Business Standard - July, 2005

Is there a bubble in real estate prices?

“This is a question that  concerns not only every real estate developer, but also those who invest their funds in property, be it for business-related purposes (as in the case of housing finance institutions or banks) or for personal use (a house, a workplace and so on).

I don’t think we are experiencing a real estate bubble in the country, as of today. The media and various other agencies are looking only at some isolated locations, such as those in the national capital region - Gurgaon and Noida - or the mill lands in Mumbai and so on, and conclude that there is a real estate bubble because prices have suddenly shot up in these areas within a span of a few months..

However, it is necessary to take into account the bigger picture, that is, real estate being developed and sold not only in the mega cities, but also in all the metros and level-two towns across the country.

There are a number of isolated pockets across the country that may classify for a bubble but these are centrally localized.

Let’s examine some important characteristics that constitute a bubble. One of the first indicators is rapidly rising prices. However, this itself does not imply a bubble because prices may start from under-valued levels. Have prices moved above historical averages? If we consider the period 1995-2005, taking 1995 as a base, are the current prices out of line with those in 1995?

The answer is an “emphatic” no.

Another aspect of a bubble is overvaluation. Today, there is no widespread overvaluation prevailing as such: even the much hyped rates “sky rocketing” in the Parel area of the mill lands in Mumbai are in tune with the price bands between Napean Sea Road and Worli in Mumbai. The current rise is based on the expectation that the area will get gentrified and, therefore, property prices will be upgraded to a new level. It is, therefore, safe to say that current valuations are by and large based on strong rational fundamentals and market expectation of the future values of property in these upcoming areas.

The third aspect of a bubble is the sustainability of current pricing levels. The market price of a commodity is based on its supply and demand. Similarly, real estate prices, too, are determined by their supply and demand. It is an established fact that real estate development is an extremely fragmented industry in India. This fragmented supply, with no single supplier enjoying pricing power and having the ability to influence prices, applies to geographic markets as well as different asset classes such as flats, offices or shops. Therefore, it is safe to conclude that the rise in prices has been fueled by increasing demand coupled with rising input costs.  

Let us now examine the drivers of demand and understand the sustainability of this demand as it will directly impact the sustainability of current real estate prices. While the current increase in the prices of residential property has been attributed to the easy availability of finance, it is important not to overlook the fact that this increase in borrowings is also due to a significant increase in the salaries of professionals who take mortgages to buy homes. As a matter of fact, the ratio of house prices to income levels is in the same range (if not lower) as it has been in the last decade.

Further, the overall buoyancy of the economy has resulted in greater consumer spending, which drives retail revenues, and which, in turn, drives retail property prices. And finally, corporate growth and expansion – which includes the demand for office space because of the BPO call centre boom. Since end-users such as retailers, corporates and home-owners are able to afford real estate at current prices and continue to demand more there is no question about sustainability of the current prices nor of a real estate bubble.

Since real estate is an integral part of the economy any downturn in the economy has the ability to adversely impact property asset prices. However, most people believe that the Indian economy has now embarked on a high growth trajectory and we have no reason to believe that there is going to be an economic downturn in the immediate future. There will be localized downturns and in area some developers and others will get burn with local price downturns. But, other than this, I believe that we are currently not experiencing a real estate bubble, and while the economy continues to expend the real estate sector, too, will grow.”