Capitalmind
Capitalmind
Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Commentary

RBI Housing Data Shows Housing Loans Are Taking 40% of Income as EMIs

RBI has released a report on Indian Residential Real Estate Prices. They use bank loan data to get an idea about housing prices. Since Banks appraise houses before giving loans on them, the RBI believes that “Banks and housing finance companies are comparatively practicable and reliable sources of property/house price data, due to their prominent role in institutional financing for housing as well as timely data availability in electronic form.”.

Price Data is Unreliable

This is largely, a load of bull, because not just anecdotally but in real life, I have seen the way appraisals for projects are handled, and the appraiser is actually paid for stating that the house is worth X, and he will not get any future business if he says it is worth less than X. In a way, it’s like valuing a startup – it is worth what the other side is willing to pay for it, and the appraiser will believe that look, if people are buying it at X, it’s worth X.

So you will find big dichotomies in the RBI index and what’s on the ground. And even here, since values are based on “white” components only (that is, only the amount paid by cheque and a part of which has been taken through a loan) it will not really reflect reality. If you buy a house for 1 crore, and pay Rs. 30 lakh in cash, then your house value, according to the agreement, is only Rs. 70 lakh. Your loan will be 80% of that 70 lakh.

Recently, local authorities have increased “circle rates”, which is the minimum you can register your purchase for. The circle rates is what you pay “stamp duty” on, typically 4% to 7%, to the state government, which specifies these rates by area and sometimes, by apartment block.

The increase in circle rates is often long overdue – they stay the same for years, until the authorities realize prices have gone up, and then they bump it up. When prices fall, they rarely reduce circle rates, and it is often noticed that people pay stamp duty on a higher amount than actually paid. (Because the circle rates are now higher than market rates!)

For instance the 1 crore house that was 70:30, might now move to 80:20 (80 lakh white, 20 lakh black), because circle rates are higher. If prices drop, it will then become 80:10 – since the 80 is fixed according to the circle rate.

Since circle rates are up, white components of the price are going to be higher. Which means loan values will be higher, and appraised prices will be higher. So even if overall prices are dropping, what will appear is that housing prices are going up, if you look purely at bank appraisals.

Which means housing price data, and changes are unreliable in this report.

With all these in mind, let’s see what the RBI says the housing market is up to. We do not believe the house price numbers, as they involve lack of reality due to the factors above. But what we can discern is how leveraged the loan market is, today, and there are some interesting metrics there.

Price to Income – at Five Years of Income

The RBI paper only covers cities (Mumbai, Hyderabad, Delhi etc.). They look at the (appraised) price of a house, and then tell us how many months of income the price is, compared to the borrower’s income. This is an interesting statistic, and it turns out India is pretty much at prices that are about 5 years of income.

image

Now five years doesn’t sound extreme. But we have argued earlier at Capital Mind that the ratio is not universally comparable. That the price-to-income should be based on what interest rates are, and a ratio of 7 may be small if mortgages are available at 3%, and even 4 may be too high.

Since we believe prices are actually higher (due to black component etc.) this ratio is likely to be even higher than the 5 levels reported.

EMI as a Percentage of Income: 40%!

How much, as a percentage of your gross income, would you pay to own a house? Turns out, the India wide average is as high as 40%.

This is a combination of both interest rates and prices. As interest rates have been flat (and only now, falling) prices or housing loan outstandings have changed so that the monthly installments are 40% of income.

image

Note: Typically incomes mentioned are gross. So you pay 40% to the bank, another 20% or so to the government and have the rest to live on.

40% is quite high. The US determines that the limit at which debt-to-income becomes too much is 43%. That’s total debt (including car and other loans). At average 40% EMI to Income only for housing, we seem to be living on the edge.

Our View

While the data on pricing, in our opinion, is not reliable, what it tells us about is whether India is living in affordable territory in urban real estate – at 40% of income, EMIs are at very high levels. If we should have a crisis that involves job losses or a cut in incomes, these loans are going to be in some serious trouble and will need to be restructured.