Recession, inflation haunt real estate
Steep corrections in Delhi & Mumbai in the late 1990s had spurred the demand.
This could happen again...
This could happen again...
The real estate sector has been hit by twin challenges of growth recession and high inflation. This double whammy has reduced demand for both commercial and residential real estate. At the same time, realtors have failed to curtail supply.
There is unoccupied real estate (offices, residential complexes, malls) scattered across the country and there are unfinished projects in the pipeline. In almost all urban areas, 10-20 per cent of commercial space lies unoccupied. Over-supply in residential units is worse. At the same time, there is a shortage of residential units at the middle to lower end of the spectrum.
At the high-end, in Delhi-NCR, Mumbai, Bengaluru, Chennai, Hyderabad and Kolkata, residential over-supply is huge. A recent report by Knight Frank claims NCR home sales are down 50 per cent in January-June versus January-June 2014. About 189,000 units are estimated unsold in NCR region.
Knight Frank estimates it could take 19 quarters (just under five years) to clear that inventory, some is three years old. The inventory might shift quicker if sentiment revives. But things could also slow even more. Typically, residential property is financed by long-term, floating rate mortgages. Demand is higher when growth is high and inflation is low. Real estate in India is very expensive relative to per capita income. Given over-supply, it seems normal to drop price to stimulate demand. Prices have indeed eased down by 25-30 per cent but deeper corrections may be needed.
There are some signs of revival in residential markets. Housing finance companies such as HDFC, LIC Housing, Dewan Housing and Indiabulls Housing all saw double-digit volume growth, and double-digit rise in profitability in April-June, compared to April-June 2014. However, one quarter could be a flash in the pan. Also, even if it's sustained, it might not be enough to clear, given quantum of supply.
There are unusual facets to the real estate market. A significant component of price is almost always "black". For a middle-class salaried person, real estate purchase involves converting post-tax rupees into black money. The black component means the commitment to purchases is higher than apparent if one only considers white, official prices.
There has been much talk of a crackdown on black money. This has spooked the middle class to an extent and made it a little reluctant to pay high black components. That could be a further dampener for realty markets. People pay premiums to own and this is one reason why rental yield is absurdly low. Say, a property costs Rs X. Logic suggests that the going rent as a percentage of X (the "rental yield") should be close to interest accruing if X was parked in a fixed deposit. Adjustments may be made for black: white ratios. For example, if 30 per cent of a transaction is paid in black, the rental yield should equal interest on the white component (70 per cent).
In practice, rental yields are much lower than this rule of thumb suggests. The difference can be attributed to two related things. One is the premium paid by buyers for the comfort of ownership, and the other is the expectation of capital gains. This equation could be changing. Low rental yields make it possible to enjoy better accommodation by renting. For young, upwardly mobile persons with aspirations, acquiring a home is not such a high priority. Many of this generation want to go abroad and they might not want a commitment to paying off an unoccupied property.
Until the early 2000s, both residential housing and commercial real estate was in short supply and that guaranteed high prices. Banks started offering floating rate mortgages with affordable equated monthly installments to retail customers a decade ago. Real estate firms went public and raised money from stock markets only after 2007. The resulting boom between 2007 and 2011 drove prices (already high) into orbit. It also triggered the current supply overhang.
Some projects have been stalled for years. Other projects are complete but unoccupied. Interest rates remain high. Logic suggests the real estate market is due for further steep corrections, at least in high-end urban areas. That should mean already-battered real estate developers will take a further beating. But although logic leads to that conclusion, the real estate market doesn't necessarily work on logic, due to the many distortions. The june quarter uptick in mortgage volumes might mean it is bottoming out. On the other hand, it is worth bearing in mind that there were steep corrections in Delhi-Mumbai real estate in the late 1990s, and mortgage volumes rose. The lower prices stimulated demand. This sort of market action could happen again.
- by Devangshu Datta
Source :- Business Standard
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