Thursday, August 03, 2017

Straight Talk: Why It's 'Plain Stupid' To Buy A House In India?

The crash of the Indian housing market is imminent. Two incidents gave me pause for thought recently.

Firstly: Just as I was about to tee off at the Milpitas golf course in California this September I heard a "fore" and was fascinated to see a fellow golfer tee off from the backyard of his home. I thought, "What a life/luxury!"

I realised that this 7200 yard golf course is inhabited by a mere 50 families and Zillow (an app that dispenses info on real estate prices) indicated the price of each bungalow was in the range of US$1.1-1.3 million (approx ₹7.5 crore).

'Yes, we do sell affordable homes, if you happen to be Donald Trump.'
One cannot ignore that the US of A was built on the premise that infrastructure (rail, road, bridges etc) are the bedrock of economic activity and the growth of any nation. And the USA has by far the best infrastructure in the world.

Secondly:The chief accountant of one of the top three builders in Bangalore visited me looking for a job and shared that the builder hadn't sold more than three apartments amongst their entire national inventory in the last four months.

After my four-week sojourn in the US, when I returned to India, it took me a whopping 2.5 hours to travel a distance of 30km from the airport to home, And along the way in a traffic jam, I saw a larger than life hoarding of a top Indian builder offering a four-bedroom apartment "starting at only ₹6.5 crores"—that's about a million USD.

This indicates and is reflective of a demographic—that there are a large number of people in Bangalore for whom a starting price of only a million USD for an apartment might seem attractive. And "only" is supposed to significantly enhance the value proposition of the apartment that's built right next to a crematorium and on illegally reclaimed land near a gutter that emanates more methane than a human body and tolerance can possibly fathom.

Well this is the reality of a country that's falling apart due to the officer-builder nexus/mafia, and where tier-1 and tier-2 cities are choking to death because of rampant construction.

What a sham on the part of the builder and what ignorance on the part of the gullible home buyer.

The lack of town planning and inherently corrupt city councils have made most cities un-habitable in India. God forbid if ever (once in a lifetime) one has to transport an aged parent or loved one to hospital, he/she will has a great likelihood of being sacrificed along the way because an ambulance has no way/infrastructure to beat the traffic jams.

So that raises a question—what is really the right price of real estate? How in the eyes of that builder is that apartment worth "only" a million USD?

Every asset has an intrinsic value. The cost of replacement or the cost of building the asset is the intrinsic value. Add to it the profit of the seller/maker and that leads to the discovery of the fair market price.

For way too long (almost since the beginning of 2001) real estate prices have seen only one direction and that's up. I have a few acquaintances in Gurgaon and Delhi and Chandigarh who gave up their jobs in order to deal in real estate. I've seen them buying an asset in the morning and then selling it within two days at a neat profit. It's almost like the tulip mania (when the Dutch thought that the world was going to run out of tulips).

India's Black market economy helped. It is conjectured that the top six politicians in India have a combined net worth in benami property and assets that is equal to or more than the top 50 richest people in the Forbes list. For way too long, corruption has siphoned off the nation's and taxpayers' wealth to fill the coffers of people in positions of authority. The lack of a robust tax and tracking system has allowed a parallel black economy to mushroom and fuelled a bubble in almost all asset classes, but above all in real estate.

The general cost of construction per sq feet (at standards that are followed in India) is about ₹2000. Builders have a funny inexplicable formula of "super built up." They sell part of all public areas to the buyer and add that to the area of the flat. Most say that the mark-up in the area sold is only 25-27 %. That implies that if one is buying a 2000 sq ft apartment, one is likely to get 1600 sq ft of carpet area. Well if this is the norm and is legalised, it's good too. But the truth is something else.

My mother, like all mothers on the planet, wants to see her son own a house. The proverbial "one's own roof over one's head" in times of future distress. So a few years back I did start looking for a house but instinctively bought a laser area calculator (digital planimeter) to find the floor area of the house being sold. I used to carry the device during each visit to an apartment. Surprisingly most builders who claim to have a 25% attributed to super built-up area actually have 40% mark-up! So a big fraud there.

A house is an emotional investment and very few people carry a planimeter when selecting a potential purchase. And the brokers have a knack of playing with buyers' emotions by painting the picture of a perfect home and actually talking about the location of the temple, the balcony , the virgin sun rays in the morning and generally making a customer believe that the said asset is being eyed by seven other prospective buyers. And human beings are emotional, gullible fools generally governed by cognitive biases.

Besides the 15% defraudment (unavoidable premium that one pays for the other person's fraud) one has to pay for parking and floor uprise, etc etc. Talking of Bangalore in particular, a typical third grade apartment in a smelly location ends up costing about ₹20,000 (UA$300) per sq ft of carpet area—and by the way you don't own a piece of that land.

The recent demonetisation has taken the wind out of the sails of this Ponzi scheme and the forthcoming RERA (Real Estate Regulation Act) is likely to bring some discipline but how will the builders make their infinite profits while duping the gullible customer? They won't be able to.

And that will start the big correction in the real estate market.

Today, the monthly installment over 20 years (if you own a house) is generally 3.5 times the present monthly rental of the same house. So if someone typically buys a home between the ages of 35-40, he/she is likely to pay 3.5 times the probable rent of that same place in EMIs (equated monthly instalment). Can you imagine paying 3-4 times your monthly rent for the next 20 years of your life just to gloat about owning a house—and then being stuck with it?

The only certainty in life is the uncertainty around it. Imagine being retrenched in a downsizing exercise, or having to change your job? Owning a house at present Indian valuations is likely to make you nervous not confident.

Imagine being unreasonably bollocked by your boss and that irresistible feeling once every few years to tell him to go to hell. But not being able to, because the payment of EMI is just round the corner.

Imagine your desire to live your life fearlessly and meaningfully on your own terms and conditions but not being able to do so because of the burden of your EMI?

The logic behind the "round the corner" housing market crash is simple. Too much easy money has flowed into this asset class and the present prices aren't sustainable. Either the rentals have to double from the present levels (which they can't because that's a function of demand and supply) or the real estate prices have to correct by at least 50% from the present levels.

Sadly, I believe my mom will never see the proverbial roof over her son's head in the near future.

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