Why Real Estate Prices are Going Down at a Slow Pace

A few days back an email popped up, asking us, why had we stopped writing on real estate. We would like to assure the reader that we haven’t stopped writing on real estate, just that we have taken a break from writing on the topic.

It’s just that it is very difficult to write new things about Indian real estate in a scenario where very little data is available. But yesterday while reading a book we came across a concept from behavioural economics which weaves in beautifully with the real estate scenario that prevails in India currently. So, let’s discuss that in today’s edition of the Diary.

In his book A Man for All Markets—From Las Vegas to Wall Street, How I Beat the Dealer and the Market, Edward O Thorp discusses the concept of anchoring in real estate. As he writes: “Anchoring is a subtle and pervasive aberration in investment thinking. For instance, a former neighbour, Mr Davis (as I shall call him), saw the market value of his house rise from his purchase price of $2,000,000 or so in the mid-1980s to $3,500,000 or so when the luxury home prices peaked in 1988-1989. Soon afterward, he decided he wanted to sell and anchored himself to the price of $3,500,000.

And this is when the troubles of Mr Davies began. Luxury home prices started to fall pretty soon. But Mr Davies was anchored to a price of $3,500,000. While the price of $3,500,000 had meaning to Mr Davies, it did not have any meaning to the market in which he was trying to sell his house because the prices had come down. In fact, that is exactly how anchoring is defined. As John Allen Paulos writes in A Mathematician Reads the Stock Market: “We… become attached to any number we hear. This tendency is called the “anchoring effect”.

Anyway, getting back to the story of Mr Davies. As he hung on to his “anchored” price, he didn’t find any buyers for his house. As Thorp writes: “During the next ten years, as the market price of his house fell back to $2,200,000 or so, he kept trying to sell at his now laughable anchor price. At last, in 2000, with a resurgent stock market and a dot-com-driven price rise in expensive homes, he escaped at $3,250,000.”

In the end Mr Davies ended up selling the house at more or less his anchored price. Of course, what he forgot or perhaps ignored in the process of being anchored to the price that he was, was that there is a certain time value of money. As Davies writes: “In his case, as often happens, the thinking error of anchoring, despite the eventual sale price he achieved left him with substantially less money than if he had acted otherwise.

The point being that if Davies had sold at a price slightly lower than his anchored price and invested the money somewhere else, he would have ended up with more money by 2000, than the $3,250,000 he managed for the house.

Now how is this concept of anchoring relevant in the Indian context? In a weak real estate market the dangers of anchoring are faced by the seller of a house. This is precisely what is happening in India right now. Over the last few years, in many markets in the country, real estate prices have fallen. Despite this, many sellers are still anchored on to the peak price their home had achieved a few years back. I see this phenomenon play out very well in and around Delhi.

And given this, they aren’t ready to sell at the current market price. In some other cases, the home prices have been stagnant over the last few years. And investors are anchored to a higher price at which they are likely to make a good return on their real estate investment. I see this phenomenon play out in cities like Pune. These investors are also not in a mood to sell.

This has essentially led to a situation where real estate transactions have crashed across many markets in the country but the prices haven’t. This isn’t good for the real estate market because unless homes that have already been built are sold to buyers who want to live in them (and not invest), the huge inventory of built up homes with no one living in them, won’t clear.

Unless this inventory clears, no new homes will be built or homes will not be built at the same pace as they were in the past. And the new homes that will be built will only add to the inventory of homes that is already there. Clearly, we have a problem here. Also, with the home owners anchored on to a price, they will lose money in the years to come, given that it is highly unlikely that real estate prices will go up or even if they go up, they will not go up at the rate that they did in the past.

Meanwhile, the home owners will have to bear the cost of maintenance, property tax etc. Hence, overall, they will lose money on their real estate investment. In fact, they might just be better off by selling their home and investing the money even in a fixed deposit.

But that of course is not going to happen given that the idea that real estate prices only go up, is highly ingrained (or should I say we are anchored to it) in us Indians. And that is not going to change anytime soon.

The column originally appeared on Equitymaster on March 23, 2017


Miracles don’t happen, it’s just chance


I ran into a long-lost friend (yes even in the age of Facebook) at a mall, after a decade, over the Christmas weekend. And he couldn’t believe that we had met after so long. “It is indeed a miracle that we met,” he said. He didn’t stop at that and continued.

“What if, I had walked into the mall an hour earlier? What if I hadn’t walked towards this side of the mall?” “What were the chances of us meeting?” he finally asked. The question was obviously rhetorical and I didn’t answer it.

Nevertheless, running into a long-lost friend or an acquaintance isn’t as a big deal as we normally make it out to be. Let’s understand this through an example. As Michael Brooks writes in the introduction to Chance—The Science and Secrets of Luck, Randomness and Probability: “Take the calculation by author Ali Binazir, who claimed, via a chain of reasoning about your mother and father meeting, eggs getting fertilised, and human longevity, that odds of you existing are 1 in 102,685,000 – a 10 followed by 2,685,000 zeroes.”

What this bit of fancy maths tells us is that our chances of being born are very low indeed. On the face of it, it seems like a miracle. But is that the case? As Brooks writes: “Such odds are, at first glance, impressive. They create a sense of awe. But they are also nonsense. You are the result of all those things actually happening, whatever the odds of two random people falling in love, or a particular sperm fertilising a particular egg. And so is everyone else on the planet…I hate to say it, but you’re not, as Binazir claims, a miracle. You’re just a link in the human chain.”

The point here being is that the odds of me existing are low. But that is also true about every individual on this planet. And given that, does it really matter?

John Allen Paulos explains this in A Numerate Life—A Mathematician Explores the Vagaries of Life, His Own and Probably Yours through a concept called the Fundamental Confusion of Coincidences. As he writes: “The probability of an unusual event or sequence of events is usually very small, in fact minuscule, yet the probability of some event or sequence of events of the same vaguely defined general sort is usually quite high. People regularly confuse the two probabilities.”

In my case, running into a particular friend at the mall was obviously low. But that is true about everyone who steps out of home. So of all the people stepping out at a given point of time, someone is going to run into someone he knows, after a long time. And that is the way to look at it the situation.

In fact, we underestimate the role of chance in our daily lives and tend to attribute something happening to a “miracle” too easily. As Paulos writes: “If an event or sequence of events gives rise to a supposed miracle that is deemed a divine intervention, the one deeming it so must face some obvious questions. Why, for example, do so many people refer to the rescuing of a few children after a destructive tornado as a miracle when they chalk up the death of perhaps dozen equally innocent children in the same disaster to a meteorological anomaly?”

And this is a very important question to ask. As Paulos points out: “It would seem either both are the result of divine intervention or both are a consequence of atmospheric conditions. The same point holds for other tragedies. If a recovery from a disease after a long series of struggles and treatments is considered a miraculous case of divine intervention, then what do we attribute the contracting of the disease in the first place?”

Nevertheless, one rarely gets to see this kind of thinking anywhere. Brooks explains this phenomenon by saying “dealing properly with chance takes real mental effort”. And that is clearly missing in the world that we live in.

The column originally appeared in the Bangalore Mirror on January 6, 2016

Delhi’s real estate obsession defies logic

I was recently in Delhi to attend a few family functions. And as often happens in Delhi, when you want to make a conversation with someone you don’t know that well or you meet only once in a few years, you end up talking about real estate.

During the course of these discussions over plates of oily Kashmiri food, which I have stopped liking many years back, or cups of tea and coffee, I came to realise that the Delhi middle class is still obsessed with the idea of owning real estate. Of course, I am drawing this conclusion from a small sample, but that is the drift I get every time I go to Delhi.

This love for owning real estate continues, despite the fact that the real estate sector in Delhi and the National Capital Region (NCR) surrounding it, continues to be in a mess. Lakhs of people are still stuck with homes which are under-construction and have been under-construction for a while now. Despite this, still others are ready to buy under-construction homes so that when the price goes up, they can cash-in.

The arguments offered in favour of owning real estate all centre around a very basic point that the American writer Mark Twain made: “Buy landtheyre not making it anymore.” The thing is that everything that sounds sensible isn’t necessarily sensible.

The real estate scene in Delhi and NCR has been rather dull over the last few years. Prices in many areas have fallen by close to 20%. In areas where prices have not fallen they have been stagnant. In fact, investors in real estate would have made more money with a greater peace of mind, by investing their money in bank fixed deposits. In fact, even if they had let their money sit idle in savings bank accounts paying 4-6% per year, they would have made more money.

Nevertheless, those who own more than one home, continue owning their second or third home, in the hope that the trend will reverse and they will make money someday. This during an era when the rental yields in Delhi are around 1.5-2%. Rental yield is essentially the annual rent that can be earned from a home divided by its market price.

Owners of real estate miss out on this return as well primarily because there is a great fear that once a home is let out, the kirayedar for the lack of a better word (tenant just doesn’t sound the same) will not vacate when the contract runs out.

In fact, I know of people who have bought a second home on a home loan, as an investment. In some cases, the home is still under-construction. This means that the interest on the home loan needs to be paid, without the possession in sight. In cases where fully-constructed homes have been delivered, they are paying an interest of 10-11% on their home loan, while getting a rental yield of 2%. Some tax benefits are also there.

But the basic question is why would you borrow at 10-11% and earn a return of 1.5-2% on it? Beats me. For those who have put in their savings, it still doesn’t make any sense to be earning 1.5-2% per year, when the rate of inflation is 5%.

This proposition only makes sense if the money being deployed is black money (i.e. no tax has been paid on the income earned) and cannot be invested through the conventional modes of investment. The irony is that it takes more paperwork in India to open a bank account than to invest in real estate. Also, real estate comes with own share of hassles. There are maintenance charges and property taxes to be paid every year and these eat into the savings of real estate owners.

Nevertheless, these people are still confident that real estate prices will rise someday. And they are not ready to sell in at the current market price. Why is that?

They are ‘anchored’ to a certain price. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Most of us suffer from a common psychological failing. We credit and become attached to any number we hear. This tendency is called the “anchoring effect” and it’s been demonstrated to hold in a wide variety of situations.”

How does this apply in case of the real estate scenario in Delhi and NCR? The current crop of investors in real estate has heard numerous success stories and the huge amount of money and returns made by the investors in the past. They are anchored to these returns and are waiting for higher prices. This means they won’t sell at current prices.

There hope of higher prices won’t materialise anytime soon given that a huge amount of homes are still under-construction. In many cases the construction has stopped. At the same time new home launches continue.

What people also don’t realise is that even in a situation when prices are not falling, they are losing money once they start taking inflation into account. This is referred to as a time correction. And that is clearly on in Delhi and other parts of the country.

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

The column originally appeared on Huffington Post India on December 9, 2015

Of prisoner’s dilemma and the discounting wars of Indian e-commerce

This week the ecommerce companies operating in India are at war.

Snapdeal had its electronic Monday sale on October 12, 2015.

Fllipkart has The Big Billion Days Sale between October 13 and October 17, 2015. This sale is limited to its smartphone app.

Amazon has the Great Indian Festival Sale during the same period. Amazon’s sale isn’t limited to its app, like Flipkart’s. Nevertheless, the company is offering higher discounts on the app.

Over the next few days you will see reports in the business press with senior executives of these companies saying that they have managed to sell this much and sell that much.

The trouble is everyone will talk about revenue numbers. No one will tell you that they are losing money on each product they sell and the more they sell the more money they will lose.

In fact, the business press is already talking about the positive impact of these sales. As Rahul Taneja of Snapdeal told the Mint newspaper: “We are well on track to reach $100 million sales on our Electronics Monday Sale.”

Nevertheless, things are not as simplistic as they are being out to be. The Indian ecommerce scene should be viewed from the lens of the prisoner’s dilemma.

The dilemma was first put forward by Polish mathematician Melvin Dresher while he was working at the Rand Corporation in the United States in 1950. It was given its name by Canadian Mathematician Albert Tucker.

And this is how the dilemma goes. There are two people who are suspected of a major crime. They are apprehended during the course of carrying out a minor offense and put in jail.

As John Allen Paulos writes in A Mathematician Plays the Stock Market: “They’re then interrogated separately, and each is given the choice of confessing to the major crime and thereby implicating his partner or remaining silent. If they both remain silent they’ll get one year in prison. If one confesses and the other doesn’t, the one who confesses will be rewarded by being set free, while the other one will get a five-year term. If they both confess, they can expect to spend three years in prison.”

The best solution here is for both individuals to remain quiet and get a prison sentence of one year. But the individuals are being interrogated separately and hence, one doesn’t know how the other will react. So what happens?

As Paulos writes: “Given…human psychology, the most likely outcome is for both to confess; the best outcome for the pair as a pair is for both to remain silent; the best outcome for each prisoner as an individual is to confess and have one’s partner remain silent.”

So even though the best outcome is for both to remain silent and spend one year in prison, the most possible outcome is that both of them will confess in the hope that they will get away free. In the process they land up in jail for three years.

Now how is this linked to what we started with i.e. the discount wars of Indian ecommerce? As Paulos writes: “The charm of the dilemma has nothing to do with any interest that one might have in prisoner’s rights…Rather, it provides the logical skeleton for many situations we face in everyday life. Whether we’re negotiators in business, spouses in a marriage, or nations in dispute…If both (all) parties pursue their own interests exclusively and do not cooperate, the outcome is worse for both (all) of them; yet in any given situation, any given party is better off not cooperating.”

Economist Dani Rodrik explains the situation of prisoner’s dilemma in the context of advertising carried out by competing companies in his new book Economics Rules—Why Economics Works, When It Fails and How to Tell the Difference.

As he writes: “Assume that two competing firms must decide whether to have a big advertising budget. Advertising would allow one firm to steal some of the other’s customers. But when they both advertise, the effects of customer demand cancel out. The firms end up having spent money needlessly.”

What is happening here? As Rodrik writes: “When the firms make their choices independently and they care only about their own profits, each one has an incentive to advertise, regardless of what the other firm does: When the other firm does not advertise, you can steal customers from it if you do advertise; when the other firm does advertise, you have to advertise to prevent loss of customers. So the two firms end up in bad equilibrium in which both have to waste resources.”

Now replace the word advertise in the above paragraph with the sales that are currently on and the situation is very similar. Let’s say Flipkart (or Amazon or Snapdeal, it doesn’t really matter) announces a big sale over five days to acquire new customers as well as sell more to existing ones. It makes tremendous sense for Flipkart to do that as long as it is the only company doing it.

If Amazon and Snapdeal (and other similar ecommerce websites and aps) decide to ignore the Flipkart sale, they will lose out on their customers. So they need to announce their sales as well to prevent Flipkart from stealing their customers and retain their customers.

The moment they do this, Flipkart loses out on the advantage it would have had if it was the only sale in town. The vice versa is also true.

Now Amazon and Snapdeal also have a sale on just to ensure that they don’t lose out on their customers. A classic prisoner’s dilemma.

Also, each company now has to offer greater discounts on their products, to make it look like a sale. This means accumulating more losses than they currently are. The Indian ecommerce players don’t mind doing this given that they are currently looking to drive up their revenue.

The higher the revenue number they are able to generate, the higher the valuation they get. And this helps them raise more money from investors. This, in turn, helps them keep running the show given that their current operations are loss-making.

Akhilesh Tilotia of Kotak Institutional Equities in a report titled .com 2.0 – Value versus Valuation makes a very interesting point. As he writes: “It will be instructive to note that the proportion of people who have purchasing power in India is limited to the top 10% or so of the population.” So the number of people that Indian ecommerce companies can tap is limited and is nowhere near as is typically made out to be.

And this has important repercussions. As Tilotia writes: “It is important to consider whether India’s e-commerce GMVs[Gross Merchandise Values] and volumes are going to come from (1) a larger number of users doing more transactions or (2) a smaller base of consumers (say the top-end 100 million or so users) driving all the volume. If it is going to be the latter, customer engagement and retention will be more important than customer acquisition.”

If customer retention is more important than customer acquisition then any one company launching a sale will lead to others having to join in, in order to retain their customers, even though they may not want to do the same. The prisoner’s dilemma is at work.

As John Allen Paulos writes in Beyond Numeracy: “The parties involved will be generally better off as a pair if each resists the temptation to double-cross the other and instead cooperates…If both parties pursue their own interests exclusively, the outcome is worse for both of them than if they cooperate.”

But that’s not going to happen because that is what competition is all about. And it does work at some places.

The column originally appeared on The Daily Reckoning on October 14, 2015

What business news channels have in common with Chacha Chaudhary

I normally don’t watch business news channels given that I find them quite flaky and get put off by their lack of depth. Nevertheless, these days with nothing better to do while having lunch, I sometimes do end up watching these channels discussing the vagaries and the volatility of the stock market.

And one of the things I have noticed is that the anchors as well as the stock market experts who offer their opinion on these channels speak with a lot of conviction and confidence. They appear to be in control of things. They appear to know what is happening, when the world around them is probably going crazy. We never hear them use words like probably, maybe or phrases like I don’t know. Further, they seem to have this uncanny ability to understand and explain something just as it has started to unravel. Their story telling abilities are simply terrific.

The uncanny ability of these anchors and experts to explain things at the speed of thought reminds me of a thought bubble in the Chacha Chaudhary comics, which used to say: “Chacha Chaudhary ka dimaag computer se bhi zyada tez chalta hai (Chacha Chaudhary’s mind works faster than a computer).These anchors and experts are perhaps the Chacha Chaudharies of this day and age.

How is such speed possible? If the anchors and experts are so much in control and seem to have so much insight with such clarity, why are they not making money out of it? Why are they offering their advice for free on TV?

As the British economist John Kay writes in his new book Other People’s Money—Masters of the Universe or the Servants of the People?: “We deal with radical uncertainty through storytelling, by constructing narratives…The reality of market behaviour…relies on conviction narratives – stories that traders tell themselves, and reinforce in conversation with each other. Such narratives are the means by which we cope with radical uncertainty – the unknown unknowns that characterise… business and securities markets.”

The anchors and the experts appearing on business news television are in the business of telling us stories, which offer an explanation for why the market moved the way it did on a particular day. These days the most offered explanation is that economic jitters in China caused the stock market to fall. But this explanation is always offered after the stock market has fallen. No anchor or market expert ever says: “The stock market will fall today because there is economic trouble in China”.

As Kay writes: “The ‘explanations’ provided…by…market commentators…are little more than rationalisation of the noise generated by…market volatility.” And given this, it is worth asking that how useful is it for investors to listen to these explanations and make investment decisions after that.

Bob Swarup calls this phenomenon the illusion of explanation. He defines the term in his book Money Mania as: “Believing erroneously that your arguments…explain events.”

Further, how is it that the anchors and the market experts have an explanation for everything that happens in the stock market? And what is even more surprising is how they are able to come up with explanations so quickly. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Commentators…provide a neat post hoc explanation for every rally, every sell-off, and everything in between…Because so much information is available—business pages, companies’ annual reports, earnings expectations, alleged scandals, on-lines sites and commentary—something insightful can always be said.”

Over and above this there are many data releases which can also be used to come up with explanations. These data releases include inflation as measured by the consumer price index and the wholesale price index, index of industrial production, export and imports numbers, bank credit growth, and so on. And if all this does not fit into a convincing narrative you can always blame the Reserve Bank of India for not cutting interest rates.

Investing in specific stocks is not easy as it is made out to be by business news television. In fact, what anchors and market experts specialise in is making things simplistic rather than simple, given that they have limited time at disposal to say what they want to say. In this situation, where everything has to be said in thirty seconds to a minute, it is hardly surprising that things ultimately become simplistic. And this is clearly not good from an investor point of view.

What works for these anchors and experts is the fact that while coming up with explanations and predictions, their past record is not available for examination.

As Jason Zweig writes in Your Money and Your Brain: “Whenever some analyst brags on TV about making a good call, remember that pigs will fly before he will broadcast a full list of his past predictions, including the bloopers. Without that complete record of his market calls, there’s no way for you to tell whether he knows what he’s talking about.” This is a very important point that needs to be kept in mind when listening to anchors as well as experts on television.

Also, it is worth remembering here that which way a stock market will go is impossible to predict regularly on a day to day basis.  Nassim Nicholas Taleb in his book The Black Swan—The Impact of the Highly Probable lists a certain category of experts who tend to be…not experts. In this list he includes economists, financial forecasters, finance professors and personal financial advisers.

As he writes: “Simply, things that move, and therefore require knowledge, do not usually have experts, while things that don’t move seem to have some experts. In others words, professions that deal with the future and base their studies on the nonrepeatable past have an expert problem…I am not saying that no one who deals with the future provides any valuable information…but rather that those who provide no tangible added value are generally dealing with the future.” Given this, the stock market experts clearly have an expert problem.

Hence, the next time you switch on your television to try and understand what is happening in the stock market, do remember all that has been pointed out above.

Happy investing!

The column originally appeared on The Daily Reckoning on September 25, 2015