Time to get real about prospects of real estate

By Priya Sunder

India’s property market is fundamentally flawed. It is unusual in any part of the world that one would borrow at 10-12% and willingly accept a yield of 2%, on an asset where capital appreciation is marginal or non-existent.

Why is the real estate market so out of kilter? The imbalance between investment and return can be squarely attributed to the large parallel economy in the real estate market. Larger the volume of black money, higher the cost of real estate.

There are three constituencies who participate on the demand side of this market. The first is those who buy property because they need a place to live. This group is the most authentic, natural market. A larger proportion of this group will ensure a long-term, sustainable growth.

The second is those who buy property to rent. People have surplus cash, and like their investments in other asset classes, they invest part of this surplus in property. They hope to derive a rental yield, or perhaps sell the property for capital appreciation. Without placing big bets on capital appreciation, robust rental yields are an indication of a developed property market. In most parts of the world, the buy-to-let market is a significant part of the overall property market because of its healthy returns.

The third constituent comprises of people who have surplus cash that they can’t fully account for. It’s not easy to deploy such money into financial markets because it leaves a long trail. That money historically, and even today, finds its way into gold or property. The buyers wanted an avenue to route black money to avoid scrutiny. For the longest time, no questions were asked. Many builders used this money to settle payments towards the unorganised sector such as labourers, contractors, sometimes even mafia.

As a result, people who bought property with such concealed cash did not expect any return on investment. Their behaviour was akin to hiding money under a mattress. The property could even be locked for decades to avoid tenancy hassles. Even when it was rented, they were happy with a trivial rent, and that is the reason today’s rental market is content with a 2-3% yield.

The NDA government’s thrust on eliminating black money resulted in demonetisation, post which a large amount of unaccounted cash found its way into banks. We see that as the pressure on the parallel economy increases, regulations strengthen and RERA grows teeth, each property transaction will become trackable and traceable. This will result in more builders becoming organised and professional, eventually leading to the decline of black money in this sector.

Every market operates on the principle of demand and supply. In the real estate market today, there is excess supply and low demand. With the tightening around regulation and compliance, the cash component of the real estate market has shrunk, resulting in dwindling demand. Also, people who bought property to sell find that they are having to sell at a loss. To avoid the loss, they postpone the sale, thereby minimising real estate transactions.

When demand starts to shrink, there will be pricing pressure. Prices must fall and reset to reactivate the market. A new equilibrium must be established for the market to stabilise. When this new price level is reached, the cost to acquire property will be less, translating to higher rental yields.

What does all this mean for someone who owns a property and is looking to sell; for a tenant; or for someone interested in buying real estate today?

From an owner’s perspective, you may find yourself in a situation where you are unable to sell your property even at cost. You can either hold on the property and hope that prices increase in future, or you can choose to sell at a lower price today, invest the proceeds in another asset that grows faster and recover your loss.

If you’re a tenant and not approaching retirement anytime soon, it may be a good idea to continue renting. If renting property is not such a great deal for a landlord, it is a great deal for a tenant. You can live in a ₹1 crore property by paying rent at 2-3% of its value. Not owning a property gives you the greatest flexibility in terms of job changes or location changes. However, if you’re approaching retirement and don’t want to deal with the uncertainty of living in a rented property, you can buy property provided it doesn’t affect your financial independence.

As an investor, you are aware that the property market is not likely to go through the roof anytime soon. Unless you find distress sales, it may not be worth participating now because you would be better off investing in other asset classes that have a faster rate of growth.