India’s real estate market is being run by crooks

Vivek Kaul

The real estate sector remains down in the dumps. Nevertheless, insiders(the builders, the real estate consultants, the housing finance companies etc.) would like us to believe that “acche din” will be here for the sector pretty soon and hence, we should be investing in it.

In a recent report JLL India, a real estate consultant, pointed out that: “Many home buyers as well as investors have been speculating about the movement of residential property prices in Mumbai…The market’s readings indicate that that it will start moving up later this year. An average price appreciation of around 6% is expected by the end of Q4 2015. Mumbai’s residential property market will start seeing a lot of buying activity in around six months, with buyers taking advantage of prevailing market conditions to get good deals. The increased market activity is expected to continue next year too.”

What the report does not point out is the fact that the Mumbai Metropolitan Region has an unsold inventory of homes of close to 46 months or 192.27 million square feet. This data was released by Liases Foras, another real estate consultancy, sometime back. What it means is that if homes continues to sell at the current rate it would take around 46 months for the current stock to sell out. A healthy market maintains an inventory of eight to 12 months.

JLL India may have its own estimates of unsold inventory but they can’t be significantly different from that of Liases Foras. And if there is so much ready supply available, how can real estate prices go up?

This is just one example of research reports that real estate consultants keep coming up with where the conclusion is that “real estate prices will continue to go up”. For them it makes sense to do this simply because they make more money if the real estate sector is doing well, given that there are more deals to execute and more commission to be made in the process. And if the real estate sector is not doing well then they need to tell the world at large that it will start to do well, soon. These positive reports are splashed across the media, given that real estate companies are huge advertisers and a healthy real estate sector is a boon for the media.

The trouble is that the real estate sector in India has a huge information asymmetry, or something that the Nobel Prize winning economist George Akerlof referred to as a “market for lemons”. In a 1970 research paper titled The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, Akerlof talked about four kinds of cars: “There are new cars and used cars. There are good cars and bad cars (which in America are known as “lemons”). A new car may be a good car or a lemon, and of course the same is true of used cars.”

Akerlof then went on to explain why trying to sell a lemon is very difficult. In an essay titled Writing the “The Market for ‘Lemons'”, Akerlof wrote: “I knew that a major reason as to why people preferred to purchase new cars rather than used cars was their suspicion of the motives of the sellers of used cars.” Long story short—a buyer will not buy without proof of the used car being in good shape and the seller did not have the proof.

And this led to the market for second-hand cars not working well. Tim Harford explains this phenomenon very well in his book The Undercover Economist: “Anyone who has ever tried to buy a second-hand car will appreciate that Akerlof was on to something. The market doesn’t work nearly as well as it should; second-hand cards tend to be cheap and of poor quality. Sellers with good cars want to hold out for a good price, but because they cannot prove that a good car is really a peach, they cannot get that price and prefer to keep the car for themselves. You might expect that the sellers would benefit from inside information, but in fact there are no winners: smart buyers simply don’t show up to play a rigged game.”

Hence, the market for second-hand cars has huge information asymmetry—one side has much more information(the seller) than the other(the buyer). And given that the market does not work well.
The real estate market in India is a tad like that. The insiders have all the information and there is no way to verify if the information they are putting out is correct. Take the case of something as simple as the prevailing price trend in a given locality.

There is no publicly available information. All you can do is ask the broker operating in that area and more often than not, he will tell you that “prices are on their way up”. If you are able to figure out a price, there is no way of figuring out whether there are deals happening at that price.

Hence, the system as it currently stands is totally rigged against the buyer. Even when the buyer buys an under-construction property there is no way of figuring out if the builder will deliver everything that he has promised at the time of the sale. There are regular cases of builders promising to build a swimming pool, taking money for it and then not building it. Then there are cases of parking lots being sold even though that is not allowed. In the recent past, builders have disappeared after taking on money and not completing the project.

As Nate Silver writes in The Signal and the Noise –The Art and the Science of Prediction: “In a market plagued by asymmetries of information, the quality of goods will decrease and the market will be dominated by crooked sellers and gullible and desperate buyers.” And that is precisely what is happening in India.

In fact, the real estate market in India currently is like the stock market used to be in the 80s and the 90s. India’s biggest exchange the Bombay Stock Exchange(BSE) was run by and for brokers. Other stock exchanges operating in different cities ran along similar lines. Small investors investing in the market were regularly taken for a ride.

The Securities Exchange Board of India was given statutory powers in 1992. And it took time to crack the whip. The National Stock Exchange started operations in November 1994 and gradually took away business from the broker dominated BSE. The BSE has been trying to play catchup since then.

The real estate business in India needs to be cleaned up along similar lines. The Real Estate (Regulation and Development) Bill, 2013, envisages setting up of a real estate regulator in each state. The builders need to be registered with the regulator and at the same time disclose essential details about the projects. These provisions if and when implemented are likely to reduce the information asymmetry which plagues the sector. But till then “caveat-emptor” will continue to prevail.

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

The column originally appeared on DailyO on May 25, 2015

Why car sales are falling but not realty prices

homeCar sales for the month of February 2013 are down dramatically. For the month of February 2013 they fell by 25.71% to 1,58,513 units in comparison to the same month last year.
this column yesterday, this writer argued that falling car sales is a reflection of the overall economy slowing down. People expect the bad times to either continue or to get even worse in the months to come. And this makes them hold onto the money they would have otherwise used to buy high cost items like a car. It also means that they do not want to commit to an EMI right now. Given these reasons car sales have slowed down.
The question that immediately cropped up was that if car sales are falling, using the same logic real estate sales should also be falling and that should lead to a fall in real estate prices. If cars are a big ticket purchase, then buying a house is the biggest expenditure that most people incur during their lifetime. Also the price of cars over the last few years hasn’t risen much whereas the price of homes has gone through the roof, making them terribly expensive.
So why are people ready to buy homes but not cars? The answer of course is not straightforward. But before I come to that allow me to deviate a little.
The economist George Akerlof wrote a research paper titled
The Market for Lemons in 1970. For this paper, Akerlof ultimately received the Nobel Prize. In this paper he discusses the market for second hand cars (or used cars) and the problem people have in selling them.
Akerlof divided the second hand car market into two types of cars, peaches and lemons. Peaches were cars which were in a good shape where as lemons were cars which were in a bad shape. The individual selling the car obviously knows whether his car is a peach or a lemon but the individual buying the car doesn’t. So seller has what economists refer to as ‘insider information’ which the buyer doesn’t have.
The point is that in this transaction one side has much more information than the other side. So there is an asymmetry of information. As Nate Silver writes in The Signal and the Noise – The Art and the Science of Prediction “In a market plagued by asymmetries of information, the quality of goods will decrease and the market will be dominated by crooked sellers and gullible and desperate buyers.”
The real estate market in India is a tad like that. The sellers have all the information in the world and buyers have very little of it, almost next to nothing. And this manifests itself into situations which do not benefit the buyers at all.
Allow me to explain. Everyone talks about how real estate prices have been going up. This writer was recently told by someone that the flat he had bought in 2002 for around Rs 20-25 lakh was now going for Rs 2 crore. Fair point. But are there transactions happening at such an expensive price point? And if they are happening how are they in comparison to the past?
The point is that just looking at the price doesn’t give us the answer. One also has to look at the number of buyers looking to buy at that price point because only that can tell us how strong the trend is.
Unfortunately such kind of information is not available to most buyers in India. Hence, people who sell real estate, all the brokers and property dealers of the world, deal with buyers from a position of strength and always try to project a scenario where prospective homes are scarce. The buyers have no clue of whether deals are actually happening or not and hence tend to believe the brokers.
A real estate index which tell us the broad direction of the market would be a great thing to have. While attempts have been made in the past to launch a real estate index, nothing robust has come out till date.
There are reasons to believe that people are not buying as much real estate as they were in the past. This is not conclusive evidence but some evidence nevertheless. Try reading
any newspaper article which makes a pitch for the Reserve Bank of India cutting interest rates, the CEOs of real estate companies come across as the most desperate of the lot. This tells you at some level that they are not selling as much as they are building. But how will an interest rate cut of 25-50 basis points (one basis point is one hundredth of a percentage) lead to people buying homes is beyond me.
Newspapers provide another indicator. Every week the front page of one newspaper or another has an advertisement for a new real estate launch happening somewhere, where the buyer has to put a minuscule portion of the cost of the home upfront. This money that is raised is typically used by the builder to payoff money that is due instead of building the homes that he has advertised. A story in
The Carvan Magazine makes this point by quoting a property dealer : “If these builders were suddenly asked not to sell any more projects, I’m telling you, most of them couldn’t balance their books tomorrow.” So in effect most real estate companies are running Ponzi schemes where they are using money being brought in by the newer investors to pay off the older investors. As long as this Ponzi scheme keeps going real estate prices will continue to be high. If newer investors stop bringing in money, the builders will have to start selling the homes that they have built in order to pay off people who they owe money to.
Another interesting number is the proportion home loans form out of total loans given by banks. Home loans peaked at 12.9% of total banking credit in March 2006. As on December 28, 2012, they formed around 9.3% of total banking credit. And this in a scenario where housing prices have gone up many times between March 2006 and December 2012. Hence, it would only fair to assume that people are buying a fewer number of homes, at least by taking on home loans.
So if people are buying fewer homes why are the prices not falling? Those who work in the real estate industry would like us to believe that the cost of constructing a house has gone up. While that may be true to some extent the argument doesn’t justify the astonishing levels of price rise.
The material used in construction of a house and other forms of real estate was and continues to be easily available. Lumber which is used in large amounts is a renewable resource. Glass is made out of quartz, the second most common mineral on earth. Gypsum, which is the main constituent of plaster as well as wall board is very commonly available mineral. Cement is made out of limestone which forms 10% of all sedimentary rock formations on earth. (Source: The Subprime Solution by Robert Shiller). That leaves out the price of land on which the homes are constructed. We will just come to that.
A major reason for home prices not coming down despite the stagnant demand for homes is the fact that the market is dominated by investors/speculators and not real buyers who buy homes because they want to live in them. Anybody who has doubts about this can take a walk through the newer areas of the National Capital Territory. Most of the flats remain empty, giving an eerie feeling of a ghost town. All these flats are owned by investors/speculators. And it is these people who keep playing a game of passing the parcel among themselves and in a way ensure that prices of homes do not fall. Also they have made so much money in the past (and given that most of it is black money) they are in no hurry to sell these homes.
The story in
The Caravan quotes a property dealer to make a similar point. “There isn’t a bubble of real homes…If all these apartments were actually built, and built fairly to schedule, I guarantee you that they would find real buyers. The demand is out there. But there is a huge bubble in imaginary homes—in homes that will be delayed indefinitely or just never get built.”
Also most of the black money in India finds its way into property one way or another. Most of the ill-gotten wealth of politicians is also deployed in property. And any fall in price of real estate would mean the value of their wealth coming down.
But at the end of the day there is only so much black money going around as well. What creates the illusion of the real estate prices continuing to remain high is the supply of land. While India does not have a scarcity of land like Japan does, the problem is that politicians control the supply of land. Every state and central and politician has land held in benami. And this is the real bubble that has kept home prices high.
As Ruchir Sharma writes in
Breakout Nations “Lately Indian businessmen have been regaling one another with accounts of a leading politician from Mumbai who is known to have amassed a huge wealth through property deals. At a private screening of a new Bollywood movie, this politician asked the producer to replay a particular song-and-dance number, over and over. When the producer asked if he was taken with the leading lady, the politician said no, he was eyeing the location and wondering where the producer had found such an attractive stretch of open space in Mumbai.”
If home prices have to come down, it is this link that needs to be broken.
The article originally appeared on on March 14, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)