Cluster Development: A medicine worse than the disease

The Maharashtra State Government has tabled a scheme for Cluster Development of housing projects in Mumbai. Read my views on why the scheme is harmful and needs to be scrapped here.

Returns or Inflation?

Between July 2008 and today, the Indian Rupee has lost 40 % of its value.

Talk about rising prices, and discussion in the media inevitably revolves around the Inflation Rate. The Finance Minister talks about the Inflation Rate, so does the RBI Governor, the experts on TV channels and journos from the print & electronic media – all you get to hear from them is the Inflation Rate. Further, more often than not, they refer to the WPI (Wholesale Price Index), while what matters to the people is the CPI (Consumer Price Index). A meaningful analysis of how rising prices are hitting the venerated (just for namesake!) 'aam aadmi' is therefore, conspicuous by its absence. To understand why I say so, you first need to know what the problem with the Inflation Rate is.

This is what they show you - falling inflation (click to enlarge)

The Inflation Rate shows the difference between price of a commodity (or price index) over a period of one year. It compares the current price of a commodity with its price at the same point of time a  year ago. So if the price of loaf of bread was Rs.20 exactly one year back, and it is Rs. 22 today, we say inflation rate is 10 %. (Rs.2 over Rs.20).

But the inflation rate completely ignores prices more than one year away. If your perspective is long term, as it should be, the current inflation rate will tell you nothing about how prices have risen over a longer period of time. If prices double in a year, and remain where they are for another year, you will get an inflation rate of zero, though over a two year period, prices would have gone up by almost 50 % per annum. Therefore, while inflation rate has its uses, it is also important to look at the actual price index itself, to get a proper perspective on prices. Unfortunately, the media, and their  so-called experts are rarely interested in such finer details.

This is what the truth is - ever rising prices (click to enlarge)

Take a look at the news items, such as this or this or this Rarely will you find a mention of the actual price index. So I thought it would be worthwhile to see what was has happened to prices actually, rather than the inflation rate since July 2008. I used the Consumer Price Index (CPI), and not the Wholesale Price Index (WPI), since that is what matters the most to the people. What I found out was what I told you in the first sentence of this article – the Rupee has lost 40 % of its value in the last three & half years. The CPI (IW) which was at 143 on  31^st July, 2008 stood at 199 on 29^th February, 2012, almost 40 % higher. What does this mean? In simple terms, what ever Rs.100 could buy in July 2008 costs Rs.140 today. 

Now, if you were to adjust any of the current prices to this, you will get the real picture of price increase / decrease during the period. Adjust Sensex or the Nifty to this, and the indices which apparently have given a return of 24 % during this period actually end up with a loss of 11% ! Even property price rise has been very modest (19 % in 3 & 1/2 years) while Gold has performed the best.

As on	31-Jul-08	29-Feb-12	29-Feb-12*	Real Returns
CPI (IW)	143	199	143	0%
Sensex	14356	17753	12757	-11%
Nifty	4333	5385	3870	-11%
Gold@	12530	28599	20551	64%
Property#	117	193	139	19%

(* Inflation adjusted level) (@ MCX Spot price per 10 gms) (# NHB's Residex for Mumbai) (All Returns are absolute, not annualised)

To assess the price performance of anything over the long term, you need to deflate it with the price level. That is when you will get the real picture.   

Note: In 2011, the Government issued a new series using 2010 as the base. As per the new series, the inflation rate is 9.45% and 10.30% for Urban India in February and March 2012 respectively, even higher than what the above figures indicate. For want of adequate history, I have used the old series of CPI in my calculations above. 

Property Prices - Part II

(This is the concluding part of a two-part series on property prices. The first part is available here. We continue from where we left off……)

The Central Government has proposed to set up a Real Estate sector Regulator ‘to ensure transparency and ensure fair practices’ (see here). The draft Real Estate (Regulation & Development Bill, 2011) proposes steps such as compulsory registration of projects with the Regulator, deposit of money collected from home buyers into an Escrow account to avoid diversion, setting up of an Appellate Authority to address complaints and grievances and stiff penalties including jail terms for guilty developers. Though the provisions of the Bill are welcome, the Bill will do nothing to increase supply and bring down prices.

Can the demand come down? In a country like ours, it seems impossible unless we are talking about a calamity of such massive proportions that buying property will be the last thing on anyone’s mind at that time.

My belief is that normal economic cycles such as an industrial slowdown and high interest rates are just not enough to cause a sustainable price correction in property prices. What are needed are sweeping legal reforms with far reaching implications. Some suggestions that come to mind: 

1. Eviction of an uncooperative tenant needs to be made easier. Then a big chunk of supply (click here) currently locked up empty will come into the market. The ‘stay order’ culture has to end. 

2. Transaction costs are just too high. Stamp duty, registration, service tax, VAT etc. add to almost 10% of the cost of the flat for the buyer. What the seller sells for Rs.50 lacs costs the buyer Rs.55 lacs. Atleast the first flat for every buyer should be made tax free. Getting a decent place to stay is a basic necessity of life, a Right as much as Right to Education or Food or Freedom of Speech. 

3. Stamp duty based on the value of the agreement provides a strong incentive to under report the transaction value. Today, it is almost impossible to complete a transaction without the ‘cash’ component. This reduces government revenues, which ultimately is compensated by higher taxes from those who pay. Stamp duty should be made payable based on the area of the flat or the ‘ready reckoner’ rate alone, not on the value of the transaction. 

4. Technological solutions that allow mass production of houses in some kind of CKD (Completely Knocked Down) form should be promoted. Such technologies exist, such as pre-fabricated buildings (click here) but need to gain wider acceptability. The governments have to drive this. This is the only way supply can be increased dramatically.

It is too much to expect innovative solutions that genuinely help the people from our present crop of politicians, who are actually beneficiaries of high property prices. A large chunk of their legitimate and illegitimate wealth is invested in property. From time to time, populist announcements such as increase in FSI or redevelopment of old buildings or mill land are made to pacify a gullible population. But such steps can never change the demand – supply imbalance and bring down prices. The batch of college students who is passing out today is not going to ever be able to buy a decent house in Mumbai.

In the long run, this will feed into social unrest. Social unrest can manifest itself in any manner, not necessarily into a demand for cheaper homes. One day, a benevolent dictator may decide that legislative fiat is the only way to alter the situation and dictate ‘all tenants become owners from tomorrow’ (or something similar). Such instances are not unknown to history.  This may seem far fetched today, perhaps it is, but we are heading in that direction only.

Until that happens, do not expect a correction in property prices. Getting a decent accommodation in the city of work will remain a pipe dream for a major part of the Mumbai’s population. “Affordable housing” is just a slogan, unless you believe that staying in Boisar and working in Mumbai is a life.

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)