Monday, 20 April 2015

The argument for lower real estate prices

As the chart shows, India ranks quite poorly when compared with its other Asian peers on rental yields, or gross annual rental income as a percentage of property purchase price. The very low yields point to an “over-valuation” of this asset class, says Ambit Capital. A primary reason, says the brokerage, lies in the fact that the real estate industry is known for its exceptional capacity to absorb black money.

While official figures that quantify the size of the black economy are not available, research suggests that more than 30% of India’s real estate sector is funded by black money, said Ambit Capital in a report last month. The exorbitant property prices coupled with higher interest rates and an insufficient rise in income levels have made buying a home a distant dream in this country.

But respite on prices may just be in sight. Wielding the stick on black money, as the government seems bent on doing, should help reduce the preference of land as an asset class. This should, therefore, put downward pressure on property prices in the country.

According to Samar Sarda, an analyst at Kotak Institutional Equities, the state governments have been consistently increasing the ready reckoner/circle rates and have made the calculations a lot more quantitative and closer to the market value. This has reduced the use of cash in apartment purchases, added Sarda. Lower rental yields have also meant that the difference between the lending rates and yields is the highest in India, compared with peers (see chart).

In a fairly-priced real estate market, rental yields are supposed to be somewhere close to the cost of borrowing. “Instead, Mumbai has a rental yield close to 2% whilst the lending rate hovers around 10%,” says Ambit. According to the brokerage firm, even if one assumes buyers are willing to live with only 5% rental yields (as they might have an extremely bullish view of capital gains arising from real estate in India), this would imply halving of real estate prices in Mumbai.

While that would be too much to hope for, it would imply prices may remain stagnant for longer. The fact is that real estate prices in the metropolitan cities have remained stagnant in the recent past. Madan Sabnavis, chief economist, CARE Ratings, says another 3-4% downward correction cannot be ruled out.

No comments:

Post a Comment