Tag: Lending to commercial real estate

11 June, 2015

Taxing unsold homes will not lead to fall in home-prices, busting black money will

Vivek Kaul

Earlier this month, the Daily News and Analysis reported that the Income Tax department plans to tax builders on their unsold homes. “The move is as per the central action plan for 2015-16, under which the I-T department can levy tax on any unsold flat by treating it as ‘income from house property’,” the news-report pointed out.

This news-report has gone viral on WhatsApp and it’s being suggested that this move will force builders to get rid of the unsold homes they have or else they will have to pay income tax on it.

An estimate made by Liases Foras, a real-estate research and rating firm, suggests that the total number of unsold homes in six metropolitan cities (Mumbai Metropolitan Region, Bangalore, Chennai, Hyderabad, Pune and National Capital Territory) stood at 6.88 lakh units or 919 million square feet, as on March 31, 2015.

And once builders start selling these flats real estate prices will fall. Theoretically this makes immense sense.

The real estate companies are owners of unsold flats. This means that they will have to pay a tax on the annual letting value pf these flats as they are owners of the unsold flats. The annual letting value is essentially the annual rent at which any home can be reasonably expected to be rented out. And given the fact that an income tax will have to be paid on this notional rent, the builders would rather sell the flat than pay an income tax on it. At least, that is what is being suggested.

Nevertheless, let’s see how the numbers stack up. The rental yield in India is currently anywhere between 2-3%. As Ashwinder Raj Singh is CEO – Residential Services of JLL India points out on a recent column on Moneycontrol.com: “An average of 2% of rental yield is considered a good deal for residential properties in India.” Rental yield is the annual rent that can be earned from a property divided by its market value.

The builders will have to pay an income tax on this rental yield. As per the Statement of Revenue Foregone that is released by the government along with the budget, the effective tax rate of the income tax paid by companies comes out to 23.22%. This number has been arrived at from a sample of 564787 companies.

As the Statement points out: “The statutory tax rate was 32.445 per cent in the case of companies having income upto Rs 10 crore and of 33.99 per cent in the case of companies having income exceeding Rs 10 crore resulting in an average statutory rate of 33.217 per cent.”

In an ideal world, I should have considered, the average rate of income tax being paid by builders, but given that I don’t have access to such a number, I will work with the average rate of income tax of all companies.

At an average tax rate of 23.22%, the builders will have to pay an income tax of 0.46-0.7% (23.22% of 2-3% rental yield) on the market value of the unsold homes. This is a very small number and is unlikely to hassle builders much. On paper, taxing builders on the unsold homes sounds like a good move, but it is unlikely to lead to a fall in price. And even if it does have an impact, it will not be huge. Further, how will the income tax department determine that a flat has been completed and has not been sold?

If the builders have to be forced to sell the unsold homes, the only way to do so is to attack their funding. This means going after domestic black money which inevitably finds it way into real estate. The Narendra Modi government has shown very little interest in going after domestic black money. All the attention seems to be on trying to get back black money that has already left the Indian shores.

Another data point that needs to be mentioned here is the bank lending to commercial real estate. During the period April 18, 2014 and April 17, 2015, which is the latest data that is available, the bank lending to commercial real estate grew by 8.8%. This when the overall bank lending grew by 8.7%.

This is clearly good news. Lending to commercial real estate is finally growing almost at the same rate as overall bank lending. Interestingly, this is the second month in a row, this has happened. For the period of one year ending March 20, 2015, lending to the commercial real estate sector by banks had grown by 8.9%. The overall lending by banks on the other hand had grown by a very similar 8.6%.

Further, the total amount lending to commercial real estate by banks in March 2015 had stood at Rs 1,66,500 crore. In April 2015, this number fell marginally to Rs 1,66,400 crore.

Now compare this to the period between April 19, 2013 and April 18, 2014, the lending to commercial real estate had grown by 21.2%, whereas the overall lending by banks grew by 13.9%. All these data points clearly show that the lending by banks to real-estate companies is slowing down.

And if the trend continues, builders will have to start cutting prices to sell the huge amount of unsold homes that they have been sitting on. Stay tuned.

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

The column originally appeared on Firstpost on June 11, 2015

5 May, 2015

This one number suggests that the real estate bubble may be fizzling out

Every time I write a piece on real estate I am asked: “when will the real estate bubble burst?” This proverbial question remains very difficult to answer because of several reasons.
First and foremost we have almost no data on real estate. For something as simple as what is the going price in an area, one has to trust the brokers operating in that area. One may make that leap of faith and trust the broker, but how does one figure whether there are any transactions happening at that price? The broker has no incentive to be honest.
Further, there is no clear way of figuring out whether prices are rising or falling even at the aggregate city level. The National Housing Bank(NHB) through the Residex index tracks prices in 26 Indian cities. But the index works quarterly. Further, the NHB takes way too much time to put out the data. Currently, the data is available upto the period between July and September 2014. We are in May 2015. Basically whenever the next data set of October and December 2014 will come out, it will be many months late, making even his broad indicator practically useless.
Also, the index possibly doesn’t take the black money component into account. Black money forms a substantial part of the real estate transactions in India. Further, any evidence of prices falling that come in is at best anecdotal. Typically, the way this works is that the journalist covering real estate calls up a few brokers he is close to, and they tell him that prices in such and such area are falling.
Given this, lack of numbers on the real estate sector in India, it remains very difficult to say when the prices will start to fall or have prices started to fall, for sure. Nevertheless, there remains one data point that one can take a look at and make some broad inferences out of it.
The Reserve Bank of India(RBI) puts out the sectoral deployment of credit data at the end of every month. The latest data for the one year period ending March 20, 2015, shows that lending to the commercial real estate sector by banks grew by 8.9% to Rs 1,68,000 crore. The overall lending by banks on the other hand grew by a very similar 8.6%.
What this tells us is that lending to the real estate sector during the last one year grew almost as fast as the overall lending by banks. This hasn’t been the case for a while. For the period of one year ending March 21, 2014, lending to commercial real estate by banks had grown by 22.4% to Rs 1,54,400 crore. During the same period overall lending by banks had grown by a much smaller 14%.
So what does this tell us? Bank lending to real estate companies had been growing at a faster pace than overall lending. This despite the fact that real estate companies were sitting on a huge amount of unsold inventory (As I have written on a number of previous occasions). Also, the number of new launches that the real estate companies were coming up with had also come down significantly over the years.
Then why was lending by banks to real estate companies going up? What explains this possible disconnect? There is no straight forward answer to this question. To make a definitive statement on this, one would need the break up of the amount of lending to real estate comapnies by public sector banks and private sector banks. It would be interesting to see the growth in lending to this sector by public sector banks.
My guess is that over the years the lending by public sector banks to real estate companies has grown at a much faster pace than their overall lending. As I have mentioned in the past most Indian real estate companies are fronts for the ill-gotten wealth of politicians. And given this, a possible explanation for the lending to real estate companies growing at a faster pace than overall bank lending, is that the politicians have been forcing public sector banks to continue to lend to real estate companies.
And this has had several repercussions. As I mentioned earlier in the piece, lending to real estate companies continued to grow despite unsold homes piling up and a fall in new launches. So what were real estate companies using the borrowed money for?
This continued lending helped real estate companies to continue repaying their old loans to banks. Hence, new debt allowed real estate companies to pay off old debt. A perfect Ponzi scheme. It also allowed real estate companies to not cut prices on their unsold homes. If bank loans had not been so forthcoming, the real estate companies would have to sell off their existing inventory to repay their bank loans. And in order to do that they would have to cut prices.
The latest data from the RBI points out that this trend may now be coming to an end. As mentioned earlier the lending to commercial real estate over a one year period has grown by 8.9% whereas overall lending has grown by 8.6%. A possible reason could be the change in regime at the centre with the BJP led NDA government replacing the Congress led UPA government.
If this trend sustains in the months to come, and the lending to the real estate companies grows slower or around the same pace as overall lending by banks, then real estate companies will have to start selling their unsold homes at lower prices.
Further as a recent report in The Economic Times points out: “Home sales plunged 17% in top six markets last year and unsold inventory level rose to 647,484 units, according to property consultant Knight Frank India.” This inventory has to start hitting the market at some point of time. The real estate companies cannot keep sitting on it endlessly. The only question is when.

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

The column originally appeared on Firstpost on May 5, 2015

2 September, 2014

How politicians, banks and builders conspire to keep real estate prices high

“Sex sells,” is an old adage in show business and advertising. If I were to come up with a similar sort of statement when it comes to writing on business and economics it would have to be “real estate sells.” An article on the real estate scenario in India has more chances of being read than anything else.

People who make a living from the real estate industry, be it brokers, real estate consultants or builders, like to tell us time and again that real estate prices are only going to go up. So, it’s time that we forgot about all other ways of spending money and bought a house.
Various reasons are offered, right from shortage of land(they are not making any more of it) to now that Narendra Modi has become the prime minister, everything is going to be fine. In my previous pieces on real estate (you can read a few of them here and here) I have tried to expose several myths that over the years have come to be associated with the sector.
In this piece we will just look at one data point that tells us loud and clear that real estate prices should not be going up, as has been justified by those make a living from real estate, time and again. Look at the following chart:

City	Quarters to Sell Unsold Inventory
Mumbai	12
National Capital Territory	9
Pune	Approx 7.5
Bangalore	7
Hyderabad	8—8.5
Chennai	7
Source: Knight Frank India Real Estate Outlook

“Quarters-to-sell(QTS) can be explained as the number of quarters required to exhaust the existing unsold inventory in the market. The existing unsold inventory is divided by the average sales velocity of the preceding eight quarters in order to arrive at the QTS number for that particular quarter,” the India Real Estate Outlook Report brought out by Knight Frank points out.

What this shows us clearly is that there is a huge amount unsold inventory when it comes to residential apartments across metropolitan India. In fact, what is worse is that this number has been going up over the last few years.

The above table shows us the quarters-to-sell unsold inventory in Mumbai. This stands at 12 in June 2014. What this means is that it will take close to three years to sell the current accumulated inventory of unsold homes in Mumbai. This number was at 5 in December 2011. Hence, Mumbaikars are going slow when it comes to buying homes is a conclusion that can be easily drawn. And that is not surprising given the astronomical prices that builders want for a home in the maximum city.
Here is a similar table for the National Capital Territory (i.e. Delhi and its adjoining areas).

The quarters-to-sell unsold inventory in the NCR in June 2014 stood at a little over nine. This means that it will take a little over two years to sell all the unsold residential apartments in NCR. The number had stood at around 6 in June 2012.
If we look at this graph for other cities like Bangalore, Hyderabad, Pune etc, it is along similar lines, though the curve may not be as upward sloping as it is in the case of Mumbai and NCR.
Take the case of Bangalore where the curve is kind of flat. This tells you that people in Bangalore haven’t slowed down on buying residential homes at the same rate as people in Mumbai and NCR have. Hence, the quarters-to-sell unsold inventory has more or less hovered around 6.

Indeed, what these graphs clearly tell us is that the supply of residential apartments in India’s biggest cities has clearly been more than their demand. And given this Mumbai has 2,13,742 residential apartments which have been built but not sold. The same number in NCR stands at 1,67,000.
Hence, between two of India’s biggest residential markets, the total number of unsold homes stands a little over 3.8 lakhs. In total, the sales fell by 27% during the first six months of 2014, in comparison to the same period last year. Nevertheless, those associated with real estate expect prices to continue to go up. The Knight Frank report forecasts that the real estate prices in Mumbai will “ increase for the entire year (2014) [by] 10.1%.” An increase in prices is forecast for NCR and other cities as well.
The point here is that with so many unsold homes, how can housing prices continue to go up, unless they are rigged? Further real estate
developers are sitting on a huge amount of debt. As a recent report in the Business Standard pointed out “At end of March 2014, the country’s top listed developers were sitting on Rs 39,772 crore of debts.”
As we know most real estate developers in India are not listed on the stock market. Hence, the total amount of their debt must be considerably higher than Rs 39,772 crore. So how are real estate developers going to repay this debt unless they get around to selling the homes they have built? One answer is that they keep launching newer projects, raise money and use that money to repay their previous debt. (I discuss this in detail here). And then launch newer projects to collect money to build their previous projects. So the cycle works.
But in the recent past the number of new launches has been falling. During the first six months of 2014, the number of new launches fell by 32% in comparison to the same period last year, the Knight Frank report points out. Hence, new launches as a source of funds seems to have slowed down, but they do bring in some money nonetheless.
Another possible explanation is lending by banks. Bank lending to the commercial real estate sector has been growing at a much faster rate than overall lending. Between July 26, 2013 and July 25, 2014, lending by banks to commercial real estate grew by 18.2%. In comparison, the overall lending grew by just 11.3%.
With newer launches slowing down, the only possible explanation for this lending is that banks are essentially giving fresh loans to real estate companies so that the companies can repay their old loans. This has allowed real estate companies to not cut prices on their unsold inventory. If bank loans had not been so forthcoming, the real estate companies would have to sell off their existing inventory to repay their bank loans. And in order to do that they would have to cut prices.
Further, most real estate companies as we know are a front for politicians. During the Congress led United Progressive Alliance, a huge number of scams and a lot of corruption happened. Hence, the conspiracy theory I would like to offer here is that the money that politicians got through various rounds of corruption during the UPA rule has also found its way into the real estate market. This has allowed real estate companies to continue holding prices at high levels, despite supply far outstripping demand.
As I mentioned in the previous piece I wrote on real estate, real estate consultants make money from real estate companies and hence, it is but natural for them to keep telling us that prices will continue to go up. Nevertheless, data from the International Monetary Fund shows that real estate prices in India between the period January to March 2014, fell by 9%. This was the most in a sample of 52 countries. (Click here for table) The IMF of course does not have an incentive to ensure that real estate prices in India continue to remain high.
To conclude dear reader, if you still have the money to buy a house, this is the time to drive a hard bargain.

The article originally appeared on www.Firstbiz.com on September 2, 2014

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

12 June, 2014

What Modi can do to bring acche din for home buyers

Vivek Kaul

People have taken the Bhartiya Janata Party’s election slogan “acche din aane waale hain”a little too literally. I have often been asked on the social media over the past few weeks whether real estate prices will fall, now that Narendra Modi government is in power. I wish I had a definitive answer for that.
Nevertheless, there are many things that the Modi government can do so that home prices start to mirror the actual demand from people looking to buy homes to live in. Right now, a major part of home demand comes from investors and speculators looking to park their money. How can this be taken care of?
There are a number of steps that can be taken.
a) The Modi government wants to get back the black money Indians have stashed away internationally. As per data from Global Financial Integrity, this amounted to a whopping $644 billion as of 2011. While the intention to get back all this black money is certainly noble, how practical is it? Also, if the idea is to recover black money then why discriminate between those who have managed to transfer the money abroad and those who haven’t.
It will be certainly easier to recover black money that is still there in the country. Also, the amount of black money that has remained in the country is likely to be significantly more than what has left the shores. A lot of this money has been diverted into buying real estate. This link between black money and real estate needs to be broken.
Former finance minister in the budget speechhe made on February 28, 2013, said “There are 42,800 persons – let me repeat, only 42,800 persons – who admitted to a taxable income exceeding Rs 1 crore per year.” This number is totally unbelievable given that nearly 27,000 luxury cars are sold in India each year. Over and above this estimates made KPMG suggest that there around 1.25 lakh high networth individuals in India who have an investible wealth of at least a million dollars(around Rs 6 crore), and also own a house and other durables.
What this clearly tells us is that as a nation we barely pay taxes. This means we are generating a lot of black money. A large amount of this money goes into real estate, and ensures that real estate prices remain firm. This wouldn’t have been possible without the cooperation of the highly corrupt Income Tax department.
In fact, the Modi government could do some out of the box thinking like the Greek government, to recover this black money. The Greek government used Google Earth to track those who have swimming pools and then cross indexed their address with the amount of tax they are paying. Ideas along similar lines need to be come up with. The property dealers of the National Capital Region and the amount of taxes they pay, will be a good target to start with.
If real estate prices need to fall, more and more people need to be forced to report their income properly and made to be paid a tax on it.
b)One of the most well kept secrets of the Income Tax Act is that it actually encourages people to speculate in real estate. There is no restriction on the number of homes against which you can claim a tax deduction on the interest paid on the home loan to fund the property. Only one of these properties needs to categorized as a self-occupied property. On this self-occupied property, an interest of up to Rs 1.5 lakh can be claimed as a tax deduction.
But this limit does not apply to the remaining homes that an individual may choose to buy. Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income. We all know that these days “rents” are relatively low in comparison to the EMIs that need to be paid in order to repay the home loan. Hence, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions.
This “loophole” has been used effectively by well paid corporate employees to bring down their taxable income over the years. People who use this deduction are more interested in claiming the deduction than actually making money from an increase in price. Hence, they are likely not to sell, even in a scenario where prices may be falling.
While offering a tax deduction on a self occupied property makes some sense, there is no logic to offering a tax deduction on a home, one is not living in. This “loophole” needs to be plugged immediately.
c) The Modi government needs to work towards building a credible real estate index. Currently, there is no way of figuring out which way the real estate market is heading. Are prices rising? Are they flat? Or are they falling? These are important questions for anyone looking to buy a home to live in. Brokers will always tell you that prices are going up. Real estate consultants bring out reports on home prices, now and then. But given that they make their money from real estate companies, these reports needed to treated with a pinch of salt.
The National Housing Bank does have a real estate index. But not many people know about it. Also, it is a quarterly index, and by the time the data actually comes out, it is not of much use. As of now the datafor up to December 2013 is available. But we are already in June 2014. The government needs to look at building an index along the lines of the Case-Shiller real estate indices in the United States. This will not lead to results immediately but will really help over a long term.
d) In the short term the government needs to look at the real estate lending of banks closely. Most recent data released by the Reserve Bank of India shows that between April 19, 2013 and April 18, 2014, the overall bank lending grew by 13.9%. During the same period the lending to commercial real estate grew by a significantly higher 19.8%.
This, in an environment where real estate companies have huge inventories. So, why are banks lending money to real estate companies? And what are real estate companies doing with that money? One possible explanation is that banks have been giving fresh loans to real estate companies so that the companies can repay their old loans. This has allowed real estate companies to not cut prices on their unsold inventory and ensure that prices do not fall.
This is something that needs to be looked into closely.
e) These days more and more real estate companies seem to be interested in launching new projects, rather than delivering the homes that they have already sold to the consumer. Companies use the money they raise for new projects to pay off interest on debt as well as repay debt that they have taken on over the years. Hence, there is no money left to build homes.
In this situation, the only way left for the company to raise more money to build homes is by launching newer projects. The money raised for one project is used to pay off interest on outstanding debt as well repay debt that is maturing. In order to build homes promised under the project, another project needs to be launched. This leads to the first project being delayed. To build homes promised under the second project a third project needs to be launched.
And so the cycle continues. In order break this cycle, the idea of a real estate regulator had been proposed a while back. That does not seem to have gone anywhere. It needs to be re-considered, even though it may not lead to immediate results.
If these steps are taken in the days to come, there might be some relief for people looking to buy homes to live in.
The article originally appeared on www.FirstBiz.com on June 13, 2014

(Vivek Kaul is a writer. He can be reached at [email protected])