income tax net owes to setting a reasonable threshold for paying taxes and not changing it unduly. In contrast, in India, exemption thresholds for income taxes have been consistently raised. In fact, as Figure 7 [the chart shared above] shows, thresholds have been raised much more rapidly than underlying income growth so that today, the wedge between average income and the threshold has widened.”

The finance ministers who increased the tax exemption limit knew what they were doing. They were basically playing to the gallery. But the loss of taxes on this front was more than made up for through first through a higher service tax rate and now through various cesses like Swacch Bharat Cess and Krishi Kalyan Cess.

Of course, indirect taxes are in the end paid by everybody, even those who are not a part of the formal sector. In that sense, it was only fair on those paying income tax.

It is worth remembering that in economics there are no free lunches. If the government gives from one hand it takes away from another.

Disclosure: The basic idea for this column came after reading R Jagannathan’s column Why Nicking The Non-Poor May Yield More Tax Than Just Mugging The Rich on SwarajyaMag.com

The column originally appeared on the Vivek Kaul Diary on May 13, 2016