The Christmas season brings cheer every year. This year, the cheer is compounded with the economy showing 8%-9% growth (prices of onions notwithstanding).
Hiring and increments are back on a high. The sensex is hovering around 20,000. With this, can one expect anything but good news for the real estate sector and more importantly prices of property?
All positive indicators will boost markets in general, however, in the case of real estate, it is precisely this buoyant environment that can derail the train of good news.
One of the factors that contributed to the downfall of the western economies were the real estate markets. Fortunately for India, the RBI intervened in 2007-8 and took steps to cool down a rapidly overheating realty market. This action helped prevent a complete bloodbath in the realty sector when the meltdown hit our shores and has vindicated the RBI's stand of being hawkish when it comes to this sector. This will, I am sure give more confidence to the regulators to ensure that the sector does not see excessive overheating as has already been shown by the RBI recently.
As a result of the RBI's action of increasing risk weightages for property as well as other actions, as well as the impact of the global meltdown, developers have realized the importance of affordability for the customer. While salaries are set to rise, leading to an increase in affordability, the fact is that a part of the salary rise will be eaten away by inflation- currently hovering around 9%. Further, given the unseasonal rains impacting crop produce as well as the increase in fuel prices emanating from global crude oil prices, the hope of inflation coming down any time soon seems to be greatly reduced. This will leave the home buyer a part of the salary increase to utilize for a more expensive home. This however, does not give too much headroom for prices to rise unabated.
In the event that prices do go up too much, I am sure we will see the RBI intervene to cool down the realty sector. This will happen through steps that lead to an interest rate increase. An interesting fact is that a 1% rate hike in interest rates requires approximately an 8% salary hike (taking the maximum loan eligibility). Between inflation and the increase in interest rates by the RBI, the customer will have no surplus funds to buy a more expensive home.
The paradox therefore is that while the customer can afford to pay more for his home, rapidly rising realty rates will lead to an increase in interest rates and this will lead to a slowdown in rates.
The average rate for residential properties in Baner - Pune in January 2007 was approx. Rs.2,741 per square foot and Panjim, Rs.34,223 per square meter. Increasing at a CAGR of 11.75% and 16.41% respectively, the average rates hover around Rs.62,756 per square meter currently. Inflation on the other hand has shown a CAGR of 9.75% over the same period. Real estate has therefore outperformed inflation by a mere 2-4% in Pune and 6.66% in Goa per annum. This in itself is not alarming, however, given the RBI's hawkish view on real estate, any major upthrust in prices will most likely be followed by action by the RBI.
Overall the sector looks positive and set to reap the benefits of a booming economy but given the RBI intervention in the past, I don't think unbridled price hikes are something that we will see in the near future. The need for housing and the housing shortfall is clearly something that will drive long term demand for realty in the country and as such, investors are best off taking a long term view of their investments in real estate. I believe that speculative returns in real estate requires a high appetite for risk and is best done without leverage.
JMD - Gera Developments Pvt. Ltd.
As with other investments, real estate too carries a certain amount of risk. Readers are advised to undertake their own due diligence and take judgement calls based on their own research and not on the article.