The current Real Estate scenario: Can it derail the economy By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

August 3, 2015 | Posted by bobbysrinivasan << back to blog

Real Estate plays a very vital role in our economy. One out of three jobs created in India happens to be in real estate. Besides the 50% of capital expenditure is related to construction activities. Recently this sector is facing several challenges which will affect the economic growth of the country. House price data from the property websites suggests that in most neighbourhoods in tier 1 and tier-2 cities the prices are falling 5 – 20% per annum. The reference is the ready reckoner rates (guideline values) which are set by the state governments. Currently the ready reckoner prices are significantly above the market clearing prices. As a result transaction volumes in the property market have dropped this year after falling 10-15% per annum over the past 3 years. Prop equity suggests that in the major cities new launches are down by 50-80% per annum. Why is this so?

RBI data suggests that the banking system have turned the tap off for property developers over the past year. This has made the developers either stop construction or cut prices.
NDA has cut subsidies by 9% in 2015-16 and shift subsidies to direct benefit transfer. As a result the ability of the politician cum builder to pilfer subsidies to fund real estate is checked.
The unsold inventories are causing investors to hold back.

On the demand side there are several issues as well,

The effort to eliminate black money from the economy by the government. This is the major source of funds for the real estate. Controlling black money would considerably drop the price as well as demand for properties.
The rental yield is around 2 to 3% of the asset value. The cost of funds from the bank loan is in excess of 10%. The cost of borrowing is going up because of the NPA of banks. This spread will continue to increase making it less and less attractive to invest in real estate.

More importantly real estate plays a central role in our economy. Construction activity accounts for 50% of the total Indian capital expenditure. Construction industry is a major employer. With less or no work the labourers are finding their way back to villages. Even for the employed, their wages are dropping and combined with the poor monsoon the village economies are facing serious problems both economic and social. The cement industry is now facing a serious turmoil due to the drop in housing demand. The banks are also facing major issues because nearly 15% of loan and advance go to the real estate sector. Part of the current high level of non-performing assets (NPA) is due to this. Like in the sub-prime crisis of 2008-09 in the US, Indian economy is just overloaded with unsold houses. It is not clear as to whether the banks could unload these houses. In summary it appears that the real estate is going to be a major drag in the economy. Perhaps a big support from RBI by lowered rates of interest could help but will they do it is a million dollar question.

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