George Akerlof

Ek akela is shehar main: This song tells us all that is wrong with Indian real estate

ek akela is shehar mainVivek Kaul

Very few songs survive the test of time. One such song is ek akela is shehar main from the 1977 movie Gharaonda, written by Gulzar, set to tune by Jaidev and sung by Bhupinder Singh. As the lines from the song go:

ek akela is shehar main
raat main aur dopahar main
aabodana dhoondta hai
aashiyana dhoondta hai

(aabodana = food and water. aashiyana = a home)

This iconic song has an iconic scene which most people miss. Some 3 minutes and 26-27 seconds into the song there is a shot of what looks like Marine Drive. The road is full of Premier Padminis (or Fiats as they were better known as) and Ambassadors. If you look carefully enough there is even a white Mercedes somewhere.
The movie Gharaonda was released in 1977 and those were the days when Indians had the option of buying either the Ambassador produced by the Birlas at Uttarpara near Kolkata or the Premier Padmini produced by the Doshis at Kurla in Mumbai. The situation was akin to the early days of the American automobile. Henry Ford, the pioneer of the assembly line system of manufacturing remarked in 1909 that: “any customer can have a car painted any colour that he wants so long as it is black.”
In short the customer did not have any choice. The same was true about India in 1977. If one were to paraphrase Ford, “ any customer could buy any car that he wants so long as it is a Padmini or an Ambassador.”
But things have changed since then. Some 37 years later in 2014, a similar shot of the Marine Drive would show so many models of cars that it would be difficult to count the number quickly. This is the impact of competition and a largely free market which operates in the Indian automobile sector with very little interference from the government and in turn politicians. The companies compete with each other in order to offer the best possible features to consumers at the best possible price. This wasn’t the case in 1977 and the Indian consumer had a choice of two models of cars. The free market has clearly changed that.
Now let’s go back to the 1977 song that we started with—ek akela is shehar main. The song is about the inability of a man to buy a home in Mumbai in 1977. Thirty seven years later nothing has changed on that front. In fact, things have only gotten worse.
And the reason for this is very simple. Most homes across Mumbai and large parts of this country remain unaffordable for the same reason as the Indian consumer had a choice of only two cars in 1977. There is no free market in real estate.
Most real estate companies are fronts for politicians. What makes this very clear is the fact that even though there are thousands of real estate companies operating across India, there is not a single pan India real estate company. Forget pan India, there are very few companies that operate across large states. Most of the big real estate companies have an expertise in a particular part of the country. Why is that the case?
The answer lies in the fact that for any real estate company to operate in any part of the country it needs the cooperation of local politicians. And politicians in every area have their favourite real estate companies. This effectively ensures that even though there are many real estate companies there is very little genuine competition among them to offer the best possible home at the best possible price to consumers. Also, it limits the ability of a real estate company to grow in different parts of the country. It is not possible for the same real estate company to manage politicians everywhere. In short, the free market is not allowed to operate.
There is huge government interference in the sector to ensure that the favoured real estate companies continue to benefit. 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 spiraling prices resulting from scarcities than you could out of the hard work that goes into more construction.”
Over the years, the major infrastructure projects in Mumbai like the Bandra-Worli Sea Link or the Versova-Ghatkopar metro link, have addressed areas that have already been built up. The Sewri-Nhava Sheva link, which will open up a lot of land for housing is yet to see the light of day.
One excuse that is constantly offered by the real estate companies to justify spiralling prices is the lack of land. While this may be true about a city like Mumbai it is not true about most other Indian cities.
The Indian Institute for Human Settlements in a report titled Urban India 2011: Evidence esimates that “the top 10 cities are estimated to produce about 15% of the GDP, with 8% of the population and just 0.1% of the land area.” So clearly scarcity of land is not an issue.
This situation can be improved significantly if some of the land that the government has been sitting on can be made available for affordable housing. 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.”
Over and above this the end consumer has almost no access to price and volume trends. He has to go by what brokers and real estate companies tell him. And for these insiders the real estate prices are always on their way up. In this scenario the real estate market is completely rigged in favour of brokers, real estate companies and politicians. This is what the Nobel prize winning economist George Akerlof called a scenario of “asymmetric information”.
As Guy Sorman writes in An Optimist’s Diary “Economic actors don’t all have the same information at their disposal. Without institutions to improve transparency, insiders can easily manipulate markets.” This is precisely what is happening in India—politicians and real estate companies acting as their fronts, have been able to manipulate the entire system in their favour.
And unless this changes, the dream of owning a house will continue to be just a dream. Until then we can thank Gulzar, Jaidev and Bhupinder Singh for this beautiful song and hum it…ek akela is shehar main…

The article originally appeared on www.Firstbiz.com on August 4, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek)

Why believing that real estate prices will never fall is a stupid idea

India-Real-Estate-MarketVivek Kaul

In a piece I wrote yesterday I said that banks in India play an important role in ensuring that real estate prices do not fall. The main point was that loans given by banks to commercial real estate, between November 2012 and November 2013, has grown at a much faster rate than their overall lending.
This has happened in an environment where real estate companies have a lot of unsold homes(or what is referred to as inventory in technical terms). The number of new projects being launched by real estate companies has also fallen significantly.
Hence, fresh loans given by banks has helped real estate companies pay off their old loans. And this has ensured that they haven’t had to cut prices in order to sell their unsold inventory. If bank loans to commercial real estate hadn’t grown as fast as it has, then the real estate companies would have had to sell off their existing inventory to repay their bank loans. And in order to do that they would have to cut prices.
In response to this piece several readers said that real estate prices never fall. Still others agreed that there is a real estate bubble in India but that bubble would never burst (whatever that meant). And this is not the first time I have received such responses.
So what is it that leads people to believe that real estate prices never fall? People have seen real estate prices only go up over the last 10 years. A home that was bought for Rs 25 lakh is now worth Rs 2 crore. Hence, there is a firm belief that real estate prices can only keep going up.
In fact such confidence was observed even during the American real estate bubble that ran from the late 1990s to late 2006.
As Alan S. Blinder writes in After the Music Stopped “A survey of San Francisco homebuyers… found that the average price increase expected over the next decade was 14 percent per annum…The Economist reported a survey of Los Angeles homebuyers who expected gains of 22 percent per annum over the same time span.”
At an average price increase of 14% per year, a home that cost $500,000 in 2005 would have cost $1.85 million by 2015. At 22% it would have cost $3.65 million.
If we apply this in an Indian context we get some fairly interesting numbers. A three bedroom apartment near the Sector 12 metro station in Dwarka, a sub-city of Delhi, went for around Rs 25 lakh nearly 10 years back.
Now it costs around Rs 2 crore. If prices rise at 14% per year it will cost Rs 7.4 crore in 10 year’s time. At 22% it will cost Rs 14.6 crore. If prices rise at the same rate as they have in the last ten years, then the home would cost around Rs 16 crore. And these are huge numbers that we are talking about here. This small calculation tells us how ridiculous it is to assume that real estate prices will continue to go up at the same rate as they have in the past.
We all know what happened in the United States. The real estate bubble peaked in 2006. Prices started to fall after the last. For the last 16 months real estate prices as measured by the 20 City S&P/ Case- Shiller Home Price Index, have been rising. But they are still 20.7% below their 2006 peak.
A similar thing is playing out in the Indian context as well, wherein people are extrapolating the price rise of the last 10 years over the future. They are “anchored” into the price rise that real estate has seen over the last 10 years and this has led them to believe that prices will continue to rise forever.
What they forget is that real estate prices fell dramatically between 1997 and 2003. As Manish Bhandari of Vallum Capital writes in a report titled The End game of speculation in Indian Real Estate has begun “The previous deleveraging cycle in year 1997-2003 witnessed price correction by more than 50% in Mumbai Metro Region (MMR) property.” Yes, you read it write, prices fell by 50% in Mumbai, the last place you expect prices to fall, given that the city is surrounded by the sea on three sides and can grow only in one direction.
Other than the price rise, another reason behind the belief that real estate prices will continue to go up is the fact that there is only so much land going around. In fact, this reason has been offered for more than 100 years.
As George A. Akerlof and Robert J. Shiller point out in Animal Spirits “In a computer search of old newspapers, we found a newspaper articles from 1887—published during the real estate boom in some U.S. cities including New York—which used the idea to justify the boom amid a rising chorus of skeptics: “With the increase in population, the demand for land increases. As land cannot be stretched within a given area, only two ways remain to meet demands. One way is to build high in the air; the other is to raise price of land…Because it it perfectly plain to everyone that land must always be valuable, this form of investment has become permanently strong and popular.”
The point I am trying to make here is that the ‘limited land’ argument to justify high real estate prices is as old as land being bought and sold. Nevertheless, in most cases there is enough land going around. This is reflected in the American context in the fact that real estate prices have barely risen over the last 100 years, once they are adjusted for inflation.
As Akerlof and Shiller write “Moreover, real home prices in the United States rose only by 24% from 1900 to 2000, or 0.2% per year. Apparently land hasn’t been the constraint on home construction. So home prices have had negligible real appreciation from the source.”
What about India? While land maybe an issue in a city like Mumbai, it clearly is not much of an issue anywhere else. There is enough land going around.
Economist Ajay Shah did some number crunching in a May 2013 column in The Economic Times. He showed that there is enough land to house India’s huge population. As he wrote “A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI(floor space index) of 1. There is absolutely no shortage of land to house the great Indian population.”
Also, it is worth pointing out here that real estate prices have fallen dramatically even in countries like Japan where land unlike the United States is scarce. “Urban land prices have recently fallen in Japan (where land is every bit as scarce as it is in other countries). In fact they fell 68% in real terms in major Japanese cities from 1991 to 2006,” write Akerlof and Shiller. And the property prices in Japan are still lower than they were in the 1980s.
The moral of the story is that just because something has continued to happen till now, does not mean that it will continue to happen in the future as well. There are many fundamental reasons behind why the Indian real estate bubble is unsustainable (I made some of them in yesterday’s piece).
Let me make a few more here. Indian real estate has now become totally unaffordable. As Bhandari writes “The current real estate price represents affordability of very few, while average users have to sell their twenty years of future earnings to afford a house.”
The employment situation remains extremely grim. In a report titled Hire and Lower – Slowdown compounds India’s job-creation challenge,Crisil estimates that “employment outside agriculture will increase by only 38 million between 2011-12 and 2018-19 compared with 52 million between 2004-05 and 2011-12.” This in an environment where “India’s working age population would have swelled by over 85 million. Of these, 51 million would be seeking employment.”
With fewer non agriculture jobs being created a direct implication would be that incomes will not continue to grow at the same pace as they have in the past. And that in turn will mean a lower amount of money waiting to get into real estate. There are other economic indicators also which clearly show that the Indian economy has slowed down considerably than in comparison to the past. And the real estate sector will have to adjust to this reality.
Bhandari believes that the scenario that played out during the period 1997 ad 2003 will play out again, very soon. As he points out “One of the most important proponents of fall in the property prices is likely to start from the deleveraging cycle, by the Indian banking sector, which is running a multi decade investment to deposit ratio (108%). The reversal of easy business cycle, scarcity of capital, tight monetary cycle in domestic and international market will force scheduled commercial banks to deleverage their balance sheet over the next three to four years. One can observe the same scenario, witnessed in 1997-2003, when deleveraging by the Indian Banking Sector was accompanied by deleveraging corporates that had accumulated huge debts on their books during good times. This augurs a difficult time for the Real Estate Industry.”
Even with all these reasons it is difficult to predict when the Indian real estate bubble will start running out of steam. But that does not mean that real estate prices will never fall in India. It may happen this year. Or in 2015. Or the year after that.
But in the end, all bubbles burst. It is just a matter of time. As Blinder aptly puts it “Anyway, one thing we do know about speculative bubbles—whether in houses, stocks, or anything else—is that they eventually burst.” And what that tells us is that days of earning huge returns from Indian real estate are more or less over.
The article originally appeared on www.firstpost.com on January 8, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Why car sales are falling but not realty prices

homeCar sales for the month of February 2013 are down dramatically. For the month of February 2013 they fell by 25.71% to 1,58,513 units in comparison to the same month last year.
In this column yesterday, this writer argued that falling car sales is a reflection of the overall economy slowing down. People expect the bad times to either continue or to get even worse in the months to come. And this makes them hold onto the money they would have otherwise used to buy high cost items like a car. It also means that they do not want to commit to an EMI right now. Given these reasons car sales have slowed down.
The question that immediately cropped up was that if car sales are falling, using the same logic real estate sales should also be falling and that should lead to a fall in real estate prices. If cars are a big ticket purchase, then buying a house is the biggest expenditure that most people incur during their lifetime. Also the price of cars over the last few years hasn’t risen much whereas the price of homes has gone through the roof, making them terribly expensive.
So why are people ready to buy homes but not cars? The answer of course is not straightforward. But before I come to that allow me to deviate a little.
The economist George Akerlof wrote a research paper titled The Market for Lemons in 1970. For this paper, Akerlof ultimately received the Nobel Prize. In this paper he discusses the market for second hand cars (or used cars) and the problem people have in selling them.
Akerlof divided the second hand car market into two types of cars, peaches and lemons. Peaches were cars which were in a good shape where as lemons were cars which were in a bad shape. The individual selling the car obviously knows whether his car is a peach or a lemon but the individual buying the car doesn’t. So seller has what economists refer to as ‘insider information’ which the buyer doesn’t have.
The point is that in this transaction one side has much more information than the other side. So there is an asymmetry of information. 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.”
The real estate market in India is a tad like that. The sellers have all the information in the world and buyers have very little of it, almost next to nothing. And this manifests itself into situations which do not benefit the buyers at all.
Allow me to explain. Everyone talks about how real estate prices have been going up. This writer was recently told by someone that the flat he had bought in 2002 for around Rs 20-25 lakh was now going for Rs 2 crore. Fair point. But are there transactions happening at such an expensive price point? And if they are happening how are they in comparison to the past?
The point is that just looking at the price doesn’t give us the answer. One also has to look at the number of buyers looking to buy at that price point because only that can tell us how strong the trend is.
Unfortunately such kind of information is not available to most buyers in India. Hence, people who sell real estate, all the brokers and property dealers of the world, deal with buyers from a position of strength and always try to project a scenario where prospective homes are scarce. The buyers have no clue of whether deals are actually happening or not and hence tend to believe the brokers.
A real estate index which tell us the broad direction of the market would be a great thing to have. While attempts have been made in the past to launch a real estate index, nothing robust has come out till date.
There are reasons to believe that people are not buying as much real estate as they were in the past. This is not conclusive evidence but some evidence nevertheless. Try reading any newspaper article which makes a pitch for the Reserve Bank of India cutting interest rates, the CEOs of real estate companies come across as the most desperate of the lot. This tells you at some level that they are not selling as much as they are building. But how will an interest rate cut of 25-50 basis points (one basis point is one hundredth of a percentage) lead to people buying homes is beyond me.
Newspapers provide another indicator. Every week the front page of one newspaper or another has an advertisement for a new real estate launch happening somewhere, where the buyer has to put a minuscule portion of the cost of the home upfront. This money that is raised is typically used by the builder to payoff money that is due instead of building the homes that he has advertised. A story in The Carvan Magazine makes this point by quoting a property dealer : “If these builders were suddenly asked not to sell any more projects, I’m telling you, most of them couldn’t balance their books tomorrow.” So in effect most real estate companies are running Ponzi schemes where they are using money being brought in by the newer investors to pay off the older investors. As long as this Ponzi scheme keeps going real estate prices will continue to be high. If newer investors stop bringing in money, the builders will have to start selling the homes that they have built in order to pay off people who they owe money to.
Another interesting number is the proportion home loans form out of total loans given by banks. Home loans peaked at 12.9% of total banking credit in March 2006. As on December 28, 2012, they formed around 9.3% of total banking credit. And this in a scenario where housing prices have gone up many times between March 2006 and December 2012. Hence, it would only fair to assume that people are buying a fewer number of homes, at least by taking on home loans.
So if people are buying fewer homes why are the prices not falling? Those who work in the real estate industry would like us to believe that the cost of constructing a house has gone up. While that may be true to some extent the argument doesn’t justify the astonishing levels of price rise.
The material used in construction of a house and other forms of real estate was and continues to be easily available. Lumber which is used in large amounts is a renewable resource. Glass is made out of quartz, the second most common mineral on earth. Gypsum, which is the main constituent of plaster as well as wall board is very commonly available mineral. Cement is made out of limestone which forms 10% of all sedimentary rock formations on earth. (Source: The Subprime Solution by Robert Shiller). That leaves out the price of land on which the homes are constructed. We will just come to that.
A major reason for home prices not coming down despite the stagnant demand for homes is the fact that the market is dominated by investors/speculators and not real buyers who buy homes because they want to live in them. Anybody who has doubts about this can take a walk through the newer areas of the National Capital Territory. Most of the flats remain empty, giving an eerie feeling of a ghost town. All these flats are owned by investors/speculators. And it is these people who keep playing a game of passing the parcel among themselves and in a way ensure that prices of homes do not fall. Also they have made so much money in the past (and given that most of it is black money) they are in no hurry to sell these homes.
The story in The Caravan quotes a property dealer to make a similar point. “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—in homes that will be delayed indefinitely or just never get built.”
Also most of the black money in India finds its way into property one way or another. Most of the ill-gotten wealth of politicians is also deployed in property. And any fall in price of real estate would mean the value of their wealth coming down.
But at the end of the day there is only so much black money going around as well. What creates the illusion of the real estate prices continuing to remain high is the supply of land. While India does not have a scarcity of land like Japan does, the problem is that politicians control the supply of land. Every state and central and politician has land held in benami. And this is the real bubble that has kept home prices high.
As Ruchir Sharma writes in Breakout Nations “Lately Indian businessmen have been regaling one another with accounts of a leading politician from Mumbai who is known to have amassed a huge wealth through property deals. At a private screening of a new Bollywood movie, this politician asked the producer to replay a particular song-and-dance number, over and over. When the producer asked if he was taken with the leading lady, the politician said no, he was eyeing the location and wondering where the producer had found such an attractive stretch of open space in Mumbai.”
If home prices have to come down, it is this link that needs to be broken.
The article originally appeared on www.firstpost.com on March 14, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)