"Affordability is the key to viability" - Deepak Parekh, HDFC Chairman

In an interview reported in Business Standard, Deepak Parekh (HDFC Chairman) talks about affordability and why he is not bullish on Indian real estate. Its a great read.

For the complete interview click here.

He is touching upon one thing which has been missed in the whole Real Estate media coverage. He talks about how India will start losing business at the existing real estate prices. According to him Indian real estate is not a bubble but a correction has to ensue. Hats off to Deepak Parekh for what he is doing, inspite of 'everything is great, we are going to the moon' euphoria around.

RE Lite

RE Lite Question: Is there a real estate bubble in India?

Deepak Shenoy's chai vendor-real estate agent picture is worth a thousand words....

If ever anyone compiles a link of contrarion indicators for real estate market, chai vendors selling real estate should make the list.

Affordability

When justifying/reasoning the current surrealistic increase in real estate prices in India, people come up with quite a few reasons. Most of the reasons answer the question 'Why the prices have gone up?', but most of them do not answer the question 'Will it help sustain the current prices?'. Let me try to answer that question with whatever knowledge of economics, real estate and India I have. I'm considering only residential real estate.

Price for anything can be sustained only if it can be afforded at that price. Else prices have to come down or affordability has to increase or there has be a french revolution! I do not see any other way out.

Most common reasons given for the current sky-rocketing real estate prices

• FDI
• NRI money
• Economic Growth
• Demographic dividend
• Land is limited
• Population is dense

Demographic dividend is a future scenario. Land and Population have all been roughly the same for the past 5 years, nothing dramatically has changed in the recent past (our population has been growing at a slower rate for the past 5 years than the previous 55 years).

So then it should be the first 3 reasons. FDI, NRI Money and Economic Growth. Economic growth has been robust in the past few years, but this cannot warrant the sky high prices prevailing not only in Tier 1 and Tier 2 cities but also in Tier 3 and a few other places.
Let us look at this from a different angle.

I think we all can agree that if land prices keep on increasing at a pace more than the salary growth of the population, eventually the whole population will be priced out of the market. So this cannot happen. Prices have to stabilize and go up according to salary growth. For prices to stabilize there should be people who could afford to buy at those prices. If there is no one to buy at certain prices, prices will/should start coming down.

Let us do a simple calculation for affordability.

Apartment Price: Rs 30,00,000
Interest Rate: 10%
Interest per year: Rs 3,00,000
Interest per month: Rs 25,000

If a person pays Rs 25,000 in interest he can get a tax break of Rs 5,000. For a person to pay Rs 20,000 per month, he/she should be earning a minimum of Rs 50,000 per month in hand. So that equates to around 65,000 to 70,000 per month before tax. Per year earnings should be ~7,50,000.

I have not taken into account any capital payment, apartment maintenance, house tax. Also I've used a ratio of 2.5 for rent/earnings. The historical value has been around 3-4.

If you use a ratio of 3, you will end up with ~9,00,000 - 9,50,000 salary.

So now the question is, how many people in India are earning this kind of money. Also this is for an apartment priced at Rs 30 Lakhs. I've seen average apartments being priced at Rs 40,00,000 to Rs 60,00,000 in Bangalore, Pune, Mumbai, NCR, Chennai and Hyderabad. Coimbatore is not far behind with prices up to Rs 30,00,000 for an average apartment.

In simple words for anyone to afford a Rs 30,00,000 apartment they should earn around Rs 7,50,000 per annum. For anyone to afford a Rs 50,00,000 apartment they should earn roughly Rs 11,00,000 per annum.

Now let us talk about the NRI and FDI money. With the average Indian living in the city not able to afford real estate, will just the NRI and FDI money be able to sustain it? I think not. NRI and FDI money will evaporate quickly once the real estate appreciation stops. And it HAS to stop.

Based on how many people you think are earning Rs 7,00,000 and up, per annum you can decide whether Indian real estate is in a bubble or is over heated or is just fine and dandy.

Is there a bubble in Indian Real Estate?

3 weeks back I wrote a mail to Amit Varma of Indian Economy Blog. Amit was kind enough to post it in their blog. It recieved a good response and there was an interesting discussion in the comments section. This is the excerpt of my post and my initial response to the comments. For the complete post and discussion click here.
______________________________________________________________

I’ve heard and read reports about 5-15 times increase in land prices in Coimbatore, 1.5 crore apartments in Mumbai, 10% increase in apartment price every week in Hyderabad, Rs.27 Lakh apartments in Chennai (which will yield at the max Rs 7,000 in rent per month), Rs 50,00,000 apartment in Pune.

Being in the midst of a bursting housing bubble in US I sat down and came up with a rough calculation….

Chennai:

Residential Apartment in Velachery (close to IT shops): ~1000 sq.ft

Cost: Rs 27,00,000
Interest Rate: 8%
Interest Cost: Rs 2,16,000 per year
Tax Cost: Rs 4,000 per year
_______________________
Total Cost of owning the house: Rs 2,20,000 per year

Rent per month: Rs 7,000
Rent per year: Rs 84,000
________________________
Total earnings from the house: Rs 84,000 per year

Without deducting maintenance costs the percentage of returns on this investment will be 3.11% (less than inflation).

For this investment to make any sense, the rental value of the apartment should go to Rs 20,000 per month (Rs 2,40,000 per year). This is completely absurd as this is not going to happen (even the person who bought this apartment scoffed when I mentioned it).

The only option for this scenario to make sense is for the apartment value to come down, which means it is a bubble.

The buyer of this apartment is actually betting on the price appreciation of the apartment rather than the rental income (This is pretty similar to the greater fool theory).

• People are investing in real estate currently not based on current rental returns.
• They are investing based on either one of the following
  
  • future price appreciation
  and/or
  • future rental growth.

I’m not sure if there is anything else. For some investors socio-psychological reasons can be there, but I doubt how much percentage of the real estate investors fall in that group.

• The price appreciation (15% - 200%) seen currently is not sustainable. ( for argument sake if it is going to increase at this scorching speed, in 25 years new generations will have to live in tents/huts, it will be so much unaffordable ).
• The prices have to stabilize ( at or near inflation rate and growth rate.. how many ever years it takes).
• Once the prices stabilize the rental returns have to make sense.

Let us assume a very rosy picture of prices stabilizing at the current levels. So now the real growth due to all the factors (NRI funds, Foreign funds, local growth ..) the actual person living in the area should have grown to a level where he can pay Rs 20,000 rent for this apartment. The question is will that happen? If yes when will it happen? Will it take 5 years, 10 years or 20 years. Based on what we come up with, that many years of growth is already priced in.

• So now either the prices can remain flat and meet the rental curve sometime in the future.

or

• Prices can grow and still take a longer time for the rental curve to meet the price curve.
  

or

• Prices can come down and meet the rental curve.

I’m betting on the 3rd possibility. But based on the responses am seeing for this type of discussion and exuberance abounding I feel it might take a couple of more years for that to happen.

Welcome to the Surreal State (of Real Estate in India)!

Welcome to the Surreal State (of Real Estate in India) Blog. We have plans to blog about anything and everything related to Real Estate in India. Some posts will be informative, some will be anecdotal and some might just be purely entertaining. Either way the idea is to have fun, talking about the current Surrealistic State the Indian Real Estate has reached. Being the 'Argumentative Indian' that we all are, we will also have differing views and arguments.