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Why India’s home prices will crash?

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In a recent media interaction, Finance Minister Arun Jaitley urged RBI to reduce interest rate, as lower interest rate will fuel growth in India’s realty sector which is suffering from severe #DemandSlowdown#. He’s not wrong. There are 750,000 unsold apartments in 7 cities alone including those in Mumbai, NCR/Delhi and Bangalore.  RBI Governor Dr. Raghuram Rajan obliged FM by a 50 basis point rate cut. Will that be enough to revive housing demand? Will it save the realty sector from #crashing#? Why India’s housing sector is looking at imminent crash?
A majority of demand for homes in India are in the affordable segment. However, most developers are coming out with high priced premium and luxury apartments that most buyers can’t afford. Over 69% of the unsold homes in Mumbai are priced above Rs. 1 crore or more. The result is: huge unsold inventories.

Inventory pile up is so huge that it would take at least 5 years in NCR and 3 years in Mumbai to sell them off says a report by Knight Frank India. Dr. Rajan is right when he says salaried class can’t afford to buy flats in India’s top cities. Obviously, builders will face shortage of buyers.
Secondly, India’s home market is driven by investors rather than #EndUsers#. Thus, ifhomes prices continue to remain flat for long, investors will start losing interest, as they are in the market for good return on money invested.
Return comes in two ways: capital gains from the appreciation in the home prices andrental income. At present, apartment prices are either stagnant or witnessing mild correction in most parts of India, and more so in NCR/Delhi.
When it comes to rental income, a typical 2 BHK 1000 sq. feet apartment in Mumbai suburbs of Andheri East or Malad with quoted price of anything between Rs. 1.5 crore to 2.5 crores will generate an annual rental income of anything between Rs. 25*12 (i.e. Rs. 3 lakh) to Rs. 50*12 (i.e. 6 lakhs) that is 2% to 2.4% of the capital value of the apartment.
Expenses on account of property taxes, society maintenance charges and normal wear and tear of the apartment devour 20% to 30% of the rental income depending upon the age and location of apartment building. Then, you also have to consider capital gains taxes in case you decide to sell.
Critics will say that I’m not accounting for role of black money. That’s true. However,even people with black income who’ve invested in the property market do look for positive returns. If rent is insignificant compared to property price, and capital appreciation is not happening which is the reality whether builders accept it or not, investors will soon lose interest. Shouldn’t they? Shouldn’t any rational human being?
Investors have already started to desert some #realty# markets, Noida for example. As a result, prices are lower by almost 30% from peak of Dec 2012 that can easily be verified. The best way to verify price correction is check prices in re-sale market.
Can RBI rate cut by 50 basis point revive sentiment in housing sector and bring back home buyers as #EMIs# would now be lower?
I don’t think so. Instead it will embolden the builders-developers to hold prices at the current high levels that are not sustainable by any standard. What about home buyers? Well, 75% of the home sales are credit financed and RBI just made it easier to go for home loans by cutting interest rate?
Well, you don’t go buy something worth Rs. 50 lakhs or 1 crore just because it’s cheaper by 50 basis point to borrow now.
It’s important to realize that #homebuyers# have to pay both principal (apartment price) and interest. A 50 basis point rate cut on Rs. 50 lakhs loan @10% for 20 years means that the EMI will go down from Rs. 48251 to Rs. 46607 i.e. 1644/month. Will you buy something that cost you Rs. 50 lakhs just because your EMI is now down by Rs. 1644/month. Most people will not, especially when you can rent that Rs. 50 lakh-apartment for just Rs. 10,000 a month in places like Noida or Gurgaon.
It doesn’t make sense to buy a 2 BHK apartment for Rs. 2 crore in distant suburbs with regular traffic jams, and enslave yourself for life in a bad job or with a bad boss. Why buy when you can #rent# it out for just Rs. 50,000 a month at the most. I stay in a house that is priced at Rs. 1.5 crores but I pay only Rs. 32000/month as rent and Rs. 1 lakh security deposit when home loan interest rate is 10%. Why can’t you?
Well, even then you want to buy your dream home, what’s the hurry? Prices are not moving up so it makes sense to wait, till then, stay in a rented accommodation of your choice at least till housing regulator becomes a reality. There are so many unoccupied apartments to choose from irrespective of what your local brokers say about availability.
Some would say while rent is wastage but EMI helps in creation of an asset so why not go for owning a house when EMI is equal to rent. That’s true but EMI can be made lower by increasing the tenor of the home loan, and you’d be tied with home loan for a longer period. So, that’s not the right criteria in my opinion.
My advice: please don’t go for #UnderconstructionApartments# even if you think that payment plan offered by the builders is too good to let go off. For instance, pay 20% now and the balance 80% on possession. Well 20% of Rs. 2 crores is Rs. 40 lakhs. And at 10%/annum, your interest outgo would be Rs. 4 lakh/annum, which is more than sufficient to rent a decent 2 BHK. Plus your money remains safe that you can use to buy a ready- to-move-in apartment when prices are reasonable.
If you still want to fall into the  20:80 trap, here’s the fact: builders are delaying in handing over possession by two, three, even four, five and six years. If that’s the case, you may have to pay both rent as well as EMIs. It’s better not to fall for interest subvention scheme that has been criticized.
If an apartment is priced Rs. 50 lakhs and possession is delayed by 3 years which is very normal, your cost becomes Rs. 50 lakhs and 10%* 50*3 =Rs.65 even if you consider a simple interest of 10% per annum. Usually it’s compounded. Plus you’ve lost rental income for three years. Assuming net annual rental income of 2% of Rs. 50 lakhs means loss of another 3 lakhs.  Suppose, you’re able the sell the apartment in Rs. 80 lakhs. What would be your return: Rs. 12 (= 80-50-15-3) lakhs on an investment of Rs. 50 lakhs for a period of 6 years. Work out the % return yourself. Not much from such a risky and non-liquid investment. 
Please don’t get into the double trap of #EMIandRental#. You may not see any capital appreciation for some time to come, given the oversupply and negligible demand growth at the current levels of home prices.
Besides, what’s the guarantee that your under-construction project will ever be completed, given the over leveraged conditions of real estate companies, the nexusbetween builders-babus-politicians, and no housing regulator to police the errant builders.
Can you fight a builder who doesn’t intend to keep his words? You can’t? But why should you when you have the option of staying in a rented accommodation? Meanwhile, be a good tenant so that you can stay comfortably in a rented house like me and your land lord wants to keep you as his or her tenant for ever.Which landlord doesn’t want a good tenant?
I know you’d like to ask me: then why prices are not falling if there is so much unsold apartments lying with the builders and it’s so cheap to rent? Because, builders are using all means at their hands to keep effective supply of #apartments# constrained, and convince you that home prices will only go up that is not always true?
The following are some of the tactics, builders are using to fool home buyers – especially those who don’t read thick apartment buyers agreements – :

  • Simply by slowing the delivery of  possession of under-construction apartments to keep a check on increase in supply
  • Clever inclusion of minimum lock-in period before you can resale your property
  • By imposing transfer charges on resale that will neutralize any capital gains that you may hope to make…and hence, you’ll drop the idea of re-selling your property before possession, and by that time builders would be able offload all the inventories they have.
  • By silently inserting clauses that make paying penalty for late delivery of apartments beneficial (rather than painful) for builders. So why would they care for late delivery? They don’t, giving delayed regulatory approvals from authorities as excuse, even though builders themselves want delayed approvals because that benefit them.
  • Builders extract 15% to 18%/annum as penalty from buyers for late payment of due amount. However, most apartment buyers agreements for apartments price below Rs. 1 crore that I have studied for writing this post say builders will be liable to pay something like Rs. 5 to 20 per square feet per month after the expiry of delivery date.
  • In Mumbai, builders either don’t have penalty provision for delay in giving possession…or put a cap on how much they will pay. For instance, Lodha builder has kept it to Rs. 100,000 irrespective of delay. Worse, there are a few builders who don’t put any possession dates in their apartment buyers’s contracts. And still many trust their life-savings to these builders.
  • Let us calculate: Rs.10*1000 per sq. ft. per month =10,000*12=1.2 lakh/annum. By that time most buyers have already paid 95% of the total cost of the apartments that they have booked. Let us calculate #interestpayment# charged by bank on housing loan: 10%/annum on 90% of 50 lakhs = 4.5 lakhs/annum
  • Why would a builder bother to complete the project when he’s making a net gain of Rs. 3.3 lakhs/annum (i.e. 4.5 – 1.2) per flat by doing nothing? Builders are just having fun at the cost of hapless home buyers of under-construction properties. And you thought, you have bought your #DreamHome#.
  • In reality, you’re lending money to the builders @ 3%/annum by borrowing @10%/annum from the banks. You’re actually subsidizing the builders by letting him use your money @3% interest/annum, though you’re paying to the banks@10%/annum.
  • Then there are tricky penalty clauses like this: late delivery payment will be duefrom the date of notice received by the builders as per section 10 (a) of the over 100 pages or so Apartment Buyer Agreement that you never read.
  • One of my friends who bought an apartment in Noida certainly didn’t read the agreement, and didn’t get any late delivery penalty for almost 30 months. He has filed a case against builder and is being pressurized to withdraw the case. Meanwhile, politicians are sitting over housing regulator bill.

What the hapless buyers can do against the builders to discipline them? Use the time and tested Gandhian tactics: avoid buying any property which can’t guarantee you an annual rental of at least 5% of the price of the apartment.
And please don’t get into the trap of interest rate subvention or pay 20% now and rest 80% on possession and buy an under-construction property whoever the builder is- reputed or otherwise. Possession when? In 3 years or 6 years? Both are not the same.
Meanwhile stay a in rented accommodation if you can’t find a property that matches 5% rental criteria i.e. annual rental of an apartment should be equal to at least 5% of the apartment price. This should not be a hard and fast rule, but the closer you’re to this criteria, the more sensible your purchase is.
And under-construction property: absolutely no no in today’s market and till housing regulator becomes a reality. If you’ve already booked an under-construction apartment, please read the apartment buyers’agreement to know your rights and liabilities.
A version of this article has been published on National Scientific CompanyWhy renting a house in India is a better idea than buying one. Another version of this article has been published by The Hindu Business Line -Why Rate cut cannot revive India’s realty sector?
Please share your thoughts and experience if you have already bought or thinking of buying any apartment more so an under-construction one. It doesn’t matter even if you have a different experience from me. If we’re not connected, it’s time to get to know each other. You can follow me on twitter @RiteshEconomist
Disclaimer: the above is not a legal advice. I’m not a legal expert please. And dear buyers please take legal opinion before releasing your hard earned money to a broker or builder…it will be extra cost but worth spending it.