Yesterday I came across this article on TOI which says & I quote: “RBI governor Raghuram Rajan put the onus on real estate developers, asking them to reduce prices to encourage more people to buy properties. Rajan’s remarks came against the backdrop of low demand for housing projects, leaving developers with unsold inventories.”
Though Governor Rajan’s concerns are genuine his remarks are misplaced and devoid of practical ground realities. Real Estate operates on a “cost+” model rather than “price” model. Gone are those days when there use to be high double digits or even triple digit margins on projects.
Let’s look at the typical cost structure of a mid-size (5 to 6 acres) mid-rise (Ground + 11 structure) real estate project in a reasonably developed location within Bangalore City limits:
Note: (Above cost per sq ft is on saleable area of the project) The above cost doesn’t include bribes paid to government officials & politicians at every level. Reasonable cost of bribes is around Rs. 100/- per sq ft & may be more in CBD areas. So from the above table we can assume the per sq ft cost of project is a minimum of Rs. 4300/- per sq ft.
Assuming a sales price of Rs. 5000/- per sq ft the earning before taxes is Rs. 700/- per sq ft. Post tax (@34%) the profit on the project is Rs. 460/- per sq ft which is only 10.7% margin on the project cost.
Now this is a best case scenario. Imagine the project gets delayed (not all delays can be attributed to the developer) say because of some unscrupulous litigation or labour / tuckers strike. Every year of additional delay will increase the cost of finance & construction which cannot be passed on to the existing customer. At the end the developer will plan to increase the end price to mitigate its effects. However in the current scenario when the products are not selling the developer has to absorb any incremental increase in the cost which further squeezes its margin.
So where is the scope to further reduce the prices? Do you think it is worth doing this job at such thin margins when you have to deal with all sort of people on a daily basis right from the inception of project idea to the handover of the project?? Not at all!