Last week, in an address to major real estate (RE) developers over a webinar, Mr. Piyush Goyal made a statement that got both Twitterati and the news chirping.
He argued that prices for RE have been exorbitantly high and developers need to cut prices to sell off their existing inventory. “If you think the Government will provide you with funding so that you can hold on to your inventories till the time prices rise again, you should not have expectations.” – Goyal clarified - providing a rather honest opinion of how the government was thinking about the issue. Mr. Uday Kotak, the newly elected President of the CII (also the Managing Director of Kotak Mahindra Bank) came out in full support of the statement.
But what got us here? In today's post, we understand the irrationally high demand for real estate in India, the current supply glut in urban India, and the way ahead for the RE players.
The demand situation
Now, it is no secret that the RE prices in our country have always been exorbitantly high. Both supply-side and demand-side dynamics have played to shoot this up.
On the demand side, a house comes as an aspirational product for any average Indian buyer. It has a huge sentimental value. The idea of “having your own roof” makes the purchase decision irrational. People end up taking 10-20x leverage on their personal balance sheets to buy into real estate.
While there is no denying that having your own house has its own set of benefits (no rent, a physical asset to your own name, etc.) but in most rent vs. buy decisions, renting has always proved to be more economical over the longer run. This can only change once the rental yields in the country improve. (The present residential rental yields are ~2-2.5%against a global average of ~6-7%)
According to a wealth study report by the RBI, both Real Estate and Gold form a bulk of the Indian household savings. Indians love owning physical assets over financial assets.
The supply glut & inventory
On the supply side, the main raw material to build RE – Land, has its own set of issues. Land acquisition is often difficult in the country. Most of the land held is for agrarian purposes. On top of this, these holdings are often fragmented. Conversion of land for non-agricultural use coupled with acquiring a sizeable holding often shoots up the cost of acquisition. As a result, a lot of the affordable housing projects are generally developed in the outskirts of the city which may not be the first choice of a normal Indian buyer.
Indian Real Estate has already been reeling through tough times. In a paper co-authored by Arvind Subramanian titled ‘The Great Indian Slowdown’ published in December 2019, unsold inventory in top eight cities is already sitting at 10 lakh units against an annual run rate of 2 lakh units in sales.
How we got here, and the road ahead
Indian developers had been aggressively launching housing projects through the mid-2000s on the back of aggressive funding from NBFCs (Lending to NBFC’s by Banks instead of direct lending to the real estate sector had a lower charge on the risk-weighted assets, hence banks had been lending to the NBFCs). Then came the 2018 crisis of ILFS which sent shockwaves through the entire financial system. Suddenly, the tap on the liquidity got closed and everyone had to re-assess the entire NBFC situation.
Will RE players avoid the sunk cost fallacy and start selling units at market-determined prices? Or will they continue to push their luck a little bit longer? Only time will tell, but the push certainly seems towards the former.
About the Author: The post is written by our EZPP Partner Saket Mehrotra with relevant edits from our editorial team. Saket is a Chartered Accountant working with ITC Limited.