But Indian borrowers do not walk away from their homes — and loans — if prices dip. This is because a large proportion, often half, of almost all home purchases is paid in black money. If a house is sold for Rs 100 lakh, the official registered value will typically be only Rs 50 lakh, with the balance paid under the table in cash.
A bank may loan Rs 50 lakh, covering the entire formal price. However, the owner’s contribution is not zero: he has paid Rs 50 lakh in black. To preserve that black investment, he will keep paying his installments even if house prices dip.
The reason is that banks enjoy, without asking for it, a huge safety margin provided by the black money invested by every home owner. To preserve this black investment, borrowers will do their level best not to default and lose their property. Ironically, black money enforces loan discipline in India, far more effectively than formal contracts or legal processes.
This very black money also acts as a cushion for price falls. What seems to be happening (entirely hearsay) is that as home prices come down in India, sellers are looking for a lower “black” component. The “white” part – the actual registered value of the house – remains the same. Two good things come out of it.
One, lowering the black component requires less hoarding, saving etc. Black money needs to be hidden from the government for obvious reasons, so it tends to be in rupee bills. Hiding bills in your mattress etc. is of little use, because there is a fear that someone else may rob you. So people have done things like take a loan on insurance policies paid in cash, bought dollars in cash etc. – but the government has plugged most, if not all, of these loopholes through PAN requirements or KYC norms. The other options are buying gold or to put cash in bank lockers, which isn’t very helpful either, because gold has a huge price (which can be higher than paying the tax!). Even storage is seemingly safe locations has risks, as noted by a man whose money was eaten by termites. (Hat Tip: Madhu Menon) Heck, even the Sheikh of Abu Dhabi had his money eaten by rats. (From a conversation with Nitin Pai)
He refused to accept checks from the oil companies, at first kept his cash under his bed. When the bedsprings began to bulge, he had the cash carted to a palace dungeon. It was only after rats began nibbling at the treasure chests and insects started eating the folding money that Shakhbut reluctantly agreed to accept the principle of banking.
Two, the registrars and the income tax department are unlikely to probe further. A reduction in the “white” component necessitates a lower registration value, which can be construed by the registrar or the IT department (to which the registrar must file all registrations above Rs. 30 lakh in value) as a ploy to avoid paying income tax or stamp duty. A subsequent probe might unveil any black money, on which there is the liability of a huge penalty, tax and all sorts of criminal charges.
The by-product of the reduction of the “black” component is affordability. If you liked a house and it listed at Rs. 75 lakh, of which you could put up 15 and get the remaining 60 lakhs as a loan, you would be tempted to buy the property. But if the seller demanded half the money in cash, you would need 37.5 lakhs in cash, and then a further down payment of say Rs. 7.5 lakhs for the registered value of the house, and then a loan of 30 lakhs.
That means you needed to have 45 lakhs to buy a 75 lakh house, a 60%+ down payment which is very unsustainable. The IT/BPO managers, the highly salaried employees of large organisations get all their money in “white” – meaning, all taxes are prepaid. They may qualify for higher loans, but putting in 60% down is simply beyond reach. As the black component comes down, more such people can afford real estate and therefore there is an intermediate cushion.
Is then my view that the real estate bust is over? Hardly. We still have way too much supply compared to demand, even if this black component goes to zero. (which it has, when you buy from most established builders today) There is little, if any real estate available for the lower-middle class, and there lies the largest demand. Real estate companies would rather hoard land than give in to lower middle class development; not just because of lower margins (must sell more flats for the same overall area and less price per flat). It also is a community thing – build one such tenement and you will find the entire area branded as such and therefore no high margin “luxury” development can happen there. Local developers will stoop to any levels to prevent that happening.
This is stupid, apart from being unfair. There is way too much luxury supply so anything new in that level makes things even more unprofitable. And if you have an area with only luxury apartments, where do the staff live? (Most Indian “luxury” households have an entourage of personal staff, from chauffeurs to maids to baby-sitters to odd-job-errand-runners).
I hope this brings to builders some sense that lower income housing is as important and the lower margin creates wealth in the long term. Plus, we don’t want to see some people left behind, do we – speaking politically, that is a nightmare you don’t want. When the lower income people – the real voters if you may – feel left behind only one thing happens. Increased regulation and cost across the board, which makes sure EVERYONE is left behind. Suffering is a great leveller.