We have been having a lot of conversation speculating on the future prices of RE market, and I have been participating in it every now and then. Many members in this forum have taken different view to predict what could happen to the RE over the next few years.

I think we have thrown the fundamentals out of the window in our discussions. Let's try to find answer to some fundamental questions :

1. Assuming that percentage of workforce earning more than 10 lakhs / annum are the key to move RE (at least in cities) forward. We have had many many times (i.e., few hundreds %) increase in the last few years. Thanks to outsourcing. The sum was very less in before 2004. What is going to be the increase over the next 5 years ? Double ? Triple ? In the past 1 year at least, if at all, that workforce has stayed constant.

2. When it comes to RE, it is all about location. Let's take the case of Velachery. In 2004, many nay sayers said it is a low lying area and the price appreciation will not hold water. It has had a fantastic run since. It beats even central chennai in % returns. It was mainly due to the IT companies investing heavily in Siruseri. So, it is all about location. What areas do you think will attract lot of investments, both from government and private sector and why ? What are the future developments in the offing ? Is it a pie in the sky idea (like the new airport for chennai) ? Hear it out with a discerning ear.

List it the investments in your area. If you have government investments like train station or a market or mall, it will add value in the long run. Of course, when you buy it today, you will pay a premium for that appreciation. There is no free lunch.

3. The regulatory changes happening throughout India will have a say. India is opening up since Narasimha Rao government, we have had huge benefits from this especially in attracting FDI. The changes could change the market significantly. For e.g., the introduction of REIT (Real Estate Investment Trusts). Many small investors in particular like Pooled investments (look how fast the Mutual fund industry has grown in India). So, this could increase the number of players in the market and thereby, affect the market.

(I will try and explain the difference between the land and flat or houses in a minute, )

4. (We have 2 cases here. Read on.) What moves the RE ? To put it more broadly, what moves any market ? Yes, demand and supply, but what causes the demand to raise ? The underlying cash flow generated from it - profits. To be RE specific, the yield or rental yield. Let's forget about RE for a moment and discuss a bit about bonds. Bonds Vs. RE ? Sounds crazy, I know. Please stay with me for the moment.

Case 1 :

When you buy a corporate bond for e.g., 5 yr ICICI Bank bond paying 10% coupon for Rs. 1000. By buying this bond, you are essentially lending money to ICICI Bank to do whatever they want to do for the next 5 years. When their time is up you can sell it back to them and receive your capital back i.e., Rs.100 back. They also pay you (1000*5%=Rs.50) every six months (usually), i.e., Rs. 100 every year. The cash flow is about 10% of capital every year. In between, whenever the RBI raises the interest rates, the price will go down below Rs. 1000 and whenever they decrease the interest rates, the bond will sell at a premium (i.e., above Rs. 1000).

Case 2 :

Another case is Zero coupon bond. The difference is there is no pay off. Let's take a 8 yr ICICI Bank Zero coupon bond. Like it says, there is no coupon generated from this bond. There is no cash flow from it. But the bond is issued at a price less than par value - i.e., say about Rs. 60 and the bond value increases over the next 8 years and you can redeem it at par value - Rs. 100.

Case 1 is flat and case 2 is land. Land is a dead investment, i.e., there is no cash flow generated from it. You should essentially prepare yourself to put it away for many many years.

Now that you know the difference, what do you think the increase in rental over the next few years ? Is a 5% year on year increase sustainable ? If not what do you think is sustainable ? Before you begin to think of yourself as a flat owner, think of yourself as a tenant. Would you be okay if your landlord increases the rent by 5% every year ? If yes, then go ahead and assume it. Would you pay Rs. 20,000 for a 2 bed flat in Velachery ? if not why ? Would you rather buy ? If so, why ? What if everybody thinks your way, at some point in the future there will be oversupply in the rental and the rent income will be down, so is the RE prices.

There are of course, many many things that could move the market for e.g., politial uncertainty. In the next election, we have a hung parliament for next 5 years, you wouldnt be able to sell it when you want to!

But don't buy until you have understood what you are buying or buying into.

Thanks,
Salim.
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