The ‘Real’ Estate

Asia has been witnessing a credit boom of its own (nominal credit growth to nominal GDP growth >2x in HK, Malaysia, Indonesia and Singapore) with substantial part of the flows going into real estate with economies like Singapore, Indonesia, China and Thailand enacting measures to cool-off the real estate bubble. Of these economies, Singapore, Malaysia and Thailand have household debt to GDP in excess of 70% which could imply significant pain when interest rates rise. The low interest regime has created substantial interest in real assets.

In India, we have witnessed extremely strong housing credit growth where retail home loans are up over 10x in the last decade and developer loans by banks / HFCs are up >15x. This developer funding has been further supplemented by PE funds, capital markets and informal financing markets. Of the retail home loan growth, 70% of the growth has come from increase in ticket size of the loans, indicating the preponderance of price growth in the market.

Stretched affordability indices as a consequence have meant significant slowdown in absorption rates of apartments. IT sector which contributed most of the absorption through their massive white collar job creation have seen a decline in hiring levels and wage increases.

High housing prices have created their own cost on the economy in terms of knock-on effects on pricing of goods and services i.e. the local fruit seller charges higher as his shop rental and cost of living has gone up, cost of starting a business moves higher, malls suffer due to high rental costs.

Raghuram Rajan in his book Fault Lines wrote, “Easy housing credit has large, positive, immediate and widely distributed benefits, whereas all the costs lie in the future. It has a pay-off structure that is precisely the one desired by politicians, which is why so many countries have succumbed to its lure. It pushes up house prices, making households feel wealthier and allows them to finance more consumption.”

So question is will he act to address the issue as politicians given their interest will not. His first act at targeting consumer inflation is a step in the right direction.

The next question is what got us to the current state of affairs.

Indian RE prices expanded significantly in the post 2006 as the economic expansion resulted in massive increase in costs (i.e. cement prices) and second a belief in long-term prospects attracted massive dosage of capital. This capital was used to purchase land at higher and higher prices. The collapse of 2008-2009 was short-lived as government and the central bank coordinated a stimulus. This was helped by record low interest rates globally.

This stimulus ensured that no adjustment happened plus a short correction resulted in re-affirmation of the investor belief of continued price increases. Private financiers (many times with money diverted from their core businesses) poured in money into the market lured by the returns promised by the builders. Banks which have traditionally viewed real estate as the safest form of collateral kept financing the collateral at higher valuations forming a virtuous cycle. Lack of real returns in stocks and bank deposits and low cost of money for NRI’s ensured continued interest in the RE assets. Corruption proceeds during the last decade as their scale grew larger played their role.

With yields on residential property at record low of 2-3% (compared to lending rate of ~11%) and urban India with slowing incomes and high inflation, the final buyer has balked, investors no longer believe that they can make 20-25% returns from these price levels, banks are hurting with NPAs with no longer have the flexibility of expanding their belief in prices.

This will create an impact on not only consumption levels (consumer wealth) but also house building activity impacting GDP growth further. The central and state budgets have no room to be counter-cyclical measures and increasing interest rates globally will create pressure on the Reserve Bank to maintain spreads high enough to ensure no significant pressure on the rupee. It is likely, given the market structure where stressed asset disposals are not easy and banks do not want aggressive write-offs, we will see a combination of price correction and time discounting.

The retort we see from developers of input cost going up does not hold, even for basic agricultural commodities it is demand-supply model of price determination. It almost seems like a wish to hold on till one reaches the cliff.