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Why car sales are falling but not realty prices!!!!!!!!!!!

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Why car sales are falling but not realty prices!!!!!!!!!!!

Last updated: March 31 2013
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  • Why car sales are falling but not realty prices!!!!!!!!!!!

    Why car sales are falling but not realty prices
    by Vivek Kaul Mar 14, 2013


    Car sales in February were down dramatically, thanks to sinking demand. Sales fell 25.71 percent to 1,58,513 units in comparison to the same month last year. And with demand falling, customers are getting discounts and freebies.

    In this column on Monday, this writer argued that falling car sales is a reflection of the overall economy slowing down. People expect the bad times to either continue or get even worse in the months to come. And this makes them hold on to the money they would have otherwise used to buy high cost items like a car. It also means that they do not want to commit to an EMI right now. Given these reasons car sales have slowed down.

    The question that begs asking is this: why does not the same logic apply to real estate? What immediately cropped up was that if car sales are falling, using the same logic real estate sales should also be falling and should lead to a fall in prices. If cars are a big ticket purchase, then buying a house is the biggest expenditure that most people incur during their lifetimes. Also the prices of cars over the last few years haven’t risen much, whereas the prices of homes have gone through the roof, making them terribly expensive, if not simply unaffordable.

    The economist George Akerlof wrote a research paper titled The Market for Lemons in 1970. For this paper, Akerlof ultimately received the Nobel Prize. In this paper he discusses the market for second hand cars (or used cars) and the problem people have in selling them.

    Akerlof divided the second hand car market into two types of cars – peaches and lemons. Peaches were cars which were in a good shape whereas lemons were cars which were in a bad shape. The individual selling the car obviously knows whether his car is a peach or a lemon but the individual buying the car doesn’t. So seller has what economists refer to as ‘insider information’ which the buyer doesn’t have.

    The point is that in this transaction one side has much more information than the other side. So there is an asymmetry of information. As Nate Silver writes in The Signal and the Noise – The Art and the Science of Prediction, “In a market plagued by asymmetries of information, the quality of goods will decrease and the market will be dominated by crooked sellers and gullible and desperate buyers.”
    The real estate market in India is a tad like that – full of crooked sellers and desperate buyers. The sellers have all the information in the world and buyers have very little of it, almost next to nothing. And this manifests itself in situations which do not benefit the buyers at all.

    Allow me to explain. Everyone talks about how real estate prices have been going up. This writer was recently told by someone that the flat he had bought in 2002 for around Rs 20-25 lakh was now going for Rs 2 crore. Fair point. But are there transactions happening at such an expensive price point? And if they are happening, how are they in comparison to the past?

    The point is that just looking at the price doesn’t give us the real answer. One also has to look at the number of buyers looking to buy at that price point because only that can tell us how strong the trend is.

    Unfortunately such kind of information is not available to most buyers in India. Hence, people who sell real estate, all the brokers and property dealers of the world, deal with buyers from a position of strength and always try to project a scenario where prospective homes are scarce. The buyers have no clue of whether deals are actually happening or not and hence tend to believe the brokers.

    A real estate index which tell us the broad direction of the market would be a great thing to have. While attempts have been made in the past to launch a real estate index, nothing robust has come out till date. Nothing of real value to buyers, at least.

    There are reasons to believe that people are not buying as much real estate as they were in the past. This is not conclusive evidence but some evidence nevertheless. Try reading any newspaper article which makes a pitch for the Reserve Bank of India cutting interest rates, the CEOs of real estate companies come across as the most desperate of the lot. This tells you at some level that they are not selling as much as they are building. But how will an interest rate cut of 25-50 basis points (one basis point is one hundredth of a percentage) lead to people buying homes is beyond me.

    Newspapers provide another indicator. Every week the front page of one newspaper or another has an advertisement for a new real estate launch happening somewhere, where the buyer has to put a minuscule portion of the cost of the home upfront. The money that is raised is typically used by the builder to pay off money that is due instead of building the homes that he has advertised.

    A story in The Caravan Magazine makes this point by quoting a property dealer: “If these builders were suddenly asked not to sell any more projects, I’m telling you, most of them couldn’t balance their books tomorrow.” So in effect most real estate companies are running Ponzi schemes where they are using money being brought in by the newer investors to pay off the older investors. As long as this Ponzi scheme keeps going, real estate prices will continue to be high. If newer investors stop bringing in money, the builders will have to start selling the homes that they have built in order to pay off people who they owe money to.

    Another interesting number is the proportion home loans form out of total loans given by banks. Home loans peaked at 12.9 percent of total banking credit in March 2006. As on 28 December 2012, they formed around 9.3 percent of total banking credit. And this in a scenario where housing prices have gone up many times between March 2006 and December 2012. Hence, it would only fair to assume that people are buying a fewer number of homes, at least by taking on home loans.

    So if people are buying fewer homes, why are the prices still not falling? Those who work in the real estate industry would like us to believe that the cost of constructing a house has gone up. While that may be true to some extent the argument doesn’t justify the astonishing levels of price rise.

    The material used in the construction of a house and other forms of real estate was, and continues to be, easily available. Lumber, which is used in large amounts, is a renewable resource. Glass is made out of quartz, the second most common mineral on earth. Gypsum, which is the main constituent of plaster as well as wallboard, is a very commonly available mineral. Cement is made out of limestone which forms 10 perceent of all sedimentary rock formations on earth. (Source: The Subprime Solution by Robert Shiller). That leaves out the price of land on which the homes are constructed. We will just come to that.

    A major reason for home prices not coming down despite the stagnant demand for homes is the fact that the market is dominated by investors/speculators and not real buyers who buy homes because they want to live in them. Anybody who has doubts about this can take a walk through the newer areas of the National Capital Region (NCR). Most of the flats remain empty, giving an eerie feeling of a ghost town. All these flats are owned by investors/speculators. And it is these people who keep playing a game of passing the parcel among themselves and in a way ensure that prices of homes do not fall. Also they have made so much money in the past (and given that most of it is black money) they are in no hurry to sell these homes.

    The story in The Caravan quotes a property dealer to make a similar point. “There isn’t a bubble of real homes…If all these apartments were actually built, and built fairly to schedule, I guarantee you that they would find real buyers. The demand is out there. But there is a huge bubble in imaginary homes—in homes that will be delayed indefinitely or just never get built.”

    Also most of the black money in India finds its way into property one way or another. Most of the ill-gotten wealth of politicians is also deployed in property. And any fall in price of real estate would mean the value of their wealth coming down.

    But at the end of the day there is only so much black money going around as well. What creates the illusion of real estate prices continuing to remain high is the supply of land. While India does not have scarcity of land like Japan does, the problem is that politicians control the supply of land. Every state and central politician has land held in benami. And this is the real bubble that has kept home prices high.

    As Ruchir Sharma writes in Breakout Nations: “Lately Indian businessmen have been regaling one another with accounts of a leading politician from Mumbai who is known to have amassed a huge wealth through property deals. At a private screening of a new Bollywood movie, this politician asked the producer to replay a particular song-and-dance number, over and over. When the producer asked if he was taken with the leading lady, the politician said no, he was eyeing the location and wondering where the producer had found such an attractive stretch of open space in Mumbai.”

    If home prices have to come down, it is this link that needs to be broken.

    Vivek Kaul is a writer. He tweets @kaul_vivek
  • #2

    #2

    Re : Why car sales are falling but not realty prices!!!!!!!!!!!

    Are these comparable. Home is a basic need than a car.And involvement of middleman is more. Car is a depreciating asset while home is an appreciating one. Just my 2 cents

    Comment

    • #3

      #3

      Re : Why car sales are falling but not realty prices!!!!!!!!!!!

      Indian Real Estate Bubble – will it ever burst?

      Indian Real Estate Bubble – will it ever burst?

      by Hemant Beniwal on November 26, 2012
      Most of the people are of view that in India real estate prices will never come down due to number of reasons including demography, shift of population from villages to cites, increase in earnings, economy growth and biggest reason that lot of black money that is generated through corruption is finding its way in Real Estate. So people who don’t own property are asking out of frustration that “will Indian real estate bubble ever burst?” – “will we be ever able to afford a decent property for our family?”. OR they should take a plunge at whatever rate they are getting? Let’s try to touch few related issues…
      This is just first in a series of articles – next post will talk about affordability of property.
      My friend bought some plot in 2005 at Rs 1800 per square yard sold it in 2011 at Rs 13000 per square yard. From sale proceeds he bought another plot at Rs 6000 per square yard & in less than 2 years price in that area is Rs 15000 per square yard. It means in 6-7 years his money has grown 16-17 times or 55-60% CAGR. Do you think he is genius? YES, if I don’t share this story… One of my clients bought some property for Rs 25X & now it is valued 300X in around 3 years so 12 times or 120% CAGR. So do you think he is genius? Yes if I don’t share this story… one of my relatives bought some agricultural land for 7X and now it is quoted at 100x in less than 2 years so 14 times or more than 250% CAGR.
      Bull Market Vs Genius

      You must be listening similar stories from your friends, relatives & property experts on media. But question still is – are they genius? May be…. It’s important to understand that everyone makes money in a bull run, if he participates in that asset class – my neighbor told me that value of my house has tripped in last 4 years. So one should remember that it’s because of bull market they are making money & price increase should not make them insane. Something similar happened with equity investors in 2007.
      But in all above examples people have started feeling that they know what will happen next & which makes me worried. Friend is saying soon one new road will be connected to that colony & price will be Rs 20000 per square yard, client is saying when I can earn 100% from property why should I continue my business and relative has already converted all his financial savings in real estate & now planning to take loan to buy more. Again the question is – are they genius? Answer is NO….
      Predicting future price

      Some real estate report recently said “The real estate sector will continue to remain an attractive investment destination with the possibility of prices in residential areas appreciating by 91 to 145 per cent in select cities over the next five years.”
      Their predictability of price reminds me of various reports published in Dec 2007 “close to budget SENSEX will be 25000″. OR dialogue from movie BORDER – Pakistani soldier after arrest “humain to yah bataya gaya tha subah ka nashta Jaisalmer main, lunch Jodhpur main & dinner Delhi main hoga”
      Indian Real Estate Bubble

      So should I want to say Real Estate price increase is actually a bubble? And if it’s a bubble – Warren Buffett said “For every bubble, a pin awaits”. No because I can’t predict anything & second is related to size of bubble which you can easily understand from Carl Richard’s image.
      He said “The supposed ability to spot bubbles is just another way of talking about market timing. Market timing, while not impossible, has certainly proven to be highly improbable.
      One of the big problems with some of the recent bubble spotting methods is that they work perfectly, just so long as you’re looking backwards. Many of these techniques are based on extensive research that relies heavily on back-tested models.”
      But someone has tried to predict Indian Property Bubble – from Wikipedia “Economists have expressed opinion that the property market in Indian cities is in bubble-state and is expected to burst by November 2014.”
      Another Story “India’s property prices- now falling, in real terms”
      Recently, Indian property price increases have slowed sharply. Of the 15 major Indian cities covered by the NHB Residex, nominal house prices rose in 9 cities and fell in 6 cities during the year to end-June 2012. However, when adjusted for inflation, house prices fell in more cities (11 cities) than rose (4 cities).

      This means that every property or real estate piece does not grow at the phenomenal rate, if you see in Mumbai & Bengaluru the prices have almost stabilized. And “stabilization” for real estate developer means a recession because he is not making more number of deals. Also an indicator to check is demand vs supply phenomenon in the city. If a city is already flooded with projects in city center vicinity, why will someone plan to live in suburbs? So if demand is met, the oversupply will crash the price. Just read somewhere that 65% of the properties in Delhi NCR & 35% properties in Mumbai are in hands of speculators. Does that indicate something – no because no one can predict size of bubble. (even if its there) Check real estate bubble burst of US & Japan.
      Manshu shared his views on Onemint “Thoughts on Indian Real Estate Bubble” – sometime back he also contributed a guest post on TFL “4 Lessons from real estate crash in US”

      Comment

      • #4

        #4

        Re : Why car sales are falling but not realty prices!!!!!!!!!!!

        Can I afford a house at current prices?

        by Hemant Beniwal on December 2, 2012
        Last week I wrote “Indian Real Estate bubble – will it ever burst?” – People shared a common view that properties are unaffordable for common man & even prices are not going to come down. Sunil summed it very well “It is quite sad and sickening that real estate prices have literally gone through the roof. A common man who wishes to have a roof over his head finds his dreams shattered. In the past three years, prices have shot up to the extent that a common man cannot even buy a small shelter even in far flung suburbs because of astronomical price. For all this mess, the government is to be blamed, which has done precious little to make housing affordable.”
        In this real estate series this is my second post & will talk about “How much house I can afford?”.


        Why it is important that affordability should be measured?

        There can be two purpose to buy real estate – either for self-occupying or investment purpose. In first case it is goal & in second case it is a means to achieve some goal. When we are talking about affordability we are talking about self-occupying and that too first property.

        It is important to know this number because it will have significant impact on other goals – for example:
        • If you have locked big amount in home then lesser amount will be available for other goals.
        • You will be asset rich but cash poor.
        • If EMIs are on higher side how you will save for other goals which are even more important.
        • If you need decent income after retirement will you be prepared to sell your house & move to a small apartment? It will be tough to change as the lifestyle at that point of time will make this compromise tough. Also will your family support this kind of decision?
        So now you understand that buying house is an important decision and should not be taken in haste.
        Indicator of Real Estate Affordability

        There are a couple of indicators but the simplest & which is most commonly used across the globe is “price to income ratio” – property prices are compared to after tax income.
        In India we don’t have any accurate statistical data – anyways, we have this Australian data of last 5 decades.

        Few important points that it throws:
        • Properties can stay unaffordable for fairly long period
        • Interest rates & government policy towards housing sector plays a significant role in real estate prices.
        • Affordability is related to income – property price can be called cheap if EMI is less than 37% of income & affordable if it’s under 50% (these are Australian standards & can be different from India)
        Australian numbers are scary for any person who doesn’t own property – let’s check Indian numbers.
        Indian real estate affordability Index

        Indian Government does not provide any long term statistics – couple of years back national housing bank started providing some data but that is not sufficient to reach any conclusion. Best data available to check affordability is from HDFC Ltd – leader in Home Loans – I am not sure about the reliability but will still consider the same as something is better than nothing. This data can be found on their website – investor presentations.
        Myth Busted: Property price don’t correct/crash

        Above image clearly shows that property price correct & even it can have deep correction of 50%. This data shows that if property was priced Rs 26 Lakh in 1996 the same property was available for Rs 13 Lakh in 1999. Prices remained flat from 1999 to 2004 & starting 2005 it is in bull phase. So please stop predicting that prices will never correct.

        Few more points – assuming this data is reliable:
        • Property prices not even doubled in last 16 years – this means rate less than 4.5% which is much lower than even FD rates.
        • Prices tripled in last 8 years which is clearly a bull run – which means 15% CAGR. Last equity bull run started in 2002 & ended in 2008 beginning – in 6 years Sensex went up by 7 times or 38% CAGR.
        • Affordability number is more or less flat in last 12 years – which is close to 5 times.
        • If we assume 1995 was peak of last Bull Run – but that matured when affordability hit 22 so what are we heading towards??
        I know you have lot of interesting points to share on the above data & my analysis – feel free to add that in comment section
        Can I afford a house at current prices??

        Question is not about current prices but it is the number that should not impact complete financial life – negatively. Some time back I wrote “Financial Planning Thumb Rules where we talked about this magic number but for most of readers it was unacceptable number. Rule is…..
        “The value of house should be equal to 2-3 times of your family annual income. So if you & your spouse are earning total Rs 20 lakh – you should buy a house in Range of Rs 40-60 Lakh.”
        And if we stick with this – normal person can’t buy property in Australia or India. HDFC Ld shows average price is 5 times of income in last 12 years so should we put this as Indian Standard??
        Another rule that should be followed while purchasing property is Home EMIs should not be more than 28-30% of net income & total EMIs should not be more than 36%.
        Let’s see one Example:
        Example:
        Thumb Rule3 Times5 TimesAfter Tax Income
        100000
        100000
        MonthlyAfter Tax Income
        1200000
        1200000
        AnnualValue of House
        3600000
        6000000
        Down Payment
        720000
        1200000
        20%
        Loan
        2880000
        4800000
        80%
        Loan Tenure
        15
        15
        YearsInterest
        10.50%
        10.50%
        FixedEMI
        31835
        53059
        EMI Vs Income
        32%
        53%

        But don’t take this rule as final verdict – go hereand read points shared by Mudit & Rohan Doshi.
        Last edited March 31 2013, 05:30 PM.

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