Real Estate Was A Dud In 2015; The Business Model Is On Its Last Legs

Real estate – especially in Mumbai - has been one big flop in the last two years. The short-term price changes of a house may not matter much if you have bought it to live in it, for real estate – like gold – could well hold its own against inflation over the long term. But if you are an investor seeking real returns you would have faced a loss if prices didn’t keep moving up.

According to real estate consultant Jones Lang LaSalle (JLL), in Mumbai, the average price rise in residential properties was 3.3 percent in 2015, well below consumer inflation which was above 5 percent. In the year before, the average rise was around 7 percent, which was just a nose ahead of inflation – for some months at least.

On the other hand, investors could not have made money from rentals either, since rental yields are still unremunerative at around 2-3 percent. So both in terms of capital appreciation and rental income, realty has been a dud in 2014 and 2015.

For next year, JLL predicts a 6 percent rise, but then it had predicted a similar rise in 2015 and fell far short. With a new development plan about to be accepted in Mumbai, where floor space indices may be significantly liberalised, the glut in unaffordable property may force realtors to hold prices down again.

Not only will land availability increase, but the existing unsold inventory in the Mumbai metropolitan region (MMR) is so high that one wonders why prices should rise even 6 percent – unless JLL knows for sure that the availability of land will again be artificially curtailed by politicians out to protect the values of their benami properties, which are not yielding any real returns. According to property research firm Liases Foras, nearly 2,26,000 flats remained unsold in the metropolitan region in 2015-16.

A simple way to find out if real estate is overpriced even now is to look at what is happening to real estate shares. The logic is simple: if realtors are making big margins, as the still high prices indicate, their companies should be too.

But between January 2008 and now, the S&P BSE Realty index has lost 90 percent of its value – when the BSE Sensex has risen 25 percent during the same period. And remember, during this time, there has been no real drop in actual real-estate prices.

A simple question: how is it that when real estate prices have not fallen in absolute terms since 2008 in most cities, real estate companies have lost 90 percent of their market value? Surely there ought to be some correlation between your business and your bottomline/share prices?

Two possible reasons exist for this anomaly:

One, in 2008 as now, the real value in real estate sales is being captured outside the formal balance-sheet, that is, through black money.

Two, there could have been a near 90 percent increase in costs or a comparable reduction in margins during the same period. But input costs like steel and cement have not really gone up proportionately. The only conclusion possible is that this diminution in value could be the result of the rising cost of money or some other loss of value in the land-to-housing supply chain.

Till this value – which could be bribes or other middlemen’s costs – is clawed back by realtors, real estate prices won’t fall as much as they ought to.

Realtors have a choice. Either they go legit, and focus only on real sales to genuine buyers, which means cutting prices, or they should be prepared to see real drops in capital appreciation over the medium term. The so-called investors are distorting the market and making the business unviable.

The other option is to close shop. The current real estate business model is under serious pressure. It is being propped up to artificially create value by deliberately crimping land supplies and building permissions by crooked politicians and bureaucrats. They want to maintain high prices to protect their ill-gotten gains, but this will mean serving a limited market that constitutes 0.01 percent of the real consumer market for housing.

The real market for real estate has hollowed out. Realtors should be willing to take a haircut and begin again. Their interests are no longer coterminous with the crooks who fund them.