Real estate in India is overpriced, while rental yields are too low to make sense as a good enough investment.
If the property market were to function as efficiently as the stock market, real estate prices should crash, but the market is rigged.
The fundamental reason why property prices have to fall is because they are no longer affordable to the vast majority of Indian middle class households.
In 2015, four percent fewer homes were bought in eight of India’s major cities – Delhi/NCR, Mumbai, Bengaluru, Chennai, Kolkata, Pune, Hyderabad and Ahmedabad. These cities had nearly seven lakh units left unsold, an inventory backlog that will take at least two or three years to clear, assuming no new units are built.
That isn’t happening,
for builders are forced to announce new launches in order to ensure cash flows
that can be ploughed back to complete previously sold properties. In short,
they are into a recycling game, using new property sales to fund old ones. That’s
why they lure you with 20:80 and 10:20:70 schemes, or ask you to pay only
Rs 2-3 lakh for booking, and rest on
possession. They want the upfront cash in the hope that prices will rise after
a while to make this worthwhile.
Take another measure: rental yield on
residential property – the annual potential rental income as a percentage of
its market price – is so low in India, that it makes no sense as an investment.
Of course, returns will have to include the chances of future appreciation, but
this means investment is being planned purely on expectations of a price rise.
What if that isn’t happening too?
In any rational property market,
rental yields ought to be somewhat in sync with borrowing costs. So if the
housing finance companies are lending you money to buy a house at, say, 9.5
percent today, you should be earning at least half that by way of rental yield,
hoping to make up the other half through capital appreciation.
But in most cities in India, even on
the periphery, rental yields are in the range of 2-2.5 percent. I bought a
small 1-BHK flat in Thane (a satellite city north-east of Mumbai) two-and-a-half
years ago and the rental yield is currently around 2-2.5 percent. I bought the
house to live in, but if I had bought it as an investment, I would have been
better off leaving my money in a savings bank account. I essentially borrowed
money at a high rate (10.75 percent in my case) to earn 2.5 percent. If I had
not bought it to stay in it, I ought to be a candidate for the loony bin.
So let’s get this straight: real
estate in India is overpriced and simply not good enough as investment, and the
anecdotal stories about the high prices some people got for their properties are
really no indication of what might happen in future.
A research study in 2013 found that
rental yields the world over were significantly higher than fixed deposit rates
offered by banks - or were at least comparable. India was the only exception,
with rental yields being in the 2-3 percent range in major cities, and FD rates
above 8.5 percent (at that time, that is).
A comment by Vivek Kaul here quotes
an Ambit report as saying that Indian rental yields make no sense. Analysts Saurabh
Mukherjea and Sumit Shekhar of Ambit wrote: “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 percent (this is gross of tax
and maintenance charges) whilst the lending rate hovers around 10 percent. The
difference between lending rates and rental yields is one of the highest.”
The key question is why. And the
answer is clear. The property market is rigged. This is why despite low demand,
prices quoted are still high and yields so low. If the property market were to
function as efficiently as the stock market, real estate prices should crash,
but the market is not being allowed to equate real demand with supply.
If one accepts 4-5 percent rental
yields as a reasonable level at which property makes some investment sense, it
means prices have to crash almost 50-80 percent from current levels to equate
demand and supply.
Let’s also consider another
yardstick. If anyone is to buy property, incomes must be sufficient to cover
monthly instalments. In Mumbai and Thane, most properties in the 800 sq ft 2 BHK
range are above Rs 1 crore, even assuming some discounts have been offered to
genuine buyers with the cash to pay for it all.
To buy a property worth Rs 1 crore,
you need to raise a loan of around Rs 80 lakh. A 20-year loan at 9.5 percent
would involve a monthly EMI of around Rs 75,000. To pay an EMI of Rs 75,000
(assuming you have no other loans for car, etc), and assuming Rs 50,000 monthly
expenses, you would need a gross salary of at least Rs 2 lakh a month. And
remember, to earn that kind of money on a 20-year loan, you need a remainder
working life of at least 20 years. You can’t be older than 40-45.
How many people in Mumbai or any
other metro do you think earn that kind of monthly salary? Sure, some Dinks
(double-income-no-kids) could cobble up that kind of salary together, but the
total numbers would not run into more than a few thousand in any city. Most
middle class people thus head for suburbs well outside the cities.
The fundamental reason why property prices
have to fall is because they are no longer affordable to the vast majority of
Indian middle class households.
The problem with predicting a real
estate/property price crash is that you will look wrong most of the time.
People were expecting a 2008 global financial crisis three or four years before
it happened, but for much of the time before 2008 they looked like cassandras.
And so it will be with Indian real estate. Those predicting a crash will look foolish for a couple of years, but prophetic when it actually happens. The current level of property price is unsustainable. It has to crash. Just that we don’t know when that will happen. It could also happen through a prolonged period of stagnation in prices, where incomes rise faster than property prices for, say, a decade. The crash will happen then in slow motion, so that incomes and property prices are better aligned. But as of now, property is not a worthwhile investment in most places.