India a buy in short term, but risks remain for long term
India, Japan ink $15 bn currency swap agreement

Economy Dec 4, 2012

Why bullishness on Indian real estate is misplaced

By Sunainaa Chadha

Price appreciation in the housing segment has slowed significantly during 2012 in the top seven cities of the country with average capital value rising by only 1-3 percent, a recent survey has shown. Yet many brokerages are still bullish on India's residential market.

Dun & Bradstreet estimates the contribution of housing construction to GDP to grow at a CAGR of 6.9% over financial year 2012-2015 to reach Rs 318,660 crore despite India's top realty firms facing inventories pressure and huge debts which are creating a liquidity pressure on their balance sheets.

On Monday rating agency Icra said the housing finance market would grow 17-19 percent this fiscal despite high property prices on possible softening in home loan rates, attractive schemes being offered by banks and higher ticket sizes.

Given Indian realty's structural problem of inflated prices and hoarding of new supply, these ambitious targets seem a little too far fetched.

Here are some reasons why the housing sector, be it home financing or the residential market, will not grow at this pace.

1)Speculation in real estate is fuelling price wars and has resulted in a catch-22 situation: Speculation in not only property but also land prices is the biggest culprit of astronomical prices which have caused a bubble in India's real estate market, thereby valuing land beyond their production value. "Overpricing has been an issue in Pune, Hyderabad and Kolkata, resulting in a relatively smaller share of absorption from these cities during 2012," says Anuj Puri, Chairman & Country Head, Jones Lang LaSalle India.

Going forward, the year 2013 will be an extremely cautious year as investors will focus more on transparency, governance and liquidity before investing

The plunder by foreign investors who are only looking for a quick return have created this bubble by artificially inflating property prices.

PE fund managers provide developers with large amounts of capital at ridiculous valuations, with no tangible downside protection. And over optimism about India sent sent valuations soaring.

"Investors invest on a short-term to medium-term loan and then wait for price appreciation of properties and then sell them at huge profits," said D&B in a report today.

This absurdity is more than evident from the fact that Indian realty has witnessed close to $20 billion in investment between 2006 and 2009, of which only about $2-3 billion has been able to exit as yet, after remaining invested for six-long years.

What this essentially means is that despite repeated pleas from the finance ministry to lower property prices for unsold housing stocks, the builders cannot do so because there are no end-users to purchase that property at such valuations.

Demand has clearly tapered off for high-value properties and without getting promised returns, PE investors will not exit projects. Unless the builder or the investor is willing to take a cut on his profits, the housing market in India is not going to grow.

2. Indian realty is not up to global standards: Due to the fact that Indian fund managers failed to deliver on their promises, India seems to be slowly losing its title as the most secured investment destination. Add to that various litigation and land encroachment issues. Many projects with cash from investors have either been stuck or have not even taken off. Citing industry sources, D&B said around 1,465 acres of government land is currently under encroachment in Delhi. There have been many instances wherein corrupt sellers have sold encroached land to buyers leading at throw-away prices.

"The biggest challenge for investors is that, though they love the attractiveness of markets such as Brazil, Russia, India and China, the difficulty they have is that there isn't a profession to give them the advice or the standards to give them comfort," Sean Tompkins, recently told the Economic Times in an interview. According to Tompkins, to attract more investments it is imperative to create the right conditions to an investor comfortable.

India also has no independent body for appraising prices of lands as per international standards. This lack of transparency has resulted in the actual selling price of a property in a particular location to be several times higher than that specified by the government, as seen in the case of Delhi. The additional price paid is unaccounted for, which gives rise to the problem of black money in the economy.

3. Taking off from the previous concern, realty projects in India have been developed without any regard to local infrastructure like availability of power, water etc to make these buildings habitable. "Infrastructure deficit continues to be a key restraint for the growth of residential markets across India," says JLL's Puri.

Developers are betting big on extended townships in outskirts of cities like Navi Mumbai, and Greater Noida to cater to the demand for affordable housing by the ever growing population. "Without any infrastructure development from local municipal bodies, these colonies are merely ghost towns where habitation is next to impossible," says Pankaj Kapoor, MD at real estate research firm Liasas Foras.

Against this backdrop, the ministry of housing and poverty alleviation's move to push up the ceiling for low-cost housing might be a useful measure to get some demand built into the market. However, such projects are hardly by any real estate major in the country. India need a full-fledged regulator to be up and running in the sector to monitor the efficient use of the land. Until that happens, the demand is likely to remain mute.

Going forward, the year 2013 will be an extremely cautious year as investors will focus more on transparency, governance and liquidity before investing. Given the on-going challenges that the Indian real estate sector faces on these fronts, even fewer development companies will be successful on the public equity markets, said Ramesh Nair, managing director (West) Jones Lang LaSalle India.

by Sunainaa Chadha

Related Stories.