Sunday, December 18, 2011

Why property prices did not fall, and will not. Unless....

(This is the first of a two part series on this subject)

The Reserve Bank of India (RBI) seems to have completed one full series of interest rate hikes with its pronouncements in the latest monetary policy announced this week (full text here). But despite almost two years of continuous interest rate hikes, industrial slowdown, scams and what not, and the prognosis of some experts, property prices have remained stubbornly high. With the talk now turning to when the RBI will reduce rates, you can discount any chance of a price correction. In this two-part article, I pen down some thoughts on Mumbai's property market, based on my observation of the business.

I. Demand:

1. India has 17% of the world’s population (see here), but just 2.3 % of the world’s land mass (see here). From this, if you reduce the land occupied by its water bodies, deserts, forests, hills & mountains and agricultural land, the land available for civil habitation reduces even further. It is only natural that India should have one of the most expensive land rates in the world. Reports such as this should not take you by surprise. 

2.  Considering the population growth rate around 30 years ago, demand today might be growing at 1.1 % p.a. or around 75 lac houses per year for the country as a whole. (Here I have assumed that a person enters the property market at the age of around 30 and two births create a demand for one house 30 years later)  

3.  To this, you can add demand caused due to migration from rural to urban areas, and move from smaller homes to bigger homes due to rising prosperity, and it is clear that the actual demand growth is much higher  than 1.1 % in cities like Mumbai. The economy just cannot build enough houses to keep pace with it. 

4. Property is also bought as an investment. People don’t mind buying a flat and simply locking it up. This absorbs supply without meeting demand of those who want a place to stay.

II. Supply: 

You cannot manufacture buildings on an assembly line
1. You just cannot mass produce houses, as if on an assembly line. Construction is a highly labour-intensive manual process. My observation is, even for a medium sized project involving a few buildings, a few hundred apartments which will accommodate a couple of thousand families, it takes anywhere upto 4 years from the time a project is announced to the time the last of flat is built and families can move in. By that time, demand would have gone up manifold!  Does the economy have so many project managers, architects, civil engineers, labourers, plumbers, electricians, carpenters, etc. who can work cohesively and dramatically increase supply? The truth is - supply can only increase inch by inch, while demand is increasing by leaps and bounds. In my opinion, this is the single biggest factor that drives prices in a country like India.

2. A builder may need as many as fifty different approvals from various government departments to get a project cleared. At each stage, he either faces red tape or bribery. This either reduces supply or increases the cost to the ultimate buyer.

3. Builders ‘release’ only a few flats for sale at a time, usually the least saleable ones first. They have enough supply of money, formal as well as informal, to enable them to hold on to their inventory. If they find themselves in trouble, banks restructure loans to protect their own NPAs. So there is no urgency for the builder to sell. This happened in 2009. 

4. There are thousands of flats lying empty and unused in Mumbai and elsewhere, just because the owners don’t want to risk renting them out. This supply is permanently out of the market. 

5.     At a systemic level, the leveraging among buyers is just not high enough to force distress selling due to a marginal interest rate hikes, such as what we have seen: 3 to 4 per cent increase over a two year period.

In other words, the supply - demand gap is just too much to allow normal economic cycles to induce a price correction. Even the hint of a correction will bring in a hoard of buyers at support the market.

(to be continued)

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