The Delusional Optimism of India’s Real Estate Companies

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Daniel Kahneman, the Nobel Prize winning psychologist, in his brilliant book, Thinking, Fast and Slow, writes: “One of the benefits of an optimistic temperament is that it encourages persistence in the face of obstacles…[The] confidence [of the entrepreneurs] in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

This optimism of an extreme delusional variety has been visible among India’s real estate entrepreneurs. For the last five to six years, they have been saying that a recovery in the sector is just around the corner, and the fact that it hasn’t happened yet is because the Reserve Bank of India (RBI) refuses to play ball by cutting interest rates, adequately.
Rajeev Talwar, the Chief Executive of DLF, recently told the Business Standard: “We are in a new economic cycle… When demand picks up, it will take everybody by surprise.”

Niranjan Hiranandani, chairman of Hiranandani group, told the same newspaper: “Any depression will not last long.”

Isn’t a period of five to six years a long enough time?

A report by Crisil Research points out that the absorption of new homes (i.e. sales) in in top 10 cities (Ahmedabad, Bengaluru, Chandigarh, Chennai, Hyderabad, Kochi, Kolkata, Mumbai Metropolitan Region (MMR), National Capital Region (NCR) and Pune) has fallen by 8 per cent per year on an average in the last six years.

What does this mean? It means that if real estate builders sold 100 new homes in India’s top 10 cities in 2010, in 2016, they managed to sell only 63. In absolute terms, this is a fall of 37 per cent. And Mr Hiranandani is talking about any depression not lasting long. I guess six years is a long enough time.

In fact, things haven’t looked good even in the last three months. As per real estate research firm, PropEquity, housing sales stood at 22,699 units during the period July to September 2017, in eight key cities. The sales had stood at 34,809 units during the period April to June 2017. This means a collapse of close to 35 per cent in a period of just three months.

The eight key cities are Gurgaon, Noida, Mumbai, Kolkata, Pune, Hyderabad, Bengaluru and Chennai.

What are the reasons for this collapse? As I have been saying over and over again, real estate prices in India, are beyond what most people can afford and unless this anomaly is corrected, sales will continue to remain sluggish.

Over and above this, real estate companies have really worked hard to break whatever little trust the prospective buyers had in them, by not delivering homes on time.

Further, investors are no longer the driving force in the market, given the sluggish returns in the sector. For a real estate investment to be a viable proposition, after taking in the costs and the risk involved, it should be generating a return of at least 10 per cent per year. And this hasn’t happened for a while.

The overall economy continues to remain sluggish. Take a look at Figure 1, which plots the growth of the non-government part of the GDP, which forms around 90 per cent of the Indian economy.

non govt GDP growth

Source: Centre for Monitoring Indian Economy.

The growth of the non-government part of the economy has fallen from well over 9 per cent to a little over 4 per cent in a period of 18 months between January 2016 and June 2017. This also means that incomes are not going up at the same pace as they were in the past. And given this, it is but natural people are going slow on buying a new home, which is the biggest financial commitment that they make in their lives. During a time when the rental yield (annual rent divided by market price of a home) is around 2 per cent, this makes immense financial sense.

The fear of job losses in the IT industry has also had an impact. The state of the IT industry has a major impact on real estate sales in cities like Pune, Hyderabad and Bengaluru.

In this scenario, the real estate builders have been offering discounts in order to get prospective buyers interested. As Crisil Research points out: “Pressure on residential real estate prices across top 10 cities was clearly visible during H1 2017 [January to June 2017]. While several developers offered upfront per square feet discounts, a few large developers bundled financing schemes and reduced interest schemes to offer ‘all inclusive house prices’. Home buyers, in many cases, were also offered indirect benefits such as reduced floor charges or premium location charges. Taking into account these aspects, the effective price correction was 5-10%.”

But even this 5-10 per cent correction isn’t enough to pull buyers in. This basically means that home prices continue to remain expensive. As I have often said in the past, home sales will revive as and when home prices become affordable, which is currently not the case. For home prices to become affordable builders need to cut prices from current levels. Given that a majority of them are in no mood to do so, it basically means that home sales will remain sluggish in the years to come.

Crisil Research expects that “in the next 12-18 months, prices are likely to remain stable at current levels on account of weak demand and moderation in new supply additions.” This basically means that instead of a price correction, the real estate sector in India is seeing a time correction. If prices remain stable over the years, they lose value once adjusted for inflation and in the process, they might become affordable.
Keep watching this space.

The article originally appeared on Equitymaster on October 16, 2017.

What You See is All There is?

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One story that constantly get splashed across Mumbai tabloids (the city I live in) is that of chain snatching. Almost all such newsreports give a feeling that the city is no longer as safe as it used to be.

But is this true? As Daniel Levitin writes in A Field Guide to Lies and Statistics: “We assume newspaper space given to crime reporting is a measure of crime rate. Or that the amount of newspaper coverage given over to different causes of death correlates to risk. But assumptions like this are unwise.”

Psychologist Daniel Kahneman calls this phenomenon “what you see is all there is” or WYSIATI. As he writes in Thinking, Fast and Slow: “The confidence that individuals have in their beliefs depends mostly on the quality of the story they can tell about what they see, even if they see little. We often fail to allow for the possibility that evidence that should be critical to our judgement is missing—what we see is all there is.”

Hence, what we believe in tends to get decided by what we see, and in the process, we tend to ignore the evidence that we should be really looking for. Take the case of the chain snatching in Mumbai that I talk at the beginning of the column. Any standalone chain snatching incident on its own should not lead us to draw broader conclusions. Nevertheless, that is precisely what we do, concluding that the city is more unsafe than it was in the past.

The data that we should basically be looking at is: Whether the number of chain snatching incidents has gone up than in comparison to the past? And if that is the case, then it is fair to draw the conclusion that the city is more unsafe than in comparison to the past, at least on the chain snatching front.

But this is a data point that most media reports on chain snatching tend to miss out on. A recent newsreport points out that the number of chain snatching incidents reported to the police in Mumbai, has fallen from 1,954 in 2012 to 445 in 2016. Also, the proportion of cases where a detection has been made has increased from 36.7 per cent in 2012 to 55.1 per cent in 2016. This means that a greater portion of the chain snatching crimes have been solved.

As per these figures, Mumbai is safer on the chain snatching front than it was in the past. But given that these data points rarely get reported that is not the impression that people have of the city. As Levitin writes: “Cognitive psychologist Paul Slovic showed that people dramatically overweight the relative risks of things that receive media attention. And part of the calculus for whether something receives media attention is whether or not it makes a good story. A death by drowning is more dramatic, more sudden, and perhaps more preventable than death by stomach cancer—all elements that make for a good, though tragic, tale.”

Given this, drowning deaths tend to get reported more than deaths by stomach cancer. This  leads people to erroneously believe that they are more common, which is not the case. As Levitin writes: “About five times more people die each year of stomach cancer than of unintentional drowning… Misunderstandings of risk can lead us to ignore or discount evidence we could use to protect ourselves.”

And that brings us back to the original question, is what you see really in the media all there is? Now that is something worth thinking about.

The column originally appeared in the Bangalore Mirror on February 15, 2017

 

 

The Denominator Neglect

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Among other things, schools teach Mathematics very badly, leading to a situation where most adults don’t understand the practical applications of even fifth standard Mathematics and pay for it in the process.

One such mistake that we make is known as the denominator neglect. As Thomas Gilovich and Less Ross write in The Wisest One in the Room—How You Can Benefit from Social Psychology’s Most Powerful Insights: “The effects of strategically choosing the right scale (i.e. the right denominator) can be dramatic. In one study, respondents judged a disease that kills 1,200 out of every 10,000 afflicted individuals to be more dangerous than one that’s twice as lethal, killing 24 out of every 100.”

This didn’t make any sense. The second disease was clearly more lethal given that chances were that it would kill twice the number of afflicted people than the first one would. But people still found the first disease more dangerous because the number 1,200 is much bigger than the number 24. In the process, they had totally neglected the denominator and made a blunder in arriving at the conclusion that they did.

In fact, a well-known experiment will make the point even clearer. In this experiment participants are given a choice to draw a red marble, out of two urns and win a prize. The first urn contains 10 marbles of which one is red. The second urn contains 100 marbles, of which 8 are red. It doesn’t take rocket science to figure out that the chances of drawing a red marble and in the process winning a prize are higher in case of the first urn. The probability of winning in the first case is 10 per cent and in the second case 8 per cent.

Nevertheless, as Daniel Kahneman writes in Thinking, Fast and Slow: “About 30-40% of student s[basically participants in the experiment]  choose the urn with the larger number of winning marbles, rather than the urn that provides a better chance of winning…Vivid imagery contributes to denominator neglect…When I think of the small urn, I see a single red marble…When I think of the larger urn, I see eight winning marbles.”

And that is how denominator neglect works. In fact, that also explains why different ways of talking about risk vary so much. As Kahenman writes: “You read that “a vaccine that protects children from a fatal disease carries a 0.001% risk of permanent disability”. The risk appears small. Now consider another description of the same risk: “One of 100,000 vaccinated children will be permanently disabled.” The second statement does something to your mind that the first does not: it calls up the image of an individual child who is permanently disabled by the vaccine; the 99,999 safely vaccinated children have faded into the background.”

That is how things work. The larger point is that people concentrate on absolute values in most cases and don’t take the denominator into account. This also explains why people are more likely to spend in a stronger currency than a weaker one. As Gilovich and Ross write: “People are more likely to buy expensive brand-name products when they are priced in a strong currency like the British pound that results in a relatively small price tag (318 pounds for an Apple iPad with retinal display) than when priced in a weak currency like the Mexican peso that results in a relatively large price tag(6,395 pesos for the same iPad).”

This also explains why many Indians buy gadgets when they go abroad. Of course, in many cases, the goods bought abroad are actually cheaper but in many other cases they simply appear cheaper because they are priced in a much stronger currency.

And this is how our lack of understanding of middle-school maths hurts in the decisions that we make in our daily lives.

The column originally appeared in the Bangalore Mirror on September 28, 2016

The Sunk Cost of Air India

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There are somethings one never expects a minister to say. Hence, the civil aviation minister Ashok Gajapathi Raju’s recent statement on Air India, came in as a pleasant surprise. The minister told the Press Trust of India: “It is a nice airline. I like Air India but I can’t commit taxpayers’ money for eternity. That is not done.”

This is a huge thing for the civil aviation minister to say. If you take Air India out of the civil aviation ministry (by either shutting it down or selling it off) there isn’t much that remains. Having made this statement, Raju hedged it by saying: “Let’s wish and hope that it (Air India) flies high. I am not against the public sector and I am not for only public sector at all costs. Public sector has a role and private sector has a role. Let them work in competition.”

To be honest, I have also liked Air India, on occasions I have travelled in it, as long as it has taken off on time. The leg space is better than the low cost carriers. The seats are more comfortable and the food is hot. Nevertheless, this is no excuse to keep the airline going.

As I have mentioned in the past, between 2010-2011 and 2015-2016, the airline made total losses of Rs 34,689.7 crore. That is quite a lot of money. Further, the airline also has a debt of Rs 51,367 crore, of which Rs 22,574 crore are outstanding aircraft loans. (As the minister of state for civil aviation Mahesh Sharma told the Parliament in March 2016).

A major part of the debt has helped the airline meet its expenditure, given that it doesn’t earn enough to meet its expenditure. Lenders keep lending to a perennially loss making Air India because ultimately they are lending to the government. And there is no safer lending than lending to the government, at least in theory.

Over and above the debt that airline took on, up until March 2016, the government had already poured Rs 22,280 crore into Air India, to keep it going. A further equity infusion of Rs 1,713 crore has been approved for the current financial year. Hence, a lot of public money is being spent to keep the airline going. What these numbers tell us is that the current government and the ones before it, have been basically in favour of public sector at all costs.

The civil aviation minister Raju further said: “Its (Air India) books are so bad. I don’t think that even if it is offered, anybody would come for it.” What the minister was basically saying is that nobody in their right mind will buy Air India in its current state. But is this good enough a reason to keep the airline going? That seems to be the case, given that there has been absolutely no talk of shutting it down.

Behavioural economists have a term for a situation like this—they call it the sunk cost fallacy. As Daniel Kahneman, the Nobel Prize winning psychologist, writes in Thinking, Fast and Slow: “A rational decision maker is interested only in the future consequences of current investments. Justifying earlier mistakes is not among the…concerns. The decision to invest additional resources in a losing account when better investments are available, is known as sunk-cost fallacy, a costly mistake that is observed in decisions large and small.”

Kahneman gives the hypothetical example of a company that has already spent $50 million on a project. As he writes: “The project is now behind schedule and the forecasts of its ultimate returns are less favourable than at the initial planning stage. An additional investment of $60 million is required to give the project a chance. An alternative proposal is to invest the same amount in a new project that currently looks likely to bring higher returns. What will the company do? All too often a company afflicted by sunk costs…[throws] good money after bad rather than accepting the humiliation of closing the account of a costly failure.”

This escalation of commitment is visible in many areas including war as well. As Richard Thaler writes in Misbehaving—The Making of Behavioural Economics: “Many people believe that the United States continued its futile war in Vietnam because we had invested too much to quit…Every thousand lives lost and every billion dollars spent made it more difficult to declare defeat and move on.”

This escalation of commitment is a major reason which has led to the government keeping   Air India going over the last few years, despite the mounting losses. No minister or the government for that matter, wants to admit defeat and talk about shutting down the airline.

As Kahneman writes in the context of the example we saw above: “Cancelling the project will leave a permanent stain on the executive’s record, and his personal interests are perhaps best served by gambling further with the organisation’s resources in the hope of recouping the original investment—or at least to postpone the day of reckoning.”

This logic applies to the civil aviation minister as well as the government (and not just the current one). No government wants to admit defeat and shutdown the airline. This, in a situation, when the government isn’t exactly flush with money and there are other important sectors, like education, health as well as physical infrastructure, that need more money.

Further, the airline continues to lose money and in a scenario where the Indian Railways is in a mess and needs a lot of money to be revived. If there is only so much money going around, shouldn’t that money be going to the Railways, instead of an airline?

I guess that is a no-brainer. But then no-brainers aren’t always so easy to process.

The column originally appeared in the Vivek Kaul Diary on Equitymaster on June 14, 2016

Why I Watch Cricket on Mute

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Over the four-day long weekend between March 24 and March 27, two exciting cricket matches were played. The Indian cricket team won both the matches.

I saw both these cricket matches end to end, but I had my TV on mute. I do this because I strongly feel that on most occasions TV commentary does not add any value to the visuals on the screen. And honestly, if there was an option which allowed me to just listen to the noise coming from the stadium, without the commentary, I would choose it.

Most cricket commentary and analysis is full of hindsight bias. And what is hindsight bias? As Jason Zweig writes in The Devil’s Financial Dictionary: “Only perhaps a half dozen market pundits saw the financial crisis coming before 2008, but you can’t swing a Hermès necktie on Wall Street without hitting someone who claims to have predicted it. That is typical of hindsight bias, the mechanism in the human mind that makes surprises vanish. Once you learn what did happen, your mind tricks you into believing that you knew it would happen.”

Take the match between India and Bangladesh. Bangladesh had almost won the match and needed to score two runs of three balls. They lost three wickets of the last three balls and India won the match by one run. Of these three wickets, two batsman got out trying to finish the game by hitting a six.

I think the Indian captain Mahindra Singh Dhoni summarised the situation best in what he said after the match: “At times, you look to finish it with a big shot. When you are batting well, you go for it. It is a learning for him [Mahmudullah] and others who finish games. That is what cricket is all about. If it had gone for six, everybody would have said what a shot.”

The trouble is that the Bangladeshi batsman Mahmudullah got out trying to hit a six and win the game for his team. And the commentators immediately pounced on him and declared that he should not have gone for the glory shot. The Bangladeshi cricketers were also called chokers. Nevertheless, if Mahmudullah had been able to hit a six, the same set of commentators would have had good things to say about him.

As Dhoni further said:In-form batsmen often try to play big shots to finish the game. If that shot by Mahmudullah had crossed the ropes, he would have been hailed as a courageous gutsy batsman. Now he will face criticism for playing such a shot.”

An almost similar thing was at view when Virat Kohli single-handedly helped India beat Australia. After India won, the commentators kept talking about his aggression and how it helped him play the innings that he did. The point is that if he had gotten out, the same aggression would have been blamed for his and the Indian team’s downfall.

The outcome of the game determines the analysis that follows. And the confidence with which the commentators speak makes you believe that they had really seen it coming. Of course, the fact that they have played the game in the past, adds to the confidence that they are able to project. But do they really see it coming? I don’t think so.

They day batsmen get out trying to hit shots, the analysis blames them for hitting rash shots. On days these shots come off, the commentators feel that taking a certain amount of risk is a very important part of modern day cricket.

In fact, hindsight bias impact even the commentary that accompanies every ball that is bowled and not just the analysis accompanying the overall result of the match. In the India versus Australia game, I was listening to the Hindi commentary and I think Shoaib Akhtar was speaking (though I am not sure about this) at that point of time. Virat Kohli hit a ball in the air and from the initial looks of it, it seemed that the ball would not cross the boundary and an Aussie fielder would take the catch.

So the first thing Akhtar said was “Kharab shot (A bad shot)”. Just a second later the ball had sailed across the boundary, Kohli had hit a six, and Akhtar said: “behtareen shot (what a good shot)”. Akhtar’s commentary immediately took into account the end result (i.e. Kohli hitting a six) and what was a bad shot suddenly became a terrific one.

The question is why does this happen? The Nobel Prize winning psychologist Daniel Kahneman has an answer for this in his book Thinking, Fast and Slow. As he writes: “The mind that makes up narratives about the past is a sense-making organ. When an unpredicted event occurs we immediately adjust our view of the world to accommodate the surprise. Imagine yourself before a football game between two teams…Now the game is over, and one team trashed the other. In your revised model of the world, the winning team is much stronger than the loser, and your view of the past as well as the future has been altered by that new perception.”

Then there is this other point that Dan Gardener writes about in Future Babble: “After a football team wins a game, for example, all fans are likely to remember themselves giving the teams better odds to win than they actually did. But researchers found that they could amplify this bias simply by asking fans to construct explanations for why the team won.”

This is precisely what happens to cricket commentators and the analysis that they have to offer after any game of cricket is over. Given that they have offer explanations of why the team wining, actually won, they end up amplifying the hindsight bias.

Depending on the result, the commentators offer an analysis. Some of it can be as banal as the winning side fielded better, batted better and bowled better (Something that Mohammed Azharuddin used to say all the time in his post-match comments when he was the India captain).

This is not to say that this analysis is incorrect, but why do we need a commentator to tell us this. It is very obvious. On most occasions a team that bats better, bowls better and fields better, is likely to win.

The hindsight bias also impacts stock market experts and analysts who try and make sense of the stock market on a regular basis. After a crash you will hear all kinds of pundits trying to claim they had seen it coming all along. And believe me they will make a very compelling case for it.

Nevertheless, it is important to keep in mind what Jason Zweig says. As he writes: “Contrary to popular cliché, hindsight is not 20/20; it is barely better than legally blind. If you don’t record and track your forecasts, you shouldn’t say that you knew all along what would happen in the end. And if you can’t review all predictions of pundits, you should never believe that they foresaw the future.

And that is something worth remembering.

The column originally appeared on the Vivek Kaul Diary on March 29, 2016