Recently, respected professionals like Mr. Deepak Parekh, Hon’ble Minister Piyush Goyal and Mr. Uday Kotak have pushed for price cuts in the real estate sector. While their opinion and expertise are well-respected in the matter, one cannot but imagine the adverse ramifications of such an irresponsible call for price cuts going wrong.
I wanted to share my two cents on why repeated public calls for price cuts may be far more detrimental for the economy.
Calls for price cuts can only delay demand and hamper any revival that could’ve come.
Why price cuts might not work?
Economics mandates the protection of the financier and politics mandates the protection of populism. However, this leaves the real estate developer stranded in the middle.
In the last 5 years, Real estate hasn’t seen any price appreciation, investors have kept away from the sector and the market has been dominated by end users. Necessary policy changes like GST and RERA have also left a collateral economic impact. At this moment, calls for price cuts could bring in an unnecessary avalanche.
⦿ Price cuts is a function of market dynamics and calls for price cuts pushes demand further down the road. With the number of developers shrinking by 50% between 2011 and 2017, and a significantly higher number since the implementation of RERA, who’s going to invest in a sector vilified by the government?
⦿ On implementing such price cuts, builders will lose a significant amount of their capital base which would hamper the growth of the sector for years ahead. Simple question, with no money, there are no new project launches, and with no new launches, there are no jobs; so, who’s employing this workforce?
⦿ The expected rise in costs of raw materials will make it even harder for developers to bear the burden of price cuts.
⦿ Price cuts also have far more serious cascading effects. Typically, a customer pays 5-10% of the property value during the project and the rest is funded by banks.
⦿ With price cuts you narrow down the LTV (Loan-to-Value of property), with the kind of economic uncertainty that exists, what really happens when the LTV exceeds 100%? Do Indian customers care more about their credit score or in uncertain times, would they rather default on home loans if the underlying home is valued lesser than the outstanding loan?
All of this is going to follow a complete stagnation of around 3 months when the country was in lockdown for the COVID crisis and property site visits were close to zero. If the market can take its form, then there might have been a surge in demand owing to the necessity of owning a home in a COVID world and the fear of subsequent lockdowns. Additionally, RBI’s home loan rate cuts would have supplemented actionable purchases from customers (As claimed by the government itself).
What does Real Estate mean to the Indian Economy?
As one of the largest industries in the country, real estate has a far-reaching impact on the economy. Here’s a look at its highlights –
⦿ It, directly and indirectly, employs the second largest workforce in India, second to agriculture.
⦿ It supports about 250 ancillary industries like steel, cement, interiors, etc. According to ICRA, it is the third most influential sector in the country.
⦿ Real Estate has the fourth highest GDP multiplier effect on India’s economy.
⦿ The $180 billion sector comprises $100 billion from residential real estate. It contributes to only 6% to India’s GDP when we have the fifth largest economy in the world & the second highest population coupled with one of the highest population densities in urban areas. This contrast with the global average of 13% of GDP contribution gapes at the negative bias that real estate faces in India.
⦿ The value of all outstanding home loans is around $250 billion in 2019 or 10% of the nominal GDP. Mortgage loans at 10% represents significant under-penetration compared to global peers with China at 18%, Malaysia at 34% and developed economies at 50+%.
⦿ Banks should focus on what is their most secured asset class when corporate debts are going under. Home Loan NPAs stand at around 1-2% for banks compared to 9.5% average for India.
With such statistics, it is not hard to imagine what a transformative impact the growth of real estate could have. However, it needs a more considerate policy-making approach that is currently absent.
So, what are the alternatives to price cuts?
Finding unanswered questions in policy is easier than keeping an eye out for solutions. However, such an eye is far from correct. To tackle the situation at hand, we investigated some of the alternatives that could work:
1. The government should first reduce the circle rates to protect real estate companies from tax burdens created under section 43 and 50 C of the Income-tax Act, 1961. With Ready Reckoner rates being close to the market value in several micro markets in the country, it is legally impossible for companies to sell below those rates. Moving to a dynamic circle rate concept is the only way forward to prevent black money from coming back into the ecosystem and ensuring that market forces determine the price.
2. Urban Municipal bodies should make urban infrastructure augmentation the highest priority. If COVID showed us anything, it was how crumbled our urban infrastructure is. Renewed focus on Smart Cities is the need of the hour.
3. Banks should focus a lot more on home loans, considering the low NPA. Support the developers who are originating the loan for you.
4. Work with state governments to see how stamp duties can be reduced without it causing a significant impact on state finances.
5. Real Estate developers too can find their alternatives by adding more freebies and ensuring delivery lifecycle price guarantees for customers to encourage sales.
I’d like to end this article with a plea that everyone needs to hear. The Government has done a lot to ensure only the credible developers survive.
Large scale consolidation has taken place into the hands of professional real estate companies which are setting a higher standard for corporate governance, housing and the industry overall.