Residential house prices in almost every Indian city went up right through the economic downturn. Yet paradoxically, in the months following the NDA’s landmark victory in 2014, real estate prices began to crack. Now, that crack has turned into a broad-based multi-city pullback which is having a detrimental impact on overall economic growth.
The RBI’s property price index suggests that in 3Q FY15, house prices were rising at around 5 per cent. However, house price data from the property websites which have sprung up over the past four years suggests that in most neighbourhoods of tier-1 and tier-2 cities, house prices are falling 5-20 per cent per annum. House prices, however, are significantly influenced by the “ready reckoner” rates (or “circle” rates/guideline value) which are set by the State Governments. Earlier this year several states (including Maharashtra, Delhi and West Bengal) hiked their ready reckoner rates significantly.
I believe that in the wake of these hikes, the ready reckoner prices are now significantly above the market clearing prices for real estate. As a result, transaction volumes in the property market have dropped steeply this year after falling 10-15 per cent per annum over the past three years. When my colleague, Sumit Shekhar, and I visited five property registration offices in Mumbai in June, the officials there told us that hardly anybody comes to register new properties.
The other element of real estate slowdown — and one that has a significant bearing on GDP growth — is launches of new developments. Data from PropEquity suggests that in the major cities new launches are down 50-80 per cent per annum.
A confluence of supply-side and demand-side factors seems to be responsible for this correction in the property market. On the supply side there are three factors at play. One, RBI data suggests that the banking system seems to have turned the tap off for property developers over the past year. This has, in turn, made developers either stop construction or cut prices.Two, the NDA has cut subsidies sharply (down 9 per cent in 2015-16) and is shifting subsidies to Direct Benefit Transfer. As a result, the ability of the politician-cum-builder to pilfer subsidies to fund real estate construction has been checked. Three, the knowledge that there is many years’ worth of unsold real estate inventory in most of India’s tier-1 and tier-2 cities is causing investors to hold back further purchases.
On the demand side also there are three factors. One, the draconian Black Money Bill went live on July 1 and has made high net worth (HNW) families reluctant to invest in real estate. Two, the 8 per cent point gap between the gross rental yield and bank base rate highlights the unattractiveness of real estate for investors. Three, the hike in “ready reckoner” rates highlighted above has undermined one of the main attractions of real estate for investors — as an asset class in which to park black money.
So, why should we care about this correction? Real estate plays a central role in our economy in two different ways. Construction activity accounts for 50 per cent of India’s capex (this is three times more than the scale of Central Government capex activity) and according to the NSSO, one in three jobs created in India in the past decade has been in the real estate sector.
So, as construction labourers are made redundant, they seem to be returning to their villages and putting downward pressure on rural wage growth, which has dropped to 5 per cent, a 10-year low; sharply down from the 15 per cent wage growth seen until a year ago. Such a drop in rural wages, combined with weak crop prices, is resulting in the rural consumer economy regressing. Beyond the real estate sector itself, the other big sectors that will be impacted by the correction will be building materials and financial services.
For example, the real estate pullback is already having a catastrophic impact on cement demand — my colleague, Nitin Bhasin, says that 60-70 per cent of cement production is consumed by the real estate sector and as this sector slows, cement production is likely to shrink in Q1 2015-16, the second quarter in a row of production shrinkage.
Whilst the RBI’s data suggests that around 15 per cent of the banking system’s loans are exposed to the real estate sector, I strongly suspect that the real figure is much higher because a lot of what the banks are classifying as SME, agricultural and lending to NBFCs is essentially loans which are collateralised by real estate. The problem here is three-fold — first, the SME sector seems to be struggling as the economy weakens; second, the value of the collateral is falling as house prices correct; and third, as transaction activity dries up in the real estate market, it is increasingly questionable whether banks will actually be able to sell their repossessed properties.
(Saurabh Mukherjea is CEO - Institutional Equities at Ambit Capital)