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