Residential Real Estate Report - 2008
Residential property prices crashed in the mid-1990s, and it took till 2002-03 for them to start rising again. When they did, however, the progress was rapid. Within a short span of time, the prices had risen so much that the budget buyer, who comprises the bulk of the market, was left out in the cold.
This would possibly have continued had real estate developers not been overtaken by international events of a scale that they could not anticipate. The US sub-prime crisis triggered recessionary forces globally. That, in turn, crashed volumes in the Indian property market to a trickle.
"Going forward, the market will remain slow and transaction volumes will remain low," says Anshuman Magazine, chairman and managing director, CB Richard Ellis South Asia, a realty consulting firm.
For homebuyers though, things are getting better. A correction in property prices is already underway. In the following paragraphs, we try to figure out what you should do if you are in the market to buy or sell, and how to arrive at a reasonable price, give or take a bit, at which to strike a deal
The Demand Factors
The recent housing boom was riding on the back of four broad factors -- rising incomes, job security, low property prices and interest rates, and tax benefits associated with buying a house.
While tax benefits remain, the other major drivers of demand have lost steam. Naturally, offtake at current prices has suffered.
The inherent desire to own a home remains, but people will do something about it only at lower prices. Take the example of the 5,000 or so living units that were offered for sale by the Delhi Development Authority in August at a discount of about 40 per cent to the then prevailing market prices.
It got about 800,000 applications, even though Rs 1.50 lakh (Rs 150,000) had to be submitted as the initial margin money. Even today, realty portal www.99acres.com gets around 10,000 enquiries every day
Property Prices
When the real estate market started picking up at the turn of the century, capital values were low. To give you an idea, in Gurgaon in the National Capital Region, average capital values were around Rs 1,000-1,200 per sq. ft.
That has shot up to Rs 5,000-Rs 6,000 per sq. ft, an increase of 400 per cent. However, the rise was not uniform. During the last 2-3 years is when most of them kicked up.
"It did not take into account what the end users' affordability quotient was," says Ajoy Veer Kapoor, managing director and founder, Saffron Asset Advisors, a Mumbai-based private equity firm.
Who, then, was buying? "In most of the recent projects, more than 80 per cent were speculators who wanted to exit in 6-12 months," says Vineet Singh, business head, www.99acres.com.
Besides, people started investing in real estate as it started giving returns comparable to equity. According to a study by realty portal Makaan.com, 78 per cent of the people in the India want to purchase property for Rs 60 lakh (Rs 6 million) or less.
"In the main cities there is no new supply in the segment. The only option for a homebuyer is to go for something 15-20 km away; this has fewer takers," says Aditya Verma, business head, Makaan.com.
Since developers thought that the problem was not with high prices, but with high interest rates, they did not bother to create units to cater to the broader market.
Interest Rates
Interest rates, which hit a low of around 7.50 per cent per annum in 2004, started moving up since then, primarily on the efforts of the regulator, the Reserve Bank of India, to keep speculators at bay.
Banks even started charging a higher rate of interest (50 basis points more) for second home purchases. But given the way property prices were moving, speculators were undeterred. As a result, interest rates kept moving up -- at present, they are at 10-12 per cent for new customers.
So, how is the buyer affected? Let's illustrate with an example. When the rate of interest was 7.50 per cent a year, the EMI on a Rs 30-lakh (Rs 3 million) loan for 15 years was Rs 27,810. If just the rate of interest rises to 10.50 per cent, the EMI shoots up to Rs 33,162, an increase of around 20 per cent.
Now assuming Rs 30 lakh is the loan you can get and you can find property for Rs 60 lakh within city limits, you will have to raise about half of that as down payment from your resources.
An Assocham study says demand for residential units fell by 35 per cent in Tier-II and Tier-III cities in the first half of FY09 due to high borrowing costs.
Which way are interest rates headed? The broad consensus is that they have peaked. Most public sector banks have recently cut rates by 50-75 basis points. Private sector banks are yet to announce their rate cuts.
"There is some improvement in the liquidity situation and private players, having seen the tightness in liquidity that prevailed in October, are being a bit careful before taking any major decisions," says Abheek Barua, chief economist, HDFC Bank.
He adds that over the next 2-3 months, interest rates could go down by another 50-75 basis points. The recent repo and reverse repo rate cut by 1 percentage point should also help the process.
But there could be a glitch. "These days, they (banks and housing financiers) are sanctioning only 50-60 per cent of the cost of the property and are not willing to give loans for a longer durations," says Niranjan Hiranandani, a premier Mumbai-based builder and managing director, Hiranandani Constructions.
The number was 85 per cent earlier. Higher margin money needs will make it more difficult for homebuyers to buy a house.
Stockmarket Crash
The fall of the stockmarket, halfway down from its historic high in January 2008, has contributed to a large extent to the negative sentiment.
There is no profit from equity trading to plough into real estate. Singh of www.99acres.com says: "A lot of people got burnt. It will take sometime for them to get their act together and start investing again."
Pay Hikes and Job Security
A home loan is a person's show of confidence in his income earning capacity over the long term. As the demand for high-ticket loans falls, it also signifies a dip in the confidence in job security and future salary increments.
After major financial institutions collapsed in the US, layoffs as well as pay cuts and freezes have gained currency in coffee-break banter even in India.
There have been job and pay cuts in the real estate sector itself. Even the high-growth IT sector, too, is in a spot of bother. HR consultancy Hewitt Associates has cut projections for average pay hikes in 2008 from 15.2 per cent in February to 14.8 per cent in August.
Industry insiders now believe it could even be as low as 5-6 per cent. Not much in terms of confidence-building information, is it?
These factors are together exerting downward pressure on affordability and none of them look like they are going to go away in a hurry.
The Supply Factors
Things are not hunky-dory on the supply side either. Part of that has been reflected in the stock prices of real estate companies, some of which have fallen 95 per cent from their peak.
The market has factored in the trouble such companies are in at present. Like buyers, companies, too, have been affected by the liquidity crunch. And the current housing stock is languishing.
Liquidity Crunch
During the boom, the developers had many options for raising funds -- borrowings from financial institutions, share issues, the booking amounts they took, and private equity.
"Banks exposure to the real estate sector (developers) has also taken a hit. They are not ready to sanction future loans and this has resulted in future supply getting affected," says Hiranandani. The lull in the stockmarket has closed off the IPO route. With buyers staying away, booking money is hard to come by.
"Sales of residential units have been severely affected," says Akshaya Kumar, founder and CEO, Park Lane Property Advisors, Mumbai. Most developers felt that demand would pick up during Diwali, but it did not happen, says Jai Mavani, executive director-head infrastructure and real estate, KPMG India.
A study by brokerage firm India Infoline says: "DLF could meet a large portion of its refinancing requirements from the non-DLF Asset (DAL) receivables. The situation remains precarious for others in our coverage, among them Unitech, Sobha and Puravankara. Omaxe, Parsvnath and Ansals also look weak."
The resulting liquidity crunch is biting even harder since many developers had overleveraged themselves during the boom phase. Now they do not have funds to go through with their existing projects. They have deferred future projects.
The worst part is that most of them have to pay off accumulated short-term debt. Now, financial institutions and banks are getting jittery about recovering their money and putting pressure on developers to cut prices and clear inventory to honour the debt repayment obligations.
Demand-Supply Mismatch
While the bulk of the buyers are looking for property for under Rs 60 lakh, the bulk of the units developers were building, especially after 2004-05, carried price tags of Rs 70 lakh-2 crore (Rs 7 million to Rs 20 million). But developers had a reason for doing so -- profit margins.
Says an industry analyst: "Major players in the premium segment have an operating margin of 50-55 per cent. On the contrary, in the mid-segment the margin is around 35 per cent."
While the average cost of construction of a high-end property was Rs 1,500-Rs 2,000 per sq. ft, it was sold at Rs 5,000-Rs 6,000 per sq. ft, even more in some cases. These units are now finding few takers and sellers are offering huge freebies with them to revive demand.
With repayment and cash flow pressures on developers, there is a limit to how long they can wait before being forced to cut prices to clear stock.
Here's an idea of how bad the situation is. Omaxe and Parsvnath have reported quarter-on-quarter sales decline of 42 per cent each, and Ansal Properties 27 per cent, in the second quarter of FY09.
"We believe that prices of houses will come down further, especially with cost of key inputs like labour and cement expected to come down, leading to lower cost of construction," says Sudhir Nair, head, Crisil Research.
The Selling Decision
If you are a short-term investor in property, you would find it tough to get the kind of return you were expecting based on the experience of the last 2-3 years. If you need cash and do not intend to hold on to the property for at least five years, this is the time to cut your losses and exit.
"You cannot afford to be too greedy; if you do, you will get burnt," says www.99acres.com's Singh. You have to be realistic about your price expectation and also be a little flexible during negotiations. If, however, you have a medium- to long-term horizon and no liquidity pressures, stay put.
This is a cyclical downturn that will be followed by a recovery, although it will take a while to come.
The Buying Decision
If you are planning to buy a house "wait till January-February 2009", says Pranay Vakil, chairman, Knight Frank India. If developers have to blink and cut prices, they will do so by then.
Interest rates, too, are likely to go down further, and that process will only be helped by the government's efforts to give housing a fillip and keep the economy rolling. Mavani says that this is the right time to start searching, although the buying can happen a bit later.
Given the financial health of developers, go only for ready-to-move-in projects. "If you feel it is reasonable and affordable, don't think too much. Go ahead and buy it. If you start thinking too much, you will never end up buying," says Singh. "If you are buying a house for self consumption, a 10-15 per cent swing in prices should not matter," says Mavani.
The Road Ahead
That prices must head south is inevitable. The question is when, and the answer will depend on who blinks first. While homebuyers have preferred to defer their purchases, builders haven't budged from the prices they announced and none of them have gone on record saying they will reduce prices.
Their bid to attract buyers with freebies has not met with much success either. So, say experts, now there is no option but to cut prices.
"A minimum of 25 per cent correction can be expected. Correction in Tier-II and Tier-III cities will happen a little more. Even cities like Mumbai could see significant price correction," adds Mavani.
Kumar of Park Lane Property agrees that a 10-25 per cent drop is likely. How much the fall actually is will depend partly on the location. In fact, prices have started falling in some places already.
| City | Location | Jan-Mar 08* | July-Sep 08* | % Decline |
| Delhi NCR | Dwarka | 6,938 | 5,871 | -15.38 |
| Noida Sector 61 | 5,333 | 4,694 | -11.98 | |
| Rohini | 9,327 | 9,082 | -2.63 | |
| Gurgaon Sohna Road | 3,957 | 3,858 | -2.5 | |
| Mumbai | Nerul | 6,677 | 4,607 | -31 |
| Malad (West) | 8,153 | 7,257 | -10.99 | |
| Mira Road | 3,194 | 3,122 | -2.25 | |
| Kandivali (East) | 7,288 | 6,932 | -4.88 | |
| Vashi | 6,190 | 6,049 | -2.28 | |
| Kolkata | Tollygunge | 3,112 | 2,580 | -17.1 |
| E M Bypass | 2,821 | 2,485 | -11.91 | |
| Bangalore | Hebbal | 3,967 | 2,310 | -41.77 |
| Whitefield | 3,327 | 2,288 | -31.23 | |
| Sarjapur Road | 3,588 | 2,778 | -22.58 | |
| Maleshpalaya | 2,076 | 2,031 | -2.17 | |
| Hyderabad | Jubilee Hills | 9,386 | 7,006 | -25.36 |
| Nizampet | 2,819 | 2,271 | -19.44 | |
| Miyapur | 3,404 | 2,877 | -15.48 | |
| Banjara Hills | 9,013 | 7,856 | -12.84 | |
| Kukatpally | 3,263 | 3,073 | -5.82 | |
| Pune | Kalyani Nagar | 6,392 | 5,326 | -16.68 |
The Right Price
Two crucial questions, however, remain: (a) What is a good price for a property? and, (b) What can you afford?
The price: Unlike for stocks, where individuals are mostly price takers, real estate is different in the sense that it depends partly on your bargaining skills.
Below are a set of tools you can use to see whether you are striking a deal at close to fair value. As prices are going down, haggle hard. If the seller is under pressure to pull out, your dream house can be a steal. That apart, check out the following.
Rental yield: The typical historical yield of residential properties in India has been around 5-6 per cent. The rental yield is the annual rent that a property would command divided by its market price, multiplied by 100.
During the boom phase, the rental yield in some cases had gone below 3 per cent. To give you an idea, around 2005, in Dwarka (West Delhi), you could have got a two-bedroom house (950 sq. ft), costing around Rs 22 lakh (Rs 2.2 million) on a rent of around Rs 4,700 per month, thereby translating into a return of only 2.56 per cent. In other words, prices had possibly inflated on speculative interest.
So, before you settle on the price, get an idea of the rentals that house (which you are planning to buy) would command and the prevailing prices in the area.
If the rental yield of the house is less than 5-6 per cent, then bargain further till you are able to get a price, which brings the rental yield close to the 5-6 per cent levels.
Benchmark to 2005 Prices
Says Vakil: "All the madness happened in the past two years. Before that the market had a lot of sanity and health. In the last two years, prices went through the roof."
Before you start negotiations, get an idea of prices that prevailed in that location around 2005. You can get this information from newspaper archives on the Internet, reports of property consultants that are available on the Internet, and by doing some research yourself by asking property brokers.
Once you have got an idea of the price, add around 15 per cent to account for inflation and start your negotiations. "This formula is holding very well in the commercial segment," adds Vakil.
Prices 25-35 per cent off Peak Values
There is another way you can get a fair value of a property. "Any property which is 25-35 per cent off its peak value should be a good bargain," says Kumar.
Mavani of KMPG echoes a similar view. "If one is able to get a property that is 25 per cent off peak values, then those are options worth considering," he says.
The affordability: The affordability index published by the Housing Development Finance Corporation (HDFC) will tell you which way the wind is blowing.
Around 2004, when affordability was at its highest, it would have taken around 4.3 times of an individual's annual salary to buy a house. At present, the figure stands at 5. Thereafter, affordability levels will vary between individuals. It would depend on the EMI you can afford and the downpayment you can make.
While the downward spiral in prices is expected to last for a while, you should use this opportunity to buy a house of your own before prices start to head north once again. That is still some distance away. "Perhaps by the end of 2009 prices will bottom out," says Mavani.
Adds Kumar: "If we see a recovery anywhere around 2010 Diwali, then we would have done very well." Till then happy house hunting!
How demand dampening factors will drive down prices
High home prices are making homebuyers defer purchases; price cuts are the only way to rope them in
High loan rates have made home acquisition costly. With gradual decline of interest rates expected, price reduction is the best bet to increase affordability
Fickle income security Prospects of job losses, pay cuts are making prospective buyers reluctant about big-ticket purchases funded by large loans.
Decline in wealth from stocks This fuelled speculative demand but is now non-existent, further dampening demand and realty prices.
Government Steps
The stimulus packages announced by the Central government recently did little to placate the woes of the developer community. While most of them had hoped for reinstatement of tax benefits under Section 80IB (10), there was nothing of that nature in the stimulus package.
The developers can, however, take comfort from the fact that prices of raw materials, such as steel and cement, that had already come down in the past weeks will cost them even less in the days to come. An across-the-board cut of 4 per cent in the ad valorem Cenvat rate will be effected for the remaining part of the current financial year on all products other than petroleum products and those where the current rate is less than 4 per cent.
The package however, did contain a lot for the mid-income as well as low-income houses. The Reserve Bank of India has announced that it will shortly put in place a refinance facility of Rs 4,000 crore (Rs 40 billion) for the National Housing Bank (NHB). Further, public sector banks will soon announce a package for borrowers of home loans in two categories: up to Rs 5 lakh (Rs 500,000) and Rs 5-20 lakh (Rs 500,000-2 million).
During the boom phase in the real estate industry, the middle-income and low-income groups did not receive much attention by the developers who preferred to concentrate on high-end housing.
With the government trying to revive demand in the middle-income and low-income groups, this section should see lot of action in the coming days. Already many developers have announced their plans to enter this segment, in a bid to revive sales, which have taken a severe beating, especially since January 2008.
