Buoyant in the long run

Real estate sector is a major job creator avenue but certain drawbacks are creating hurdle in its full-fledged development
     Print Edition: September 2014
Buoyant in the long run
Buoyant in the long run

The real estate sector, which is a major job creator and wealth generating avenue, has also been saddled with drawbacks like inventory pile-up, high prices, regulatory inefficiency and dwindling sales.

Rapid land and infrastructure development in smaller cities and towns, backed by bank loans, higher earnings and improved standards of living has given a boost to housing and construction demand. The BJP government's aim of constructing 100 smart cities is a move to ease migration burden on tier-I cities and accommodate the rising quantum of floating population with adequate facilities.

These cities will be developed as satellite towns of larger cities and by modernising existing mid-sized cities. However, these cities, in themselves, may not be major contributors to the real estate sector because the developer market in tier-II cities is quite small. Robust infrastructure framework and sound development in real estate go hand in hand.

Delay in approvals and weak infrastructure policies have crippled the full-fledged development for long. Unless there is a marked progress on this front, real estate growth will be stifled. The new Government's maiden budget focuses on boosting infrastructure through the PPP mode. Schemes for development of airports in tier-I and tier-II cities have also been proposed.

Infrastructural changes are helpful only when they bring about land efficiencies, which implies cheaper land at a commutable distance. Moderation in land prices is a must. In the Union Budget 2014-15, the Government has taken concrete steps to boost affordable housing. It allocated Rs 4,000 crore for low-cost housing schemes. Along with this, the Finance Minister has also hinted that there will soon be a relaxation of FDI norms for the affordable housing sector.

With steps like this, the real estate sector can be highly hopeful of diminishing gap between demand and supply for low-cost housing. Also Government has emphasised the importance of availability of cheap credit to make housing affordable for economically weaker sections (EWS), lower income groups (LIG) and middle income groups (MIG) segments of the population. Housing loans will be eligible under priority sector lending by the RBI and also housing loans to individuals up to Rs 50 lakh for houses of values up to Rs 65 lakh located in the six metropolitan centres viz. Mumbai, New Delhi, Chennai, Kolkata, Bengaluru and Hyderabad and Rs 40 lakh for houses of values up to Rs 50 lakh in other centres for the purchase or construction of dwelling unit per family.

The recent move to introduce REITs, or Real Estate Investment Trusts, is quite a progressive one as well. REITs have great potential to tap cash flow into the Indian economy, and help smaller investors to access income-generating real estate assets, without having to invest a large amount. Providing tax incentives to REITs for investment in housing, especially the affordable housing sector, will increase chances of its success.

One of the important aspects affecting the health of real estate sector is the pricing rationale. When considering this aspect, the availability of capital in the system should be evaluated.

The increasing number of private equity and relaxed norms for FDI has definitely brought in more funds and liquidity to the capital-starved real estate, but has the money been put to intended use? The excess fund flow from overseas had resulted in undue complacence and developers feel no requirement to lower prices to push sales. The result is exorbitant price levels in Mumbai Metropolitan Region (MMR) and NCR.

However, at the same time, it would be unfair to place the entire blame on developers. The money coming in demands an internal rate of return (IRR) of 20-25% and the developers are obliged to fulfill it. Thus, they put the stakes in high priced luxury projects to real returns.

These few projects have the ability to spoil the entire economic balance in real estate and eventually this money plays dirty role in creating inefficiencies. Excess capital leads to a vicious circle which eventually serves no purpose. Prices are pushed up because developers no longer feel the need to keep reasonable pricing to push sales.

Everything from the land prices to the construction cost becomes inflated, leading to delays in deliveries and pushing away the end-users. It is a quagmire where the investor is just left in the lurch and the so-called capital fails to generate returns. Another detrimental upshot of this occurrence is the proliferation of speculators and investors.

After burning their fingers in saturated and unproductive markets like MMR and NCR, investors shifted focus to the IT hubs Pune and Bengaluru in 2009-10. Both these cities, with similar dynamics, became the apple of every overseas investor and began to see huge influx of funds.

Reits have great potential to tap cash flow into the indian economy, and help smaller investors to access incomegenerating real estate assets, without having to invest a large amount, says Pankaj Kapoor, founder and MD of Liases Foras

This is where the problems started arising. The cities witnessed about 20% price rise in 2012-13 when their sole driving factor, the IT sector was not doing well. These two cities are the classic examples of how prices are inflated due to massive influx of money. The FDI and PE money flooded both these markets and led to a surge in the price levels making it more of a speculative investor-driven market.

The prices are thus rendered `unproductive and sales have declined. The real estate sector has been grappling with the burden of high construction cost since long which is also a primary reason for high home prices in most micro markets.

Construction cost has about doubled in two years, while government's imposition of taxes and premiums has also shot up significantly. Recent development such as rise in sand prices due to ban on sand mafia and closure of quarry mines in Tamil Nadu have accentuated the pressure. This leaves no option for developers but to raise the apartment prices.

Unless the government is forthcoming with its policies and easing the bottle necks, this will weigh on the realty sector and eliminate scope of reduction in prices. The long term perspective of the market is very encouraging. However, in the short term, unless there is price correction sales are not likely to improve, we do not see efficiencies coming in. With more money flowing, market seems to remain inefficient and is set for a time correction prolonged over 2-3 years.

The author is Pankaj Kapoor, founder and MD, Liases Foras

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