The Delusional Optimism of India’s Real Estate Companies


Daniel Kahneman, the Nobel Prize winning psychologist, in his brilliant book, Thinking, Fast and Slow, writes: “One of the benefits of an optimistic temperament is that it encourages persistence in the face of obstacles…[The] confidence [of the entrepreneurs] in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

This optimism of an extreme delusional variety has been visible among India’s real estate entrepreneurs. For the last five to six years, they have been saying that a recovery in the sector is just around the corner, and the fact that it hasn’t happened yet is because the Reserve Bank of India (RBI) refuses to play ball by cutting interest rates, adequately.
Rajeev Talwar, the Chief Executive of DLF, recently told the Business Standard: “We are in a new economic cycle… When demand picks up, it will take everybody by surprise.”

Niranjan Hiranandani, chairman of Hiranandani group, told the same newspaper: “Any depression will not last long.”

Isn’t a period of five to six years a long enough time?

A report by Crisil Research points out that the absorption of new homes (i.e. sales) in in top 10 cities (Ahmedabad, Bengaluru, Chandigarh, Chennai, Hyderabad, Kochi, Kolkata, Mumbai Metropolitan Region (MMR), National Capital Region (NCR) and Pune) has fallen by 8 per cent per year on an average in the last six years.

What does this mean? It means that if real estate builders sold 100 new homes in India’s top 10 cities in 2010, in 2016, they managed to sell only 63. In absolute terms, this is a fall of 37 per cent. And Mr Hiranandani is talking about any depression not lasting long. I guess six years is a long enough time.

In fact, things haven’t looked good even in the last three months. As per real estate research firm, PropEquity, housing sales stood at 22,699 units during the period July to September 2017, in eight key cities. The sales had stood at 34,809 units during the period April to June 2017. This means a collapse of close to 35 per cent in a period of just three months.

The eight key cities are Gurgaon, Noida, Mumbai, Kolkata, Pune, Hyderabad, Bengaluru and Chennai.

What are the reasons for this collapse? As I have been saying over and over again, real estate prices in India, are beyond what most people can afford and unless this anomaly is corrected, sales will continue to remain sluggish.

Over and above this, real estate companies have really worked hard to break whatever little trust the prospective buyers had in them, by not delivering homes on time.

Further, investors are no longer the driving force in the market, given the sluggish returns in the sector. For a real estate investment to be a viable proposition, after taking in the costs and the risk involved, it should be generating a return of at least 10 per cent per year. And this hasn’t happened for a while.

The overall economy continues to remain sluggish. Take a look at Figure 1, which plots the growth of the non-government part of the GDP, which forms around 90 per cent of the Indian economy.

non govt GDP growth

Source: Centre for Monitoring Indian Economy.

The growth of the non-government part of the economy has fallen from well over 9 per cent to a little over 4 per cent in a period of 18 months between January 2016 and June 2017. This also means that incomes are not going up at the same pace as they were in the past. And given this, it is but natural people are going slow on buying a new home, which is the biggest financial commitment that they make in their lives. During a time when the rental yield (annual rent divided by market price of a home) is around 2 per cent, this makes immense financial sense.

The fear of job losses in the IT industry has also had an impact. The state of the IT industry has a major impact on real estate sales in cities like Pune, Hyderabad and Bengaluru.

In this scenario, the real estate builders have been offering discounts in order to get prospective buyers interested. As Crisil Research points out: “Pressure on residential real estate prices across top 10 cities was clearly visible during H1 2017 [January to June 2017]. While several developers offered upfront per square feet discounts, a few large developers bundled financing schemes and reduced interest schemes to offer ‘all inclusive house prices’. Home buyers, in many cases, were also offered indirect benefits such as reduced floor charges or premium location charges. Taking into account these aspects, the effective price correction was 5-10%.”

But even this 5-10 per cent correction isn’t enough to pull buyers in. This basically means that home prices continue to remain expensive. As I have often said in the past, home sales will revive as and when home prices become affordable, which is currently not the case. For home prices to become affordable builders need to cut prices from current levels. Given that a majority of them are in no mood to do so, it basically means that home sales will remain sluggish in the years to come.

Crisil Research expects that “in the next 12-18 months, prices are likely to remain stable at current levels on account of weak demand and moderation in new supply additions.” This basically means that instead of a price correction, the real estate sector in India is seeing a time correction. If prices remain stable over the years, they lose value once adjusted for inflation and in the process, they might become affordable.
Keep watching this space.

The article originally appeared on Equitymaster on October 16, 2017.

How banks help keep real estate prices high

 India-Real-Estate-MarketVivek Kaul
 John Maynard Keynes, the greatest economist of the twentieth century, once remarked “markets can remain irrational longer than you can remain solvent.” In simple English, one of the interpretations of this statement is that the bubbles can keep running for a very long period of time.
The Indian real estate sector is an excellent example of the same. It has been a bubble for the last few years now, but hasn’t burst.
Before we go any further it is important to define the word ‘bubble’. The 
Financial Times Lexicon defines an asset bubble as follows: “When the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, making a sudden collapse likely – at which point the bubble bursts.”
The problem with this definition is that no one really knows when the bubble will burst. The fundamentals may point out to the fact that the bubble might burst any time soon, but that may or may not happen.
Lets try and understand this in the context of Indian real estate. How good are the fundamentals? It is a well known fact that real estate companies are having a tough time trying to sell homes they have already built up (or what in technical terms is referred to as inventory). As a November 2013 report of Colliers International points out “Pressures of increasing unsold inventory and a liquidity crunch resulted in fewer project launches. There was an increase in the incentives being offered to sell property, such as easy payment plans, discounts and free gifts with bookings.”
So homes in projects that have already been built up are lying unsold. And the number of new projects being launched have come down. As a December 2013 report 
in the Business Standard points out “New property launches in the residential segment across cities declined 12 per cent in the year, with Chennai recording the sharpest drop at 39 per cent, followed by the National Capital Region at 33 per cent and Pune at 20 per cent, according to a report by Cushman & Wakefield. Mumbai recorded just 6 per cent growth in launches.”
What this tells us is that the demand for real estate has slowed down. So, why aren’t prices coming down is the logical question to ask? One reason is the fact that a lot of homes that have already been bought have been bought by investors, who are in no hurry to sell out. Shashank Jain executive director, PwC India explained 
this point in a recent interview to the Daily News and Analysis (DNA). He said that investors are largely of two types—those looking to deploy black money—and senior executives looking to invest in their in a second or third home.
“One, the business community with an element of unaccounted surplus being parked in realty. The government is trying to control them by imposing TDS (tax deducted at source) of 1% on an amount of Rs50 lakh and more. Two, a significant chunk of investment is made by white collar executives, especially in the metro micro markets. This class of investors is putting its surplus income in a second or third home. They don’t have exit pressure. That again means that prices will not come down significantly,” said Jain.
This explains to some extent why real estate prices are not falling. But it does not explain why real estate companies are not cutting prices to get rid of their surplus inventory. It only explains why investors are holding on to homes they have already bought.
It is important to understand that any bubble keeps running till money keeps coming into it. Between 2005 and 2012, a lot of money came into real estate through the private equity route. As Manish Bhandari of Vallum Capital writes in a report titled 
The End game of speculation in Indian Real Estate has begun “Private Equity investments drove in hordes after opening of Foreign Direct Investment (FDI) in real estate sector in the year 2005. The high structural growth story of India attracted a lot of private equity capital the in real estate industry during the Yr 2005-2012, with major inflows coming in the Year 2007-09. Close to $US 20 bn of inflow came to into real estate & construction business, which has put the prices on steroids.”
So, over a period of time, money coming in from the private equity investors has kept real estate prices high. But as Bhandari says private equity inflows peaked during the period 2007 to 2009. There has to be a more recent reason for real estate prices not falling.
The answer lies in some interesting data provided by the Reserve Bank of India (RBI). Between November 30, 2012 and November 29, 2013, the total loans given by banks (excluding food credit) grew by 14.7%. During the same period loans given to commercial real estate grew by a much faster 19.1%. This, in an environment where real estate companies have huge inventories and the launch of new projects has slowed down considerably. So, why are banks lending money to real estate companies? And what are real estate companies doing with that money?
The only possible explanation 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.
But that hasn’t happened. Interestingly, between November 2008 and November 2013, total loans given by banks (excluding food credit) grew by 57.4%. During the same period lending to commercial real estate grew by 86.2%.
And this is what has kept real estate prices high. As Pankaj Kapoor, owner and managing director, Liases Foras, a real estate rating and research firm, 
told Business Today recently “if capital availability becomes difficult, developers may have to cut prices to push sales.”
It is also worth remembering that the average life of a private equity fund is seven to eight years. And all that money that private equity investors have brought in over the last few years, will now have to be returned by real estate companies. In order to do that real estate companies will have to sell the existing inventory that they have piled up.
As Bhandari points out “With the average life of private equity fund being around 7-8 years, the Year 2013 marks the beginning of private equity returning back to shores. The imperative is to see down inventory and return the capital back to investors…The exit of private equity, a fair weather friend of developer, is going to create distress sale situation in real estate industry, shortly. This would lead to depressing price situation for the next 18 months, scaring further fund raising in this sector.”
Another factor that could work towards real estate prices falling are the impending Lok Sabha elections. A lot of black money of politicians is locked up in real estate. And this will have to be unlocked in order to get money to fight elections. As Bhandari points out “According to various estimates an election for central government can cost upwards of US$ 5-6 bn, while average state government elections costing around one billion dollar. With impending central and state election in ten states, costing around US $15 bn, Real Estate will witness outflow of money to fund these elections over the next 18 months.” A similar trend played out before the 2009 Lok Sabha elections when prices fell by around 20% in many markets. But that was also an impact of the start of the current financial crisis with the investment bank Lehman Brothers going bust.
Whether this happens again remains to be seen, simply because as Keynes said ““
markets can remain irrational longer than you can remain solvent.”
 The article originally appeared on on January 7, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)