loan to value ratio

Mr Mistry, When It Comes to Buying a Home, the Price is More Important Than the Interest Rate

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Keki Mistry, the bossman at HDFC, India’s leading housing finance company, recently told The Economic Times, India’s leading business newspaper: “In my view, it is the best time to buy property. First, by virtue of the fact that interest rates are significantly low. Since 2008, we have not seen rates as low as this. I don’t believe rates will go down any further. Second, property prices haven’t gone up in recent times so one would believe there is time correction of prices.”

Asking Mistry if it’s the right time to buy a home is like asking Nandan Nilekani about the privacy concerns around Aadhaar. Or asking RBI governor Urjit Patel if demonetisation has been a success. Or asking me, if freelance writers should be paid more.

The answers in all the three cases will be a definite yes. Mistry is in the business of giving out home loans. And for him, it is always the right to give out home loans, as long as he takes a margin of safety into account and lends out only a certain portion of the price of the home being financed through a home loan.

Nevertheless, it is important to try and understand what Mistry is really saying here. The first point he makes that interest rates are low, and he doesn’t really see them going down anymore. Mistry might be right about this. Interest rates have been low because of the deluge of money that has come into banks because of demonetisation.

Mistry further says that home prices haven’t gone up in recent times and there has been a time correction of prices. And hence, this is the right time to buy property.

What does Mistry mean by a time correction of prices? Let’s say that a home was selling at Rs 50 lakh in a suburb of a big metropolitan city a few years back. Even today, it is going at the same price. Meanwhile, the price of every other thing has gone up. Once we factor in this inflation, the home has seen a time correction of prices, given that the purchasing power of Rs 50 lakh today is really not the same as the purchasing power of Rs 50 lakh, a few years back.

Given this time correction of prices, buyers should not wait any further and buy homes. This is basically what Mistry is saying.

The trouble is this makes little sense. As always there are several nuances that are involved here. First and foremost, there is the black part of that needs to be paid while buying homes across most parts of the country. It is difficult to generalise the proportion that needs to be paid in black, given that rates vary across the country. But let’s say around 20 per cent of the price of the home is to be paid in black. This works out to Rs 10 lakh (20 per cent of Rs 50 lakh).

Hence, the official price of the home works out to Rs 40 lakh (Rs 50 lakh minus Rs 10 lakh). A housing finance institution like HDFC will not finance the entire thing. HDFC’s average loan to value ratio at the origination of the home loan is 64 per cent. In this case that would mean a loan of Rs 25.6 lakh. (64 per cent of Rs 40 lakh). This is roughly around the average home loan size of HDFC at Rs 25.7 lakh.

Hence, HDFC will finance around Rs 25.6 lakh of the cost of the home of Rs 50 lakh. The buyer has to finance the remaining Rs 24.6 lakh. This basically means that the buyer needs to finance nearly half of the cost of the home. And that is the real equation that the buyer needs to take a look at.

This basically means whether the buyer has Rs 25 lakh of savings which he can use to buy a home of Rs 50 lakh. If he has the money he can buy the home. If he doesn’t, he can’t, irrespective of where the interest rate on the home loan is.

What about the low interest rate that Mistry was talking about? How much difference does it make? The EMI on a loan of Rs 25.6 lakh at 10 per cent per year for a period of 20 years would work out to Rs 24,801. This would have been the case a on a new home loan, a few years back. Now at 8.5 per cent interest, the EMI would work out to Rs 22,303 per month or around 10 per cent lower.

Hence, the lower EMI does help. But the basic question still remains; whether the prospective buyer has a savings of around Rs 25 lakh. Actually, the savings need to be more once we take brokerage, the cost of moving, making the home liveable enough, etc., into account. But for the ease of calculation we will leave all that out and just concentrate on the price of the house.

Now compare this scenario to where the price of the home over the last few years has fallen by 20 per cent and is currently going at Rs 40 lakh. Assuming a 20 per cent black part, the official price of the home works out to Rs 32 lakh. Of this HDFC would lend around Rs 20.5 lakh (64 per cent of Rs 32 lakh). Hence, the buyer would need around Rs 20 lakh to get the deal going.

This meant that anyone with savings of around Rs 20 lakh could carry out the transaction and buy the home. This requires Rs 5 lakh lower savings than the earlier example. In this situation, the prospective buyer is more likely to buy than the earlier one.

The point is similar to the one I have often made in the past, if people need to start buying homes again, the home prices need to come down. Lower interest rates just don’t help enough. And this is something Mistry needs to understand.

To conclude, it is safe to say that if 20 per cent of the price of a home being bought needs to be paid in black, then the buyer needs to have half of the price of the house as savings. Only then can he go ahead with the transaction and buy the home.

The column originally appeared in Equitymaster  on May 9, 2017

RBI needs to answer some questions on home loans

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One of the things that young journalists (or even old ones) are taught when they first join a newspaper is to think of a headline first, before they start writing.

The logic for this is pretty straightforward. Newspapers have limited space and pieces written using this concept tend to be more structured and readable.

Given their limited space, newspapers do not have space for rambling (or at least they should not). So all news-reports as well as analysis ideally needs to be definitive, where there is no scope for being all over the place.

The trouble with this approach is that while it helps come up with structured reports as well as analysis, it leaves very little scope for rambling and stuff that is not so definitive.

I know I have been rambling up until now, but just humour me a little more and I might come to the point sometime later in this column.

And actually that’s the beauty of writing on the web. There are no space constraints. This allows writers like me to ramble once in a while and come up with stuff that is not so structured and not so definitive.

This helps, given that life as well as the economy are largely unstructured, not so definitive and a little all over the place. And this is one such column.

Every month, the Reserve Bank of India (RBI) declares the sectoral deployment of credit data. This provides details of the different kind of lending carried out by banks. One of the data points that the RBI shares is the total amount of home loans given by banks.

The latest data was released on October 30, 2015. As per this data, between September 19, 2014 and September 18, 2015, banks gave out home loans worth Rs 1,04,135 crore. This forms 21.6% of the total lending carried out by banks.

How was the situation a year earlier? Between September 20, 2013 and September 19, 2014, banks had given out home loans worth Rs 75,058 crore. This formed around 16.5% of the overall lending by banks.

So what does this tell us? Between September 2014 and September 2015, the banks gave out a greater amount of home loans both in absolute as well as proportionate terms, in comparison to the period between September 2013 and September 2014.

So far so good.

Now compare this to the news that you keep hearing about real estate companies sitting on huge number of unsold homes. If that is the case then how are home loans being given by banks going up?
What this perhaps means is that people are no longer buying under-construction properties (which make up for a significant part of unsold homes of real estate companies) and that is why the number of unsold homes has not been falling.

Instead people are buying completed homes. These are homes which were completed in the past. Investors who had bought these properties are now perhaps exiting. I am not sure about this, but that is the best possible explanation that I can come up with and it’s clearly not definitive.

Why are people buying fully completed homes? For the simple reason that too many under-construction homes over the last few years have continued to be under-construction. A recent report brought out by the business lobby Assocham pointed out on that an average a real estate project in India was delayed by 33 months or close to three years. In this scenario, it will take a real brave-heart to buy an under-construction property.

Further, with banks giving out more home loans, does that mean home prices have fallen, leading to people buying more homes? There is no way this can be figured out from the data as it is currently put out by the RBI.

What the RBI needs to reveal along with the total amount of home loans is the number of home loans as well. If this number is provided then it will become very easy to calculate the average home loan size. This average home loan can then be compared to the average home loan from the previous years and that can give us a good indication of which way home prices are headed.

If home loan size has gone up then we can safely say that prices have gone up as well and vice versa. Further, if the RBI can provide an average loan to value ratio (i.e. the total amount of the home loan divided by the market price of the home being financed), it will give us an even better indication of actual home prices and which way they are headed. One trouble here is that almost all real estate transactions in India have a black money component and there is no way the RBI can estimate that.

Nevertheless, despite this problem, if the RBI gives out the number of home loans along with the loan to value ratio (data which should not be very difficult to agglomerate) it will become slightly easier to make much more definitive statements about the real estate sector in India.

This becomes even more important from the point of view of the fact that there is very little data available on Indian real estate. Most data currently is provided by real estate consultants and they have an incentive in projecting things to be much better than they currently are.

Further, the current real estate indices (the RBI’s All-India Residential Property Price Index and National Housing Bank’s Residex) which give us some indication of which direction the real estate prices are headed, by the time they are published are fairly dated. There is no real time data coming out on Indian real estate which can be used to estimate which way are the real estate prices are headed. And that’s the most basic piece of information needed from any market.

At the same time, the National Housing Bank (which is wholly owned by the RBI) and regulates housing finance companies, should also be putting out similar data. One estimate here suggests that banks give out two-thirds of all home loans and housing finance companies, the remaining. In a country where the entire real estate sector is rigged against the consumer, this will be one consumer friendly move, which will be definitive.

Hope the RBI is listening.

(The column originally appeared on The Daily Reckoning on Nov 2, 2015)

One idea that real estate companies want to borrow from Gulzar

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In the film Ek Thi Dayan, lyricist Gulzar wrote a song, which had the following line: “koi khabar aayi na pasand to end badal denge [if we don’t like some bit of news, we will change the end.]”  In the recent past, the real estate companies do not seem to have liked the bad news that has been read out to them. And to tackle that they plan to create their own news. Or at least that is what a recent development suggests.

The Confederation of Real Estate Developers Association of India (CREDAI), a lobby of real estate companies, which has about 10,000 members, now plans to collect its own data on the industry.

As President of CREDAI Geetamber Anand told Business Standard: “The need to come up with its own set of data cropped up after varying figures from real estate consultants including Knight Frank, JLL India, Liases Foras and others, which at times create panic amongst the buyers fraternity.”

A spate of research reports brought out by real estate consultants in the recent past has suggested that real estate developers in large cities are not able to sell homes that they have built. A recent research report by Knight Frank suggested that over 7 lakh homes were unsold in the top eight cities of the country. The report also estimated that it would take more than three years to sell homes that have piled up.

Other real estate consultants have come up with similar reports with similar numbers. This is something which has not gone down well with the real estate lobby, which now wants to put out its own data. How can someone else tell them that all is not well with them?

What has also not gone down well with them is a recent comment by the Reserve Bank of India governor Raghuram Rajan, asking them to bring down prices.

As Rajan said: “It would be a “great help” if realty developers sitting on unsold stock bring down prices…Once the prices stabilise, more people will be keen to buy houses…I think we need the market to clear.”

The CREDAI responded to Rajan with the following statement: “While we respect the RBI governors concern for kick starting the real estate sector, it would be prudent to say that from the developers side a substantial reduction in prices has already happened across the country [italics are mine] and any further decrease in sale prices would be a deterrent for the growth of a sector that contributes so much to the economy and employment at large.”

CREDAI President Anand told PTI that “housing prices have gone down by 15-20 per cent on an average in last two years across India, while input costs have risen by 15-20 per cent.” The good bit here is that here is a top real estate lobbyist admitting that prices have fallen. It is tough to get them to admit even this much. Nevertheless, if the reduction in prices has already happened, why there is an inventory of 7 lakh unsold homes across top 8 cities? Also, the total number of unsold homes all across the country would be much higher than 7 lakh, but no such data is complied.

The real estate companies need to go back and learn some basic economics. One of the most basic laws in economics is the law of demand. The law essentially states that there is an inverse relationship between the price of a product and the quantity demand by consumers. If the price of the product goes up, demand falls and if the price of a product falls, the demand goes up.

In case of the real estate sector in India what the law of demand tells us is that if prices had fallen enough, people would have bought homes to live in and the unsold inventory would have cleared out. Nobody likes to let go of a good deal. But that hasn’t happened.

Why? Some simple Maths should explain this. In the National Capital Territory (Delhi and other smaller cities around it) an average flat costs around Rs 75 lakh (most research reports agree on this number). Assuming 20% of the price has to be paid in black (and I am being extremely conservative here), the official price of the flat is Rs 60 lakh (80% of Rs 75 lakh). A bank or a housing finance company gives a loan against this price.

The housing finance company HDFC has a loan to value ratio of 65%. This means it gives 65% of the value of a home as a loan on an average. This would mean that HDFC would give a loan of Rs 39 lakh. The buyer would have make Rs 21 lakh as a down-payment. He also needs to raise another Rs 15 lakh to be paid in black.

Hence, the buyer would need to raise Rs 36 lakh (Rs 21 lakh down-payment and Rs 15 lakh black) on his own. How many people have that capacity even in a city like Delhi? And I am not even taking into account the cost of furnishing the house, the cost of moving into it, other expenses like stamp duty etc.

The same maths works for all other big cities as well. What this clearly tells us is that home prices are way beyond what most people can afford. They are in a bubble zone. The sooner the real estate companies understand this, the better it will be for all of us.

They may want a different end, but that isn’t going to happen. The longer they hold on to prices, the longer they will have to hold on to all the inventory that has piled up.

The column was originally published on Sep 8, 2015 in The Daily Reckoning

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