The imminent crash of the Indian housing market and why buying a house is a stupidity

Two incidents moved me recently...

Firstly:

Just as I was about to tee off at the Milpitas Golf course 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 realized that this 7200 yarder golf course is inhabited by a mere 50 families and Zillow (the app that correctly dispenses info on real estate prices) indicated the price of each bungalow between approx. 1.1 – 1.3 million USD (approx. IRs 7.5 Cr)

One cannot ignore that US of A was built on the premise that the infrastructure (rail, road, bridges etc) are the bedrock of economic activity and the growth of any nation. And 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 3 apartments amongst its entire national inventory in the last 4 months.

After my 4 week sojourn in the US, when I returned back to India, still in a state of daze, it took me a whopping  2.5 hrs to travel a distance of 30 kms from the airport to home and along the way in a traffic jam, I saw a larger than life hoarding of an apartment built by a top Indian builder offering a 4 bed apartment “starting at ‘only’ 6.5 crores” 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 would be seemingly attractive. And ‘only’ is supposed to significantly enhance the value proposition of the apartment that’s built right next to a crematorium and on an illegally reclaimed land on a gutter that emanates more methane than a human body can tolerance or human mind can fathom.

Well this is a reality of this country that’s falling apart due to officer builder nexus/mafia, due to tier one and tier two cities choking to death because of rampant construction.

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

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

So that raises a question – what really is the right price of real estate and why that apartment in the eyes of that builder can be ‘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 the way up. I have a few acquaintances in Gurgaon and Delhi and Chandigarh who gave up their jobs in order to deal in real estate. They have been found buying an asset in the morning and selling the same in 2 days at a neat profit. It was almost like the tulip mania when the Dutch thought that the world is going to run out of tulips.

India’s Black market economy helped. It is allegedly believed that the top 6 politicians in India have a combined net worth in benami property and assets that is equal or more than top 50 richest people in the Forbes list. For way too long corruption has siphoned off the nation’s and tax payers wealth to fill the coffers of people in the position of authority and an inherent lack of 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 IRs 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, he is likely to get 1600 sq ft of carpet area. Well if this is the norm and is legalised, its good too. But the truth is far from reality

My mother like all mothers on the planet wants to see her son own a house. The proverbial ‘one’s own roof over the head’ in times of a 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 same during each visit to an apartment. Surprisingly most builders who claim to have a 25% attributed to super built up actually have 40% mark up in area. So a big fraud there.

House is an emotional investment round the globe and no one carries a planimeter when selecting a potential purchase. And the brokers have a knack of playing with ones emotion 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 7 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 other persons 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 20000 (300 USD) per sq ft of carpet area – and by the way you don’t own the 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 and make a charlie out of the gullible customer? They wont be able to………..

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

Today the monthly instalment 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 ones home between 35-40 years of age, he/she is likely to pay 3.5 times the probable rent of that same place in ones 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 in the feeling of owning the 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. 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 goto hell. But not being able to, because the payment of EMI is just round the corner.

Imagine that one desire to live one’s life fearlessly and meaningfully at one’s own terms and conditions is being quashed by the burden of one’s EMI.

The logic behind the ‘round the corner’ housing market crash is simple. Too much of 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 atleast 50% from the present levels.

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

Manu also writes on Huffington Post

What Infosys’s Vishal Sikka’s tenure teaches us about ‘ Strategy ’

Recently Wipro’s Azim Premji and Infosys’s Vishal Sikka made joint statements about the stresses and tough times that lie ahead in the Indian IT sector and how the global factors have caused immense uncertainty – I agreed, for its been 2 years that I have been - through this blog, making a case that greed, unsound economic decisions and self-fulfilling political pursuits by nations and central banks have pushed the world to a brink of dangerous unanticipated consequences and that the present prices of ‘pretty much’ all asset classes are unsustainable.

But this piece is about strategy. I read this word so often that I am now almost sick of it. Speak to an over enthused student at a business school – he wants to excel in strategy and make a career out of it, speak to a new CEO – he would talk of a 10 year strategy and vision and make the incumbent employees feel scummish for their lack of strategy and vision, speak to a consultant (highly paid youngster at probably the big four with all authority and no responsibility) and he would regurgitate so much on strategy through his 100 page presentation that the customer would really start cursing the historical past, when the consultant wasn’t on board.

Well strategy is fashionable, it sounds great – but in reality its bullshit. As Peter Drucker says Culture eats strategy for breakfast everyday

200 years ago when nations orchestrated wars to take over other nations and land masses across the oceans, strategy made sense. A strategy once made could remain relevant for 50 years as letters and information could be sent/received over sea/horses at most twice a year. Officers of invading nations had orders to execute a decision and the same could be reviewed only after a few years. Results to judge successes or failures was possible – at best – over a decade.

Today all it takes is a tweet by Trump to make the price of fortune 100 company crash or a claim by wikileaks to make Hillary lose a winning US presidential election or a unfounded misinformation that encourages a nation to invade another and create a world havoc that is likely to have a century long ramification.

Disclaimer : Now I don’t know who Vishal Sikka is or what he stands for or what he brings to the table and I have nothing against him. He is just a case in point because I remember him as a non-promoter Indian to get the highest salary in India, to get an annual compensation of about 6 mill USD besides all the stock options. But I read 3 newspapers everyday to have a fairly good memory and to form an opinion.

When Sikka joined Infosys somewhere in June 2014 as the first non-promoter CEO, he was the next big thing in India. He talked of strategy and he talked of vision and the world took notice. The stock price of Infosys soared and he became the poster boy. At the time of his joining, the annual revenues of Infosys were about 6.9 billion USD and he talked of a six year 2020 vision of 20 billion in revenues. ie a approx. 2 billion increase in revenues each year. And he maybe got more bonus. Many of the rockstar executives who built Infosys over last 2 decades, allegedly quit out of frustration.

This reminds me of the despicable Jack Welch who made a fortune for himself but made the most ruthless organisation by firing 5-10% of workforce every year. As Simon Sinek says, companies that sacrifice their people for numbers rather than numbers for people aren’t built to last.

So as time progressed Sikka’s rhetoric of his vision became louder and the performance became quiter at about 7.9 billion USD in FY 2016 but he still maintained the gusto of his rhetoric.

The last Q3 FY17 results of Infosys are due on Jan 13^th 2017 (oops that’s a Friday) and Sikka already warns of tough times ahead and by the way all of it is the fault of BREXIT and Trump.

And going by the HY (half year) run rate of FY17 Infosys will achieve about 9.5 billion USD in annual sales. With three years to go for 2020 – a 3 billion USD per annum increase.

Whats the point:

Its not Sikka’s fault. He has no role to play. The multitude of global factors and externalities are so diverse that any CEO or alleged strategist who talks of a 10 year or a 5 year strategy is only fooling himself or the board.

Its good to have a general aspiration (call it vision) for next 5-10 years. But having a 5/10 year strategy and a promise can help you get a bonus but all that matters is the next few quarters.

Companies are wasting too much time on vision and strategy not realising that merely a tweet, a simple geo-political externality or an event on which no one has a control can change the dynamics of our aspirations and strategy overnight.

Boards must realise and encourage the following:

1. Growth is important – and imperative. Don’t put so much pressure on CEOs that they are forced to make specious commitments.
2. Preserve cash – When a Brexit or a trump hits you – no one knows. Cash is king and cash is the one that will help you survive in tough times.
3. Leveraging created on the assumption of ‘future growth of present revenue run rates’ (sounds almost as exotic as CDO’s of 2007 isnt it) is a sure shot recipe of disaster.
4. The Baniya style of business has stood a test of time over 200 years, till Goldman arrived on the scene and changed the rules of the game. Live within your means and borrow what you can pay from present income – not future income.
5. Every decision maker must have a skin in the game. Convert decision making executive’s present bonus and compensation into future equity if you want the organisations to survive.
6. Conservatism isn’t a bane, it’s a virtue. For fools are full of confidence and wise are always in a state of doubt.
7. Every present expense must pay for itself – strategic decisions taken in present for future issues without having a control on future are likely to be disastrous and not reflective of a sense of ownership or good leadership.
8. Stop expecting month on month or quarter on quarter. Allow your CEO’s to work in peace and keep a quiet watchful eye. Fire them if you don’t like them but don’t create noise and disturb them every single day.
9. In an ever connected highly efficient world make a 3/6 month strategy – if at all. Anything more than that is gas.
10. Keep a watchful eye on people talking of 300 years of vision and balance sheet (surprisingly same people couldn't retain their CEO for more than one). Anyone reading this will probably be dead in less than 40 years and anyone talking of 300 years probably has no plan at all.

And lastly for GOD’s sake – stop talking about strategy and start working on culture.

Manu also writes in Huffington Post