Home truths

After every rate hike announced by the Reserve Bank of India — and there have been several in the last year — there is speculation in the media that property prices will start sliding downwards. Home and auto loans go up, adding a further burden on the middle class, but news stories about the possible, even inevitable, dip in realty prices are a kind of silver lining in an increasingly cloudy scenario.

Yet, as anyone who is a potential property buyer knows, this almost never happens. In both, big cities and small towns, buying a home is a stressful affair, and not the least because the prices are up in the clouds. In metropolises like Mumbai, Delhi and Bengaluru, they are at stratospheric levels. An outing to see property can depress as the realisation dawns that anything half-way decent is way beyond one’s budget.
The media might say with confidence that a 15 to 20 per cent reduction in existing rates is a given since loans will become expensive for builders and buyers, and with demand sliding builders will have to dispose off their inventory at whatever prices they can get. Yet, the harsh reality is that builders almost never reduce per square-feet prices and, at best, after a lot of bargaining, may throw in the odd discount or freebie, such as free parking space, though don’t count on it.
Why is it so? Why do the normal laws of economics — a squeeze in demand leading to price reductions — not apply to the realty sector? Why, when it is obvious that though home sales have slowed down and builders are facing a cash crunch, do property prices not fall, or even crash, as happens in almost every other business, such as automobiles and commodities?
To make sense of this anomaly, one has to understand the way the realty business and the property market work in India. Though there are many local factors, such as land acquisition laws which are different in each state, even each city, some aspects are common across the country.
For starters, it is important to know that this is one industry without a regulator. This is surprising, even shocking, given that the housing sector contributes almost five per cent of the gross domestic product. In the past few years, the stock markets and the telecom industry, among others, have been brought under a regulatory authority, but not housing. It still functions in the same opaque and haphazard style as it did 25 years ago. Nothing has changed. Laws pertaining to the housing industry are introduced in an ad hoc manner, but an overarching set of regulations which protect the consumer does not exist.
This suits builders and their patrons — politicians mainly but also officials — just fine. No one wants to take too close a look at this murky business because all kinds of skeletons will come tumbling out. In some instances politicians are directly and openly involved in construction, in others it is more surreptitious but the ugly fact is that the realty sector is now home to unsavoury elements and practices.
The economics of real estate work in a totally bizarre manner. Of any project cost, 50 per cent goes for land acquisition and a 20-odd per cent in construction. The rest is the builder’s profit, out of which he has to compensate the several layers that lie between the announcement and execution of a project. An entire rentier class of petty babus and others higher up the bureaucratic and political food chain has to be kept happy, otherwise the work can stop any time. (The percentages can vary, but this would be a fairly typical scenario.)
Yet, despite all these hassles, average profitability in the construction industry is a whopping 18 per cent! That is twice the profit margin in sophisticated markets like the US. Note that this figure applies only if every transaction is done by cheque; given that a majority of real estate details involve black money, often to the extent of 50 per cent of the deal, the profitability of the realtor can rise substantially. In addition, the lack of transparency and tightly enforced rules mean that builders also indulge in unethical practices like charging for open areas, loading all kinds of costs in the name of “super built up area” and then giving shoddy quality.
During the good times, builders can build up a sizable war chest of funds that can help them when recession hits. When the cost of money goes up and banks demur at giving any more loans — as happened in 2008 and 2009 — the bigger players have huge funds to fall back on. The more informal sources of finance are also always available; investors pay up to 50 per cent of the project upfront before it even starts (and before the requisite permissions come through) and then clean up by selling their units when it opens to the public. In short, a builder is rarely short of money and therefore all this talk of distress sales of houses and apartments is just hogwash. Which is why, prices of housing — which have shot up in the last 12 months — are not likely to come down.
For the buyer, this is a double whammy. He has to not only contend with high prices but also high interest rates. Existing home loan payers are watching with dismay as their EMIs go up almost like clockwork every few weeks, while potential home owners are wondering if they will ever be able to afford a house.
This situation will continue till there are comprehensive reforms in realty which are then imposed strictly. With genuine competition and transparency, prices of mobile phone calls and air tickets came down; there is no reason why, despite high land prices, this should not happen in the property business. In the West, the price of an apartment is advertised openly, so that everyone — neighbours, estate agents and the tax authorities — knows what the going rate is. And there is limited scope for cheating. India ought to aim for that ideal by setting up a tough regulator. But it is a fair bet that it won’t happen anytime soon. Too many vested interests exist behind the scenes who are quite comfortable with this state of affairs. Meanwhile, you and I can get ready to shell out a fortune for a roof over our heads.