Last week I was having a discussion on Indian property market with an Indian friend of mine, who works at a real estate focussed fund in Singapore. His views were quite intriguing but in sharp contrast to what I had written earlier. I thought of sharing few of our discussion points with you.
Snapshot of his viewpoints on Indian Real Estate are listed below, followed by my comments in italic:
1. Property prices are quite over-priced while rental yields are too low. Hence property doesn’t make as a sound investment & prices will fall to remove this anomaly.
my comments: Agreed on low rental yield. India is probably the only country where the spread between the borrowing cost and rental yield is so high. In most of the developed economies the borrowing cost is either equal to or lower than the rental yield even on residential properties. Indians buy real estate primarily not for rental yield but for capital appreciation or self use. In fact majority of our population shall continue to buy properties for self use. For investors historically a decent property has delivered double-digit annualised return on capital value. However this may not hold good any longer. Still we can expect 5% – 8% appreciation on capital value (price) if we buy under-construction properties or those in pre-launches. With tax benefits & power of leverage we should be able to make lower double digit return (10-13%) on our investment when we exit.
2. Property prices will fall sharply because majority of population cannot afford to buy real estate in India.
my comments: Sorry this is not going to happen as nobody sells below the cost of production. Barring few opportunistic development in Mumbai, Real Estate is no longer a high margin business for rest of India. I shall be quite surprised if any worthy builder makes more than 20% post-tax ROI on its investment. So out of desperation if any correction has to happen it shall happen by around ~5 to 10%. Reason being, as I discussed in my earlier write-up, real estate is like a services industry operating on a “cost +” business model. If you look at the cost side of property development business, the biggest cost item is land. So long the land prices don’t come down the price of end products won’t come down either, no matter how much we think otherwise.
3. To improve market sentiments & make property affordable, sizes of properties need to reduce further in sync with those in global cities like Singapore, Hong Kong, London or New York.
my comments: This has already happened in Mumbai where a 2BHK size is around 600 sq ft. It is also happening in markets like Bangalore where an average 2BHK size has come down from 1400 sq ft to 1000 sq ft in less than 5 years, just to improve “affordability”. So how much does one expect the size to reduce further to make it more affordable? Even animals in zoos have larger cages to live in. Add to that we have horrible infrastructure and pathetic quality of life. We travel for hours everyday just to commute few Kms from home to offices. Hence people will continue to live near their places of work and unwillingly pay a premium on rent or price.
Higher property prices and horrible quality of life is a sad reality of urban India. So long we don’t build newer, smarter & liveable cities on the lines of great western cities we shall continue to suffer. Prices are not going to crash as we are not making land anymore!!