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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Posts Tagged ‘Real estate’

Some thoughts on real estate

Posted by Muthu on January 29, 2015

Every asset class goes through cycles. Ups and downs, bull and bear markets, boom and bursts, euphoria and despair are all very normal. No one and no asset class can escape this cycle. Likewise business and economy have their own cycles.

We Indians have been having for generations a peculiar belief that gold and real estate never fall in value. Last few years have been proving our people how wrong those beliefs are.

Gold price falling for last few years is nothing new.

Gold prices fell from $892 per ounce in 1980 to $272 in the year 2000. A fall of around 70% in value over 20 year period.

When gold has depreciated by 70%, the rupee has depreciated by 600% in the same period. One Dollar was worth Rs.8/- in 1981. Whereas the conversion rate was Rs.48/- in 2002.

So the gain we saw in the Indian market while prices fell globally was due to the depreciation in the value of rupee and strong appreciation in the value of dollar. It was not gold which gained but the dollar. This further strengthened our illusion that gold prices never fall.

Likewise people have forgotten the correction which happened in real estate prices between 1997 and 2003. Prices actually fell by around 30% even in places like Mumbai. Only from 2004 the mad appreciation of property prices started which again started slowing down from 2012. People are finding it difficult to sell properties for the last few years. Unsold inventories are piling up in all major cities. More than price correction, real estate goes through time correction. Let us assume a flat was bought in 2012 for Rs.1 crore. If it’s price remains stagnant for next 6 years and there are no buyers for the flat, people think that they have not made any loss. This is due to money illusion.

Money illusion is a separate topic I can write about. Let me explain the above. Rs.1 crore of 2018 is not same as Rs.1 crore in 2012. Inflation erodes the value of money. Assuming 8% inflation, if a buyer sells the flat for the same price after 6 years, he gets only around Rs.61 lakhs back in real term. There is a loss of 39% on the sale. Since most people buy on borrowing, if we take the interest paid, the loss would be more.

Government is taking steps to reduce black money. From recent news reports, it looks like having unaccounted money may even become a jailable offence. As India develop over years, we would become less corrupt and have less black money in circulation. The fall during the last few years would have been more severe but for the black money holding the prices.

People think that since our population is huge and as ‘God does not produce land any more’, real estate will go only in one direction, which is up. I’ve mentioned about this in May 2013 and I would mention it again.

Economist Ajay Shah says that if we place 1.2 billion people (population of India) in 4 person homes of 1000 square feet each and 2 workers of the above family in office or factory space of 400 square feet, it would occupy only 1% of land area of the country. Just 1% of land in India! FSI (Floor Space Index) assumed of the above calculation is just one. FSI is much higher in developed countries.

People lament that we are fast losing agricultural land near developing cities. What they do not know is that land under agriculture in India is higher than that of China. We are self sufficient in food, vegetables, minerals etc. India is one of the few places where one gets sunshine throughout the year. We are only 34% of the size of China but have more arable land then them. Vivek Kaul in one of his pieces has mentioned that at 157.35 million hectares, India holds the second largest agricultural land globally. Only, the United States has more agricultural land than India.

So just because more people want houses, housing prices are not going to hit the roof. The supply and supply capacity in India is much higher than what demand can be. Also as black money gets reduced and infrastructure improves, housing would become affordable for the masses.

Housing as an industry would develop a lot in the years to come. But for prices to pick up, it may take few more years. Real estate price growth in the long run would be 2% or 3% above inflation. If inflation is 6%, we may expect a long term price growth rate of around 9%.

These are some of the thoughts on real estate I want to share with you today.

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