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
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.
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.
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