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8/9/2019 Topic6-ShilpiKeshari

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WINNERCRISILYOUNGTHOUGHTLEADER2010

ShilpiKeshari

IIFT,Delhi

RealtyPrices:Isitabubblewaitingtoburst?


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Shilpi Keshari |IndianInstituteofForeignTrade(IIFT) Page 3

ExecutiveSummary

The rapid growth of the real estate market in India in the recent years has raised concerns

about its sustainability and implications for financial and macroeconomic stability. The real

estate bubble builds up when certain factors lead to irrational rise in prices. India is seeing a

current trend in price rise, both in residential and commercial property, which can be called a

bubble and may burst. Besides local factors like locality having basic amenities,

macroeconomic factors like countrys economic, commercial and industrial growth too

impact real estate prices.

The experience of housing bubble and ensuing crisis in USA and Japan act as examples for

India to learn from. As per IMF research in the World Economic Outlook (April, 2003), on

an average the impact of housing bubble on economy is twice as large as that because of

stock market crash in developed nation. India being a developing nation gets a breather but

with a growth-rate of 7.4% the regulators need to be on constant vigil for any sign of looming

crisis so that steps can be taken to prevent it.

The paper attempts to analyse the factors that can lead to Realty bubble burst and trends that

are currently observed in India. It tries to see role of increasing household debt in the recent

crisis. Finally it tries to analyse if the bubble present in India will actually burst in recent

times or not by taking into consideration both view and counterviews supporting a bubble.


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The main attempt is to find the scenario for real estate based on reasoning and information

pertinent to India.

ABubble!

Increase in value of a real estate not supported by its fundamental valuation leads to a

housing bubble, and when it bursts the whole economy is impacted. The big economies like

Japan, Australia, Britain and USA had seen the bad impact of housing bubble burst on their

economy. The US subprime crisis, due to real estate bubble collapse, engulfed the entire

world. Low interest rates coupled with development of new and innovative financial products

played an important role in the bubble formation across developed (OECD) nations. The

speculation of possible real estate bubble burst in the Asian economies is ripe at present.


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RealEstateSector-India

Problem of Indian can never be of over supply, as a large section of our 1.17 billion

populations is still without housing. To provide housing to 100 million people 100,000 new

buildings of 25 floors each with 10 apartments on each floor (assuming 4 persons per

apartment) would be required. The demand in India is highly heterogeneous and present

mostly in metros and the large urban centres of trade and commerce.

In commercial real estate segment a strong domestic economy and aggressive corporate

expansion plans have led to healthy demand from sectors such as IT/ITES, BFSI. As per RBI

data, in 2009 housing loans increased by 7.30% essentially due to the effect of teaser rates,

without which mortgage lending might have declined. Loans to the real estate sector were up

15.30%. The home loan portfolio for banks grew at a CAGR of 25% in the past five years.

Factors that led to high real estate prices in India in last few years:

rising business opportunities in IT/ITES and BFSI sector

rising employment and disposable income

easy availability of bank finance at affordable rates owing to surplus liquidity with the

banks

tax advantages for housing loans, making them ideal vehicles for tax planningfor

salary earners

softening of interest rate environment

increase in young and earning population, nuclear families

growth in the middle class population almost 1/3rdof the population

emergenceof a number of tier II and III cities as upcoming business centres

migration to urban centres due to lack of opportunities in rural areas

Housing loans growth by financial institutions due to presumed less risk owing to the

tangible nature of the primary security and the comfort obtained from the SARFAESI

Act, 2002.

The real-estate market trends can be studied with changing macroeconomic indicators like

disposable income and industrial growth especially in services sector.


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House price change in India

% change over previous year

Source: National Housing Bank

Table 1- RESIDEX for major cities (base index=100 for 2007)

CITIES Jan-June

2008

July- Dec

2008

Jan-June

2009

July-Dec

2009

Jan-Mar

2010

Apr-Jun

2010

Mumbai 112 117 124 126 134 160

Delhi 124 130 121 113 106 110

Chennai 104 95 120 143 164 183

Kolkata 114 140 162 185 165 176

Bengaluru 73 76 58 59 64 68

Pune 101 97 103 117 124 135

Faridabad 100 121 139 145 154 152

Source: www.nhb.org.in/Residex/


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Mckinsey Global Institute projects Indias urban population soaring from 340 million in 2008

to 590 million in 2030, and to meet urban demand, between 700 million and 900 million

square meters of residential and commercial space will be required to be build per year.

Identifyingrealestatebubble

Putting Indian scenario into a particular stage of bubble development is difficult due to its

heterogeneity. There is some euphoria in the market but the main factor for price rise is

mainly insufficient supply in urban centres.

The home loan growth pattern in an economy and the

controls set by the central bank can give some ideaabout the possibility of the bubble bursting. The

concern comes from increasing load of household

debt and wide gap between borrowings and

repayments. Such situation calls for caution on the

dangers of building up of systemic credit risk and the instability of the financial system as a

whole. During bubble not only new buyers engage bigger mortgages, but even existing

owners increased their mortgages to turn capital gains into cash thereby causing a rally in

housing prices.

Two indicators of excessive supply and the formation of a bubble are decrease in rents in an

area and increase in the number of unoccupied apartments. Another indicator of excessive

supply is if rents in the area are falling. When there is an increase in speculative purchases a

number of apartments are vacant. This causes rents in the area to fall although property prices

continue to rise.

An experimental design model based on structural VAR was proposed in Paper by RBI titled

Identifying Asset Price Bubbles in the Housing Market in India Preliminary Evidence.

The model is based on four shocks interest rate, non food credit, GDP growth, and housing

prices. The assumptions taken are:

1.

Growth rate in non-food Credit highly correlated to housing credit growth, hence

taken a good measure of former

2. Housing price is represented by the index of housing prices


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PossibleBubbleBurst

The real estate industry is picking up, but slowly and unevenly.

Affordability is a major issue among low and middle income groups. However government

initiatives based on earlier success model across world (Singapore, UK, South Africa, etc)

affordable housing can be provided to people across India.

Price/Rent ratio is typically used for measuring undervaluation/overvaluation of real estate

prices, calculated by dividing the gross rental yield by 100 so the higher the yield, the lower

the price/rent ratio.


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Rents in Mumbai have not kept pace, and as a result rental yields on apartments have slipped

to 2.3% to 3.7% showing a possible bubble.

Products like teaser loans have come up which are considered to be risky. Their complex

nature is keeping the customers baffled. An estimate by CRISIL pegs teaser loans at 20-25%

of the Indian financial systems outstanding home loan portfolio of 3.4 trillion in September.

They may in fact be a starting point of the financial innovation but may lend up into cases

that led to sub prime crisis. Teasers rates may have been a good option during recession but

not in current situation when the regulator is trying to reduce liquidity. Banks in India are still

considering whether to continue with the teaser loans or not.

The

danger

of

bubble

burst

is

low

in

India

Besides high prices in urban centre, factors supporting probable bursting of bubble are not

many. In many developed countries, the supply already exceeds demand and manifests itself

in the form of large housing inventories. But India has shortage of supply. Some valid

reasons to consider before predicting a crisis are-

1. Market is largely end user driven not speculator driven which cause the bubble to

burst when they pull the money. Most residential homes are being bought for self-use

or by HNIs with holding capacity.

2. As a reaction to low demand in 2008 developers reduced prices and lowered unit

sizes, and the focus shifted from high-value housing to the more mid-income

affordable segment.

3. A large percentage of houses (and more than 70% of second sales) have a cash

component which is not funded by the bank. A bank funds 80% to 85% of the

registered property price, which for most second sales (and some first sales) is 70% to

80% of the actual deal size. In the Indian banking scenario, the cases of repossession

are rare, and the banks in reality stand to lose no money as the market value of the

property is far more than the funded amount.

4. The level of household borrowing in India is very low. Between 1994-95 and 2007-

08, annual household borrowings grew by 26% but this was only 24% of household

asset. Indian still prefer to park their funds in bank deposits or in stock market.


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5. According to the 11thFive Year Plan, there is still shortage of 26.53 million dwelling,

meaning that there is enough scope for banks to make a huge play in the home loan

market, even if they were to stick to traditional products where the risk is less.

6. Case of Mumbai is unique. Being land locked and overpopulated it has extreme

shortage of supply leading to price rise. It saw 60% rise in RESIDEX from

2007-10. Whereas, Delhi expanding horizontally has seen NCR region come up with

many new housing project. The price rise (RESIDEX) in Delhi had only been 10%

since 2007.

7. Indian banks are taking risks (introduction of teaser loans) but at the same time a lot

more care is taken before a home loan is sanctioned to a middle class or lower class

person. In the U.S., loans were given based on the value of the asset (the house). In

India, the primary yardstick is the capacity of the borrower to repay. Hence the

conservatism of banks is also a factor. Necessary documentation is detailed. Banks are

compulsorily required to provide their customers, simple illustrations on how floating

rates are pegged and what their precise implications are.

8.

The resilience of Indian economy in the aftermath of sub prime crisis hints at a better

and more stringent monetary policy set by RBI. Chance of Indian banks going

overboard by providing unabated loans to sub prime lenders is less in India.

Introduction of base rate made credit pricing and practices more transparent.

9.

Although 100% FDI is permitted into townships, housing, built-up infrastructure and

construction development projects, it is not allowed in Real Estate Business.

Governmentintervention

Due to lack of previous experience in handling a housing bubble burst the RBI has taken a

few steps recently as a part of calibrated policy response, by nudging financial institutions toexercise due diligence in the assessment of credit risks for exposures in the housing sector,

while increasing the regulatory risk weights/provisioning for housing and real estate loans.

The second-quarter monetary policies 2010-11, by RBI comprise:

Cap on the LTV of all housing loans at 80%

Increase in the standard asset provisioning for teaser-rate loans by five times to 2.0%

from 0.4%


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Proposal to increase the risk weights for residential housing loans of Rs.7.5 million

and above to 125% irrespective of the LTV levels.

Interest rates hike by 25 basis points taking the repo rate to 6.25% and reverse repo

rate to 5.25%

Conclusion

A number of factors seem to have an impact on the housing market and the possibility of

bubble formation, income growth, monetary policy mix, tax and regulatory incentives and

procedural ease of loan disbursals, etc. The speculative factor basically builds on the

psychological factors like hype built around advertising, asymmetric information and herdbehaviour causing prices to rise to unsustainable levels.

The study of Indian market makes it evident that due to its heterogeneous nature the banking

sector will have cushion against probable bubble in urban centres. The presence of large

number of factors both supporting and against the idea of bubble burst make the possibility of

identifying the bubble even more difficult. So a number of eclectic approaches for

identification have to be used.

The monetary policy to prick the bubble may have damaging impact on other sectors. The

monetary policy of easy availability of credit should also be backed by prudent policies to

protect banks with large exposure to housing sector.

Blindly going by the experience of the bubble from aboard will not solve the purpose for

India because of the basic difference in the Indian market and psychology. As mentioned

earlier the factors supporting Indian resilience are many and they are important. Overall

economic growth and abundant demand in the market will sustain the market price rise and

the chances of a real estate bubble engulfing the financial and economic life of India is not

very large.


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References

NHB Website

IBEF website

Global Property Guide website

Report by MGI, Indias Urban Awakening: building inclusive cities, sustaining

economic growth

Risky Business: Are Teaser Rates for Home Loans Pushing Real Estate to the Edge?

Published: February 11, 2010 in India Knowledge@Wharton

RBI Occasional Papers, Identifying Asset Price Bubbles in the Housing Market in

India Preliminary Evidence, Himanshu Joshi

URBAN

LAND

PRICE

BUBBLE,

A.M.Godbole

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