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Real Estate in India – Not Quite The Same As The U.S.

Very good comment by Bhaskar, to my last post:

RM by definition is a floating rate loan. However, Hybrid ARMs are common products in the US and is the significant source of the problem.

5/1 ARM – Fixed for the first 5 years and floating rate adjusted once every year after that.

2/28 ARM – Fixed for the first 2 years and floating rate adjusted once every year after that.

The US banks entice customers with a significantly low fixed interest rate that grows to a much higher floating rate when the fixed term resets. There are “caps” specified in the contract that limit the increases at the end of fixed term (for ex. 3%) and every year after that (for ex. 1%).

The Hybrid ARM products were well received since the customer believed he could just refinance into another hybrid ARM at the end of the fixed term. It worked for the past 8 years or so, when the RE prices continued to increase. Now, with RE prices falling, it is another story.

Additionally, the use of Home Equity Lince of Credit (HELOC) (essentially a credit card with the additional home equity as collateral) is rampant. The interest rates for HELOC are 7.5% compared to 14% for credit cards. (Source: HELOC has been funding the customer spending in the past few years.

In India, Hybrid ARMs are not common. Fixed rate loans are revised periodically, but they do not come with initial teaser rates. HELOCs are not used commonly, though similar products are available. This is the significant difference, which allows users to hold substantial equity in their house. Also, the savings rate of a household in the US is almost 0% compared to 40% or so in India.

(Click here for Graph)
If someone did publish the graph for India, I bet it will be very different.

What you say is very interesting, thanks! I agree – we don’t have teasers in India or hybrid ARMs. There are equivalents but yes, our system is different. The problems in the US can perhaps be attributed to teasers or hybrid ARMs, but the underlying issue was that a price decline was simply not accounted for. And in a way, neither have we.

I think the problem in India is perhaps different – and not fuelled by lower equity ownership of houses like in the US. The problem in the US is unfettered securitised lending, which is affected by the high foreclosures, which in turn is affected by lower owned equity. In India, it is really a reversal of the real estate market and therefore an effect to the fortunes of those closely associated with it.

The problem could start from the fact that the foreclosure system is very weak and slow. Banks therefore may try to hike or “margin-collect” earlier, and RBI may tighten definitions of NPAs here. Renegotiations are more difficult and less organised.

And it’s not really the first time homeowners that are affected – since they will try to keep their houses. A rabidly large set of people, even those without the capability to do so, have bought multiple properties on margin financing. Because they could.

The other, and perhaps bigger problem is properties bought during construction – a large part of new sales. These involve even lesser margin (just a lakh or so upfront for a 50 lakh property, and then payments on a month/bi-monthly basis). A very large part of these were sold to speculators, and those that could leverage on bank loans, and of course, with prices going up, no one cared.

So technically I could buy a 40 lakh house, get 90% financing (in 2005), and need to put down only 4 lakhs. But not even that much – if the house was under construction over say 20 months, the builder expects me to pay say Rs. 4 lakhs every second month. Of that I put in only 40 grand – the banks fund the rest.

For 20 grand a month – 40K every two – I get a 40 lakh house, plus I only need to pay “interest” to banks until the house is complete. Meaning, I would pay say 8% on only that part of hte loan which is paid out – which as you can see is next to NOTHING.

With 20 lakhs in cash I could easily buy 10 houses and survive a few months (planning of course to roll over one house every couple months till I profit enough to keep the rest) For this prices should only go up – and for a long time, they only went up.

With prices actually coming down, such guys are hosed. They expected to roll over and get some profits to pay the next slab on the remaining houses, and now they don’t have that leverage. So they don’t pay the builder.

The builders are therefore slowing down the apartment construction, because they don’t have the cash they planned to get on each slab.

With construction slowing, others who bought are paying bank interest for no reason, without the tax benefits either – they eventually get ticked off and could decide to liquidate and buy a ready house instead. That lowers prices more, and so on. Banks can’t foreclose – they don’t even have the property ready yet – and they’re now facing increasing NPA pressure that they can’t do much about.

Demand for ready houses increases temporarily but slows down as people realise how the underfunded developers have cut corners to provide possession – and the market prices of those houses stay low (until someone goes in, fixes the place and then resells – a long cycle)

At some point, prices spiral downwards. Pressures can seem to come from cement prices, or some RBI regulation or something external, but it was the build-up that was designed to crumble – and it will.

The cycle has happened at least twice in my lifetime in Bangalore, and I’m sure it will happen again. This time, the situation looks grim because the volume is so much higher, but at this point I’m not unduly worried because it could still be an urban and local phenomenon as high quality construction has not really picked up in the smaller towns.

Note: I have no links because a) I’m lazy and b) there isn’t an organised source. I’ll try to collect some. I’m talking about what I see, hear and read, a consolidation of sorts. If you have links, please post them in the comments. I deeply appreciate them!

  • Prakash G.R. says:

    >Good one!

  • Anoop says:

    >Will price really come down?? My wife refuses to believe that and to some extent me too. You say you have seen the price crashing two times. Would you please tell me how it was?? Is it something like a house is being sold at a
    particular location 50Lakh and after 3 years, it could be sold at 40 Lakh(did not consider inflation). So it is 20% percent less. Can it happen? I think it will take lot of time seeing the Indians mentality – land prices always increase. I really don’t know who are these people buying. I find it really difficult to buy a house, while I am earning 70K per month and having 4lakh in cash. When i think about uncertainty like job loss, recession, interest rates, and seeing my future expenses. It appears to me horrible.

  • Anonymous says:

    >My wife/daughter are pushing me to buy a house saying prices will not come down. But I am adamant that it is foolish to buy at these levels and prices should come down. If recession strikes globally
    I am sure prices of everything Stocks, Gold, Oil, Houses will all come down. Cash will be King.

    But it is difficult to get this message to my friends and relatives.

  • Anonymous says:

    >Some links …


    It doesn’t get better than this

    Metro property prices to take a beating

    Price correction in Bangalore residence realty (quotes an IndiaTimes article)

    Realty in Bangalore witnessing stabilisation phase

  • Bhaskar says:

    >India’s hot property market is likely to cool soon: Kamath

    Appeared today in the web version of Economic Times.

    – bhaskar

  • Deepak Shenoy says:

    >anoop: 1995, apartment in my building went for 35 lakhs. In 1997, one went for 18L (similar sized). Last year, 10 years after the 35 lakh sale, someone sold an apartment for 58L.

    1987 was a slump of sorts in Bangalore because after a fire in the Gangaram’s building the government banned 7 storey buildings. That time was another high rise buildup and slump.

  • Ranjit kumar says:

    >Hi Deepak,

    I agree with you and wanted to add one more point, “highly spread speculation with little payments which creates a tangled mess”. Please find the following link which describes my experience with real estate and people belief’s.

    Ranjit kumar

  • Anonymous says:

    >Hi Deepak,

    That was a good piece of info. I was desprately trying to buy a house (because of the complesion from my wife) but the rates too high that i cannot afford, keeping an eye on my future expenses. It’s surprising to see stil there are buyers at these unreasonable rates.
    Did you foresee any timeframe when the real estate prices are going to cool down?


  • Anonymous says:

    >Yes, real estate prices will cool down. There is every indication of a bubble now. I live in Cochin where I find that many artisans like carpenters, shopkeepers, and just plain erstwhile jobless youth have become property brokers. Plus, there is no way the ultimate buyer will get his investment back, if he buys at these prices. Have patience, you’ll be able to buy again the same properties you covet at a fraction of their current prices.

  • kram says:

    >First time I’m seeing a realistic and intelligent analysis of RE prices in India. To answer some of the inredulity of newcomers who have NEVER seen a price decline in RE in Bangalore:
    1995 MG Road-Rs.12000/SqFt
    2000 MG Road-Rs.3000/SqFt(few buyers)

    1995 Whitefield-Rs.60L/Acre
    2000 W/field-Rs.12L/Acre(no buyers)

    It took till end-2004 for prices to reach 1995 peak. Today MG Road is 23k/SqFt. Avg. long-term RE returns are just like any other asset class (around 8% – 12%).

    This time there has been a Global Synchronised RE Boom for an EXTENDED period and VERY HIGH magnitude. Both Booms are financed by export-led liquidity (India) and loose credit (pumping) by Central Banks all over the world. This is RAPIDLY coming to a nasty end. US is rumored already in recession, UK is close behind, EU will follow soon, China is an impending disaster. Can we be far behind?

    Realtors and minor Home Partners (Banks actually own 80-90% of “your” home) are in denial mode (as usual). If Home prices fall 20-25% and you own a home and lose ability to pay, you lose EVERYTHING when you lose your home!

    The de-coupling myth is losing support. Expect this decline to als obe substantial (maybe even as big as the 95-00 one). Imagine, losing 60-80% of peak (bubble) value.

    2008 is going to be a VERY INTERESTING year of high volatility and builder despair.

    Only silver lining – next boom will be even BIGGER!!!