The boom and fallowed by the mild slowdown, Indian policy makers are now trying hard to ease its regulations and encourage FDI into the sector.
India has come a long way during the last two decades backed by a strong middle-class and the youth who make up half of its population. It is a young nation, with businesses enjoying good times. India is now one of the fastest growing economies in the world after China. Amidst these developments, the real estate market in India has witnessed significant changes in the last few years and is witnessing another boom spurred by the IT and BPO businesses, and availability of cheap housing loans. These factors have created a new demand for commercial and residential houses.
Most importantly, FDI is now allowed in real estate in India. Overall, the sector is scaling up, of course against many odds: unclear titles, absurd tenancy laws, poor building standards, etc. With the ongoing liberalization in the sector, various foreign investors have shown a lot of interest to participate in the real-estate industry in India. And the industry looks all set to emerge as a big opportunity for investment.
Behind the Recent Past Boom
Over the last decade, the average household income in urban areas has grown at a CAGR of 5%. According to estimates, 80% of the real estate developed in India is residential space and the remaining 20% comprises offices, shopping malls, restaurants and hospitals. According to the 10th Five Year Plan, there will be a shortage of 22.7 million housing units by the year 2007. The changing lifestyles of Indians and better incomes have led to the development of retail and hyper malls. This, in turn, has led to the demand for space from the retail sector. Besides these driving factors, Venkat Raja, Senior Advisor at Real Estate and Infrastructure Research, RREEF/DB Real Estate, a global real estate consulting firm based in the US, says, “The primary drivers of real estate growth in India are: acute shortage of quality real estate; increasing consumer spending and affordability; changing demographics; gradual improvements in infrastructure providing access to lower cost land; governmental relaxation of legal barriers to investing in real estate and a general decline in term structure of interest rates.” The government is preparing to open up retail trade to FDI and the entry of global retailers, such as Wal-Mart, Carrefour and Tesco, is expected to fuel demand for commercial space in the coming days. However, with increasing interest rates during the past six months the dreams of owning a house has became a distant dream today for most people.
Alarming Signals
Amidst the euphoria, it would be prudent to tread with caution. As history suggests, such euphoria has led bubbles in countries like the US and the UK. Japan has also had its share of pain. And who would forget the real estate mania witnessed in South Asian countries in the late 1990s, which ultimately culminated in a grave economic crisis that threatened to engulf other nations too.
The rapidly rising prices in the real estate market give rise to fear about a possible bubble in the making. If we go by the rate of Rs.50,000 and Rs.70,000 per sqare foot in Mumbai and housing plots in Delhi’s suburb of Gurgaon at Rs.100,000 per square yard, it is very clear that an asset price bubble is building up. Especially, when watching the key ratio that relates construction cost to sale price. The construction cost of most flats on the market today will be between Rs.1,000 and Rs.2,000 per square foot, depending on the quality of work and the materials used. Experts opine that when the real estate sector reached the stage where a premium flat in Mumbai commands a higher price than the average flat in Manhattan (about Rs.40,000 per square foot, after a prolonged boom in house prices), although construction costs in New York are five times as high as in Mumbai, it is time to raise the red flag.
But there is a difference between a bubble and a robust market. Most of the Indians are not in a position to have more houses. If one compares India with the US, in India the ratio of the total value of mortgages to the GDP is only 2%, whereas, it is 52% in the US, which means in the US, for every $100 of American produce, they owe $52 as mortgage. But, in India, we owe just $2. Moreover, over the last 10 years, real estate prices have almost remained the same in India, with the exception of a few large cities like Bombay, Delhi, Bangalore and Hyderabad. To put it in another way, Indian home buying prices have not gone through the roof. However, Venkat Raja opines, “A short-term softening of the real estate markets may be healthy for the Indian economy since the role of speculative investors will be minimized. I do not expect a dot-com type bubble because the underlying demand supports the continued growth of the real estate markets. Secondly, real estate valuations are based on contractual cash flows of properties. There may be a decline in valuations depending on imbalance of demand and supply. However, such imbalances correct themselves over a period of time.”
It’s a robust market instead of a bubble if we go by the issues like – it is natural for house prices to rise when the economy is doing well and incomes are rising and interest rates are low. Economists say these factors encourage investment in housing, so demand increases and there is nothing wrong with that. The issue that should attract policy makers’ attention is the supply side: What they are going to do to ensure that supply grows with demand, so that prices stay reasonable.
Challenges Remain
Investors face significant risks like – inadequate infrastructure such as roads, electricity and water; the poor records of land ownership; difficulty in determining whether a piece of land has a clear title or not; the bureaucratic processes to acquire clearances like transfer of use of agricultural land for development; followed by the use of black market money in land purchase transactions. Besides, other factors like the proper implementation of real estate laws, regulation of stamp duty, and rent control will pose serious challenges. “The risk of litigation and procedural delays are a big challenge,” says Gagan Banga, a Director at Indiabulls Property, a joint venture between a local brokerage and Farallon Capital. A recent purchase by the company (an eight-acre plot that once housed a textile mill in Mumbai) from the state-owned National Textile Corporation is embroiled in litigation because its previous private owner has challenged its nationalization.
As Marc Faber, the renowned investment guru, put it, “The most overlooked asset class is Indian real estate, because it is so difficult to develop, given the regulatory environment. The world still has lots of opportunities, and real estate in some unusual areas is an attractive proposition.”
Going Forward
Against the real estate boom and fallowed by the slowdown, the country is now trying hard to ease its regulations and encourage FDI. Accordingly, investments started flowing into the sector. Driven by the IT and outsourcing booms, more and more foreign companies are setting up shop in India. Five million square feet of retail space is being developed.
And over $25 billion will be spent on urban housing. Raja is very bullish about the future of Indian real estate. He says, “The Indian markets will be able to sustain this boom on a long-term basis. In the short-term, the markets may correct themselves in response to speculative increases in real estate valuations. The demand factors do point to long-term boom in real estate. The primary challenges to this growth will be continued growth in infrastructure and prudent bank lending practices.”
Earlier, International players have entered in a big way to invest in South-east Asian countries like Malaysia, Indonesia, and Thailand. These countries have attracted several investors successfully, followed by China and Dubai as the next favorite destinations. However, investors are not comfortable going by reduction in capital appreciation and return in these countries. At this juncture, investors and global developers are now eyeing on India as the next most favorite destination to play a vital role. Now, it is high time for India to make attractive policies for international developers to come to this country in a big way.
A recent Goldman Sachs report predicts that India’s economy will be larger than Japan’s by 2030, and that, by 2050, India will be the third largest economy after China and the US. India’s population growth along with rapid economic expansion will result in a tremendous demand for high quality commercial and residential development, thereby providing a compelling opportunity for foreign real estate investors. The trends supporting India as the next “hot” real estate market are indeed promising.
N Janardhan Rao, Lead Economist.
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