Will the Great Indian Real Estate Bubble Finally Burst? It’s for the Modi Govt to Decide


In a surprise late evening move yesterday, prime minister Narendra Modi told the nation in a TV address, that come midnight, Rs 500 and Rs 1,000 notes will no longer be legal tender.

As I explained in a column published earlier today, one reason for doing this is to tackle the menace of fake notes. The second reason for doing this is to tackle black money.

As I mentioned in the earlier column, the move seems to be inspired from the American dollar as well as the British pound. In the United States, the highest denomination bank note is $100. When it comes to the United Kingdom, the highest denomination bank note issued by the Bank of England is £ 50. In the United States as well as the United Kingdom, the highest denomination note is essentially 50 times the smallest denomination note of one dollar or one pound.

In India, up until now the highest denomination note was Rs. 1,000 and this was 1,000 times the smallest denomination note of Re 1, issued by the ministry of finance. When a currency has notes of higher denomination, it is easier to launder money i.e. store black money, as it takes less space and weighs less as well.

As Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital wrote in a recent research note: “For instance, the weight of Rs 1 crore in the form of hard cash rises from 12kgs to 100kgs if the denomination of the sum is changed from 1,000-Rupee notes to 100-Rupee notes.”

Also, Rs 500 and Rs 1,000 form the bulk of the total amount currency notes in the Indian financial system. As per the Reserve Bank of India, the total amount of paper notes in circulation in 2015-2016 amounted to Rs 16.4 lakh crore. Of this, the high denomination notes of Rs 500 and Rs 1,000 amounted to Rs 14.2 lakh crore or a little over 86 per cent. The Rs 500 notes amounted to Rs 7.9 lakh crore whereas Rs 1,000 notes amounted to Rs 6.3 lakh crore.

This basically means that anyone who has black money stored in the form of currency notes is more than likely to have it in the form of Rs 500 and Rs 1,000 notes. Black money is basically money which has been earned and on which taxes have not been paid. As Mukherjee and Shekhar write: “Given that 48% and 39% of the total value of currency in India is in the form of Rs 500 and Rs 1000 notes respectively, discontinuing usage of either of these notes can increase the physical costs and risks of holding black money significantly.”

Given this, anyone who has these notes, must go deposit this money in a bank account or in a post office account. And if the money being deposited is black money then questions are likely to be asked by the income tax department. Hence, that is unlikely to happen, at least not in a direct way.

One repercussion of this move that is being widely talked about is that it will lead to a fall in real estate prices. Typically, real estate throughout the length and breadth of India is bought using black money. A significant part of the payment is made in cash. Either this is black money being used or it is white money being converted into black. Experts are of the view, that the Modi government’s crackdown on black money is likely to lead to real estate prices coming down significantly.

The logic is that with Rs 500 and Rs 1,000 no longer being legal tender, it will become difficult to make the black component of the payment using currency notes. With the cash component becoming difficult to pay, it is expected that the real estate companies and builders will have to cut prices.

Further, the government plans to launch new Rs 500 and Rs 2,000 notes. It will not be so straightforward to exchange the old Rs 500 and Rs 1,000 notes with these new notes, at least that is the feeling that currently prevails.

This is the logic being offered by experts who are forecasting a fall in real estate prices. As Yashwant Dalal, president of the Estate Agents Association of India told The Economic Times: “Property markets will see around 30% correction in prices…Apart from big property markets, tier II and III cities will be worst affected.” Property prices in tier II and tier III cities will fall more because the black component while buying a home is higher in these cities.

Further, as Anuj Puri, chairman and country head, JLL India, told Mint: “We have just witnessed a tremendous step towards increased transparency in the Indian real estate industry…The effects will be far-reaching and immediate, and shake up the sector in no uncertain way.” Rajiv Talwar, CEO of DLF, was a little more direct than Puri when he told The Economic Times: “There is bound to be a downward pressure on prices of everything including real estate.”

How do I see the situation? Given that I have been bearish on real estate for as long as I have been, it would be easy for me to say that prices will crash. But the past data (whatever limited data we have on real estate) doesn’t suggest the same.

So, my feeling is that real estate prices will fall, but whether they will crash or not, depends on how the government reacts to the situation. Allow me to explain.

This is something I had written in the last edition of The Vivek Kaul Letter, but it is worth repeating here. The current financial crisis that the world is dealing with, essentially started once the investment bank Lehman Brothers declared bankruptcy in mid-September 2008. Real estate prices fell across large parts of the world. But India beat the trend.

The question is why did this happen. Why did real estate prices in India not crash? How did India manage to beat a global trend? The answer lies in Figure 1.

                                Figure 1: Bank lending to commercial real estate (in Rs. Crore) Bank lending to commercial real estate (in Rs. Crore)

The Figure 1, plots the total loans given by banks to commercial real estate, essentially, builders or real estate companies, which make and sell homes, in the period following the start of the financial crisis in late 2008 and early 2009. In the aftermath of the financial crisis, real estate companies in India were also under a lot of pressure. Loans had to be repaid. At the same time the buyers had simply disappeared from the market.

To attract buyers, builders did start to cut prices. Nevertheless, that soon came to a stop. Look at Figure 1. There is a huge jump in lending between January 2009 and February 2009. In January 2009, the total bank lending to commercial real estate stood at Rs. 78,401 crore. At the end of February 2009, the total bank lending to commercial real estate stood at Rs. 90,765 crore. During the period of just one month, lending to real estate went up by Rs. 12,364 crore or 15.8 per cent.

This, when the total lending by banks (non-food credit) between January 2009 and February 2009 went up by Rs. 26,380 crore. Hence, lending to commercial real estate by banks, formed close to 47 per cent of the total lending carried out by banks during the month.

This was a huge anomaly. It is safe to say that this was a bank-sponsored bailout of the real estate sector. If this bailout had not been carried out real estate companies would have had to cut prices majorly to sell homes, to be able to earn enough money to repay the bank loans that they had taken on. Chances are they would have defaulted on some of these loans as well.

The Indian banks managed to avoid this scenario by lending fresh money to real estate companies. The fresh loans were used by the real estate companies to repay their old loans. If these fresh loans hadn’t come through then the real estate companies would have had to cut home prices, so as to be able to sell homes and earn enough money to repay those loans. And India’s real estate bubble would have ended in 2009.

Look at Figure 2. It basically plots the growth in bank lending to commercial real estate over the years. So, in June 2011, the growth rate was at 23.2 per cent. This means that the growth in bank lending to real estate companies between June 2010 and June 2011, stood at 23.2 per cent. All other data points have been plotted in a similar way.

                              Figure 2: Growth in lending to commercial real estate (in %)Growth in lending to commercial real estate (in %)

It is clear from Figure 2 that the growth in bank lending to real estate companies simply exploded in the aftermath of the financial crisis. In fact, it just went up vertically. Zoom!

And this explains, why the real estate prices in India did not fall in the aftermath of the financial crisis. Further, this also tells us why India beat the global trend of falling real estate prices. Of course, perpetual reasons like black money finding its way into real estate, were also there.

Further, the law of demand does not work in the real estate market. In a normal market, when prices go up, people buy less of that thing. In the real estate market, as prices go up, more and more people enter the market (as is the case with the stock market as well). This is what happened post 2009 in India. Rising real estate prices brought the buyers back into the market and the real estate bubble got a new lease of life.

In fact, it is clear from Figure 2, that the growth in bank lending to real estate companies goes through some sort of a cycle. Are these lending cycles linked to the rate of increase of real estate prices? The trouble is that there is very little data available on real estate prices in India. One of the real estate indices that one can look at is the Reserve Bank of India (RBI)House Price Index. Look at Figure 3. It shows one- year returns in real estate per the RBI House Price Index, since June 2011.

                                                      Figure 3: Real estate returns (in %)Real estate returns (in %)

What is clear from Figure 3 is that the annual real estate returns have come down over the years. Now what happens when we plot Figure 2 and Figure 3 together. Look at Figure 4.

                                                                   Figure 4: Comparison Comparisonn

The Figure 4 shows that every time the real estate prices start to correct (i.e. the rate of growth in real estate prices starts to fall), lending from banks to real estate companies starts to pick up. Of course, the mapping isn’t exactly one to one. But there is a clear correlation.

There are two possible reasons for this. One is that banks do not want real estate prices to fall. This is because they feel that if real estate prices fall, the real estate companies won’t be able to repay their loans. Given this banks give fresh loans to real estate companies, so that they don’t have to cut their prices. This keeps the real estate bubble going.

The second possible reason is that the government (I don’t mean just the current government here but any government) does not want real estate prices to fall. This stems from the fact that the ill-gotten wealth of politicians is largely invested in real estate and they work towards protecting its value. Also, real estate builders are major financiers of political parties at local and state levels.

How is all this relevant in the current context? Real estate prices will start falling for sure. The trouble is that this is also likely to lead to default of bank loans from real estate companies. As of August 2016, the total lending carried out by banks to real estate companies stood at Rs 1,81,700 crore. If home loan borrowers also start to default, then there will be a bigger problem.

In this scenario, will banks come to the rescue of real estate companies again? Will public sector banks be forced to give fresh loans to real estate companies? On these questions, your guess is as good as mine. I don’t have clear cut answers to these questions. If banks do give fresh loans to real estate companies, as they have done in the past, then the real estate prices may not fall by as much as they are currently expected to. Nevertheless, it is safe to say, that whether real estate prices will crash, is actually in the hands of the Modi government.

Also, it is worth pointing out here that public sector banks are currently in a mess because of corporates defaulting on loans. Will they be able to take on real estate companies defaulting on their loans as well? What will the government do in this situation?

To conclude, I must say this that if the Modi government does allow real estate prices to come down dramatically, it will improve the affordability of homes. This will allow many people who cannot currently buy homes to buy homes. Also, lower prices will spur demand, which is currently more or less dead. Higher demand will lead to the creation of many low-skilled and unskilled jobs, which the country badly needs, with one million individuals entering the workforce every month. It will also lead to a multiplier effect in industries which directly depend on real estate for their demand.

All I can say with confidence right now is: Watch this space.

The column originally appeared in Vivek Kaul’s Diary on November 9, 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

Will home loans be the next big worry for banks?


Vivek Kaul

I am amazed at the strong belief that people have that real estate prices will never fall. Every time I write a column on real estate readers get back to me with newer theories on why I am wrong. A new theory that was put forward(actually it is not so new, just that no one had come back to me with this theory for a while) to me on Twitter was that the government won’t allow real estate prices to fall.

To this another Twitter follower replied by saying that if real estate prices can fall in China(where the government is far bigger and has a lot more control over things than in India) then they can fall in India as well. Guess that is a fair point.

Anyway, this column is really not about why real estate prices will fall (in fact they have already started to fall). That bit I am already convinced about, I just need to keep reiterating it for the benefits of the believers who don’t see it coming.

What I am worried about is what will happen in the aftermath of home prices falling. Banks clearly have a reason to worry. And here is why.

Every month the Reserve Bank of India (RBI) puts out data regarding the sectoral deployment of credit by scheduled commercial banks operating in the country. For a period of one year ending May 29, 2015, the total lending by banks grew by 8.5% to Rs 61,51,600 crore. During the same period, the total amount of home loans given by banks grew by  17.1% to Rs 6,48,400 crore.

Now compare this to what happened during the period of one year ending May 30, 2014. The overall bank lending had grown by 12.7% to Rs 56,684,00 crore. In comparison the total amount of home loan given out by banks had grown at a similar 17% to Rs 5,53,800 crore.

If we go back a year further to May end 2013, the overall growth in bank lending had stood at 15.3% whereas home loans grew by 18.4%. (Actually the period here is a little more than a year, between May 18, 2012 and May 31, 2013).

What this clearly tells us is that even though the overall growth of lending by banks has considerably slowed down, the growth in home loan lending continues at almost the same pace. What conclusion can be draw here? The RBI does not give out the total number of home loans that banks are giving out. Neither does it tell us the average size of a home loan.

Nevertheless, one explanation for home loans continuing to grow can be that the increase in the price of homes has also led to the increase in the average size of home loans.

What happens if we look at the data a little differently? Over the one year period ending May 29, 2015, the total lending of Indian banks grew by Rs 4,83,210 crore. During the same period the total amount of home loans grew by Rs 94,590 crore. Hence, home loans constituted around 19.6% of bank lending during the last one year.

What was the scene a year back? For the one year period ending May 30, 2014, the total lending of Indian banks grew by Rs 6,40,570 crore. Home loans had grown by Rs 80,260 crore during the same period. Hence, home loans constituted 12.5% of the lending during the course of the period.

For the period of one year ending May 31, 2013, home loans constituted around 11% of the overall lending by banks. (As mentioned earlier, the period here was a little more than a year, between May 18, 2012 and May 31, 2013).

Now what does this tell us? With overall bank lending slowing down, banks have increasingly become dependent on home loans. As Deepak Shenoy of Capital Mind puts it: “the demand for housing loans is pretty much the only game in town for the banks.”

Home loans were formed 11% of the total loans given out during the period of one year ending May 2013. This number jumped to 12.5% during the period of one year ending May 2014. And for the period of one year ending May 2015, home loans amounted to 19.6% of the overall portfolio. Things get even more complicated once we look at the divide between priority sector home loans and other home loans. Home loans of up to Rs 25 lakh get categorised as priority sector loans.

For the period of one year ending May 29, 2015, priority sector home loans grew by just 4.9%. On the other hand home loans of value greater than Rs 25 lakh grew by 32.2%. Hence, higher value home loans are growing at a significantly faster rate. For the period of one year ending May 30, 2014, priority sector home loans had grown by a much faster 8.7%. The home loans greater than Rs 25 lakh had grown by around 29.1%.

The problem is that with the real estate bubble starting to loose fizz banks are likely to face the next spate of bad loans from the home loans that they have given out. I might be jumping the gun here a little, but the numbers show an increasing dependence of banks on home loans and that is clearly not a good sign.

As the analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled  Real Estate: The unwind and its side effects: “Over the last decade, the combined real estate portfolios of banks and NBFCs have increased at a CAGR[compounded annual growth rate] of ~20%. A breakup of this growth between value and volume shows that two-thirds of this growth has been driven by increased ticket sizes (due to the continued increase in ticket sizes), and volume growth for the sector has been relatively modest at ~8-9% CAGR over the last 10 years.”

This is going to change in the days to come. As Mukherjea and Shekhar write: “Housing finance companies/banks would be an obvious casualty if real estate prices correct.”

Disclosure: The idea for writing this column came after reading Capital Mind’s research report titled Bank NPAs Show Alarming Signs, Add to Woes of the Sector

The column originally appeared on The Daily Reckoning on July 24, 2015

Looking back: Real estate crash of 1997 reminds us prices can fall by 50%

Vivek Kaul

In response to a column I wrote yesterday many people wrote in saying that real estate prices never fall. Some others said that real estate prices cannot fall in India because India has a huge population, there is scarcity of land, and there is inflation and a lot of black money.

Fair enough.

Another logic that was offered was that real estate prices will not fall because they have only gone up in the past. Alan S Blinder explains this logic in his book After the Music Stopped:  “A survey of San Francisco homebuyers[sometime in the mid 2000s]… found that the average price increase expected over the next decade was 14 percent per annum…The Economist reported a survey of Los Angeles homebuyers who expected gains of 22 percent per annum over the same time span.” At an average price increase of 14% per year, a home that cost $500,000 in 2005 would have cost $1.85 million by 2015. At 22% it would have cost $3.65 million.

Now replace San Francisco with Mumbai or Delhi or Bangalore, and you get the drift of how people who believe that real estate prices can never fall, tend to think. This, if anything is a classic sign of a bubble. We all know what happened to American real estate starting in 2007-2008.
The naysayers might turn around and tell me, but this happened in the United States and not in India, and given that something like this is not possible in India.

So, let me tackle this by offering evidence from the real estate bubble of the 1990s, which started to run out of air sometime in the mid 1990s. As Manish Bhandari of Vallum Capital wrote in a report titled The End game of speculation in Indian Real Estate has begun: “The previous deleveraging cycle in year 1997-2003 witnessed price correction by more than 50% in Mumbai Metro Region (MMR) property.”

Yes, you read it right. Prices fell by 50% in Mumbai, where the population is huge and there is huge land scarcity. And the city had a lot of black money then. It has a lot of black money now.

Real estate prices also fell in other parts of the country. As an August 1997 newsreport in the India Today magazine points out: “Be it Mumbai’s ‘golden mile’, Nariman Point – the most expensive stretch of real estate in the world – or Somajiguda in Hyderabad; Delhi’s commercial hub Connaught Place or Koregaon Park in Pune; Bangalore’s pulsing heart M.G. Road or the sedate T. Nagar in Chennai. Each of these upmarket addresses, the most sought – after in their respective cities, are now dotted with unoccupied apartment blocks, unwanted commercial complexes and office space purchased at rates too hot to handle today.”

The point being that home prices had fallen by a huge amount across the country. “For the country’s over Rs 1,00,000 crore real estate business-one-twelfth the size of the GDP – it has been a crash without precedent. Between mid-1995, when the real estate boom peaked, and mid-1997, prices have fallen a bruising 40 per cent,” the India Today report newsreport further pointed out.

So what is the learning here? That real estate prices fall. And that they may not fall as quickly as stock markets do, but they do fall. Further, the fall can pretty much be all across the country, instead of only certain pockets. This despite, all the reasons offered in favour of “real estate prices can never fall” argument.
What this also tells us is that people have very weak memories and they tend to remember only things that have happened over the last few years. I guess up until late 2013, the real estate sector did reasonably well. And that is what people remember.

Actually, this is like information technology is the best sector to work in, argument (and Infosys is the best company). It may have been true a decade back, but clearly is not true today. Nevertheless, a whole new crop of parents forcing their children to become engineers continue to believe in it.

Getting back to the point, what those who still believe in the real estate story have not yet started to realise is that over the last one year, real estate prices have more or less been flat. And this as per data provided by real estate consultants, who have an incentive in ensuring that real estate prices continue to go up. There is enough anecdotal evidence to suggest that real estate prices have been falling at double digit rates in large parts of the country. It is just that no independent agency or organisation collates such data real time to give us a true state of the real estate prices in the country.

Also, from data that is available it can clearly be seen that real estate builders are sitting on a huge number of unsold homes. The bank funding to the sector has slowed down considerably over the last one year. The number of new launches, another source of funding for real estate companies, has collapsed, as real estate companies have not been able to deliver on their earlier projects. And investors are getting restless.

Further, those who believe in still buying real estate have no memory of the real estate crash of the late 1990s and the early 2000s. Hence, for them real estate prices can never fall. But that as I have shown is a stupid argument to make.

Also, the land-population argument is not a new one. It has been made over a very long period of time and despite that many real estate busts have happened all over the world. As Noble Prize winning economists George A. Akerlof and Robert J Shiller point out in Animal Spirits: “In a computer search of old newspapers, we found a newspaper articles from 1887-published during the real estate boom in some U.S. cities including New York-which used the idea to justify the boom amid a rising chorus of skeptics: “With the increase in population, the demand for land increases. As land cannot be stretched within a given area, only two ways remain to meet demands. One way is to build high in the air; the other is to raise price of land…Because it is perfectly plain to everyone that land must always be valuable, this form of investment has become permanently strong and popular.”

So, the land-population argument has always been offered by those who want you to buy real estate all the time. For those who are still not convinced, I suggest that you read the India Today story that I have mentioned earlier in the column. If you continue to remain a believer even after that, then best of luck from my side.

To conclude, let me reproduce an example from the India Today article: “At Himgiri, a typical multi-storeyed residential block on Mumbai’s arterial Peddar Road, the IT Department acquired a 624 sq ft flat for Rs 72 lakh in 1994. A year later, a similar flat went for Rs 60 lakh. And in June this year, a 622 sq ft flat was bought at a little under Rs 50 lakh. The list is endless.”

Pedder Road, as you would know is where Lata Mangeshkar lives and it is located in South Mumbai. And if real estate prices can crash in South Mumbai, they can crash anywhere else. Meanwhile, let me hear a few more arguments in favour of investing in real estate. Bring it on! But do remember that the one investment lesson that people learn over and over again is that, this time is not different.  

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

The column originally appeared on Firstpost on July 22, 2015

On the edge: Is Indian real estate heading for a 50% crash in prices?

We all know that real estate in India is terribly expensive and is now selling at prices making it practically unaffordable for almost everybody who wants to buy a home to live in. But how expensive is expensive? This is an important question that needs to be answered.

One way of looking at this problem is through the rental yield available on houses at any point of time. Rental yield is the annual return that can be earned by renting out a house. The number is obtained by dividing the annual rent of the house by its market price.

And what is the rental yield in India? As Ashwinder Raj Singh is CEO – Residential Services of JLL India points out in a June 2015 column in The Indian Express: “Rental yields vary across the globe, but an average of 2 per cent of rental yield is considered a good deal for residential properties in India.”

Singh goes on to write: “In India, the cities which currently offer a higher rental yield are Mumbai, Pune, NCR-Delhi, Bengaluru, Kolkata, Chennai, Hyderabad, Ahmedabad. All these cities offer a rental yield of 2 per cent and above, and you can be assured that the average is not going down anytime soon. Investing in these cities will offer you the maximum returns on investment in properties bought for generating rental income.”

Why would anyone invest for a return of 2 percent is a question that only perhaps Singh can answer? And at 2 percent the rental yield is already very low. We will leave this argument for another day.

Hence, we have an expert telling us that an average rental yield of 2 percent is considered good in India at this point of time. But is it enough? In a recent research report titled Real Estate: The Unwind and its Side Effects analysts Saurabh Mukherjea and Sumit Shekhar of Ambit provide the answer.

As they write: “In a fairly-priced real estate market, the rental yield tends to be somewhere close to the cost of borrowing. Instead, Mumbai has a rental yield of close to 2% (this is gross of tax and maintenance charges) whilst the lending rate hovers around 10%. The difference between lending rates and rental yields is one of the highest.”

What Mukherjea and Shekhar are essentially saying is that the rental yields in India are totally out of whack.


As the  chart (Exhibit 11) shows us, even China which has had a huge real estate bubble going has a rental yield better than that of India. In fact as the next chart (Exhibit 12) shows the difference between the interest rate at which money can be borrowed and the rental yield is one of the highest in the world, in India. At this point of time a home loan can be borrowed at 10 percent whereas the rental yield is 2 percent, a difference of 8 percent.


What does this tell us? The rental yield as explained above has two inputs: the annual rent and the market price of the house. A rental yield of 2 percent means that the market price of homes in India has risen at a much faster rate than the rents.

And why is this the case? As Mukhejea and Shekhar write: “Rental yields in property markets in India have remained extremely low as compared to its other Asian peers thereby pointing to the over-valuation of this asset class mainly because it can absorb black money.”

The rental yield cannot continue to remain out of whack. For it to come to the right level, the rents need to rise or the market prices of homes need to fall. Given the surfeit of homes available right now, it is highly unlikely that rents will rise. The chances of property prices falling are significantly higher.

As the Firstpost editor R Jagannathan wrote in a column in November 2014: “In India, borrowing costs for home loans are around 10.5-11 percent currently – when rental yields are a fourth of that level. If rental yields in India have to catch up with those in New York and London, Indian property rates have to fall by a third to a half.”

Mukherjea and Shekhar of Ambit make the same point when the say: “Even if one assumes that buyers are willing to live with only 5% rental yields (as they might have an extremely bullish view of capital gains arising from real estate in India), this would imply halving of real estate prices in Mumbai.” What is true about Mumbai is also true about other parts of the country.

Let me explain the maths through an example. Let’s say an individual buys a home for Rs 50 lakh. The rent that he can earn on this is Rs 1 lakh, meaning a rental yield of 2 percent (Rs 1 lakh expressed as a percentage of Rs 50 lakh).

For the rental yield to rise to 5 percent, what has to happen? One option is that the rent needs to rise to Rs 2.5 lakh. This would mean a rental yield of 5 percent (Rs 2.5 lakh expressed as a percentage of Rs 50 lakh). But as I explained above, the chances of rents going up at this dramatic rate are simply not there.

Hence, what needs to happen for the rental yield to be around 5 percent? Market price of homes needs to fall. A rent of Rs 1 lakh would lead to a rental yield of 5 percent, if the market price of the home is Rs 20 lakh (Rs 1 lakh expressed as a percentage of Rs 20 lakh). This means that the price of the home needs to fall from Rs 50 lakh to Rs 20 lakh or a fall of 60 percent. At a 50 percent fall, for a rental yield of 5 percent, the rent needs to rise to Rs 1.25 lakh (Rs 1.25 lakh expressed as a percentage of Rs 25 lakh).

This is the point that Mukherjea and Shekhar are trying to make.

While the maths looks all fine, the question is will this happen and how soon will this happen? The only way this will happen is if the black money going into real estate slows down to a trickle so that only genuine buyers are left in the market. This is easier said than done. The Modi government has had some focus on black money and let’s hope that continues and improves in the days to come, with the government focussing on domestic black money as well. A point worth repeating here is that ultimately almost all the black money is domestic given that it is generated within the country.

Also, it is worth remembering here that real estate prices don’t fall as rapidly as stock markets do. So, the right answer here is that real estate prices will fall and they will fall dramatically, but only over a period of time.

Stay tuned. The massacre has just started.

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

The column originally appeared on Firstpost on July 21, 2015