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