Saturday, 27 July 2013

Lessons from Japan to Patna: Busting the biggest myth of investing in real estate Patna.

Buy Sell Rent Patna

Japan saw the mother of all real estate bubbles in the 1980s. Banks were falling over one another to give out loans and home and land prices reached astonishingly high levels. As prices kept going up, the Japanese started to believe that the real estate boom will carry on endlessly. In fact such was the confidence in the boom that Japanese banks and financial institutions started 100 years home loans and people lapped it.

Things started to change in late 1989, once the Bank of Japan, the Japanese central bank, started to raise interest rates to deflate the bubble. Land prices started to come down and there has been very little recovery till date, more than two decades later. Since the 1989 peak…land prices have fallen by 60 percent in Japan.
Every bull market has a theory behind it. Real estate bull markets whenever and wherever they happen, are typically built around one theory or myth. Huge increases in real estate prices are built around “the myth that, because of population growth and economic growth, and with limited land resources available, the price of real estate must inevitably trend strongly upward through time.

 

And the belief in this myth gives people the confidence that real estate prices will continue to go up forever. In Japan this led to people taking on 100 year home loans, confident that there children and grandchildren will continue to repay the EMI because they would benefit in the form of significantly higher home prices.
A similar sort of confidence was seen during the American real estate bubble of the 2000s. In a survey of home buyers carried out in Los Angeles in 2005, the prevailing belief was that prices will keep growing at the rate of 22% every year over the next 10 years. This meant that a house which cost a million dollars in 2005 would cost around $7.3 million by 2015. Such was the belief in the bubble.
India is no different on this count. A recent survey found that “over 85 percent of urban working class prefers to invest in real estate saying it is likely to fetch them guaranteed and higher returns.” This is clearly an impact of real estate prices having gone up over the last decade at a very fast rate. The confidence that real estate will continue to give high guaranteed returns comes with the belief in the myth that because population is going up and there is only so much of land going around, real estate prices will continue to go up.

But this logic doesn’t really hold. When it comes to density of Population, India is ranked 33rd among all the countries in the world with an average of 382 people per square kilometer. Japan is ranked 38th with 337 people living per square kilometer. So as far as scarcity of land is concerned, India and Japan are more or less similarly placed. And if real estate prices could fall in Japan, even with the so called scarcity of land, they can in India as well.

Economist Ajay Shah in a recent piece in The Economic Times did some good number crunching to bust what he called the large population-shortage of land argument. As he wrote “A little arithmetic shows this is not the case. If you place 1.2 billion people in four-person homes of 1000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1% of India’s land area assuming an FSI (floor space index) of 1. There is absolutely no shortage of land to house the great Indian population.”

The interesting thing is that large population-shortage of land is a story that real estate investors need to tell themselves. Even speculators need a story to justify why they are buying what they are buying.
Real estate prices have now reached astonishingly high levels.  As a recent survey pointed out, 29% of the homes under construction in Mumbai are priced over Rs 1 crore. In Delhi the number is at 11%. Such higher prices has led to a drop in home purchases and increasing inventory.

The inventory level has almost doubled in the last three years. In the National Capital Region, the inventory level reached 31 months at the end of March 2013 against 15 months at the end of March 2010, while in the Mumbai Metropolitan Region the inventory level has jumped from 17 months to 40 months. In Hyderabad, it reached 49 months in March 2013 as compared to 23 months in March 2010, according to data by real estate research firm Liases Foras. Inventory denotes the number of months required to clear the stock at the existing absorption rate. An efficient market maintains an inventory of eight to ten months.

The point is all bubble market stories work till a certain point of time. But when prices get too high common sense starts to gradually come back. In a stock market bubble when the common sense comes back the correction is instant and fast, because the market is very liquid. The same is not true about real estate, because one cannot sell a home as fast as one can sell stocks.
Real estate companies in India haven’t started cutting prices in a direct manner as yet. But there are loads of schemes and discounts on offer for anyone who is still willing to buy. As the Business Standard news report quoted earlier points out “As many as 500 projects across India are offering some scheme or the other, in a bid to push sales in an otherwise slow market. Mumbai has the maximum number of projects with schemes/discounts at around 88, followed by Delhi with 56 and Chennai and Pune with 33 each. Kolkata has 30 such offers, while Hyderabad has 18 and Bangalore has 16. In Patna too we have a number of residential and commercial projects offering numerous freebies.


The real estate bubble in Patna may not burst soon, while the State of Bihar is growing in double digits. But the fact remains one day it will and in those times some Bihari investor in real estate will be caught on wrong foot. The unfortunate thing about all these collapse is that they happen when one thinks it is not possible. Therefore the advice to investors is to remain diversified in asset allocation. The other trend seen in Bihari real estate investors is their craze for properties in Delhi NCR. The only precaution is that this market will heat up earlier and bubble will be hurting the investors sitting far away in Patna more as they will be able to react only once the story is out. Remember, REAL ESTATE IS LOCAL, GLOBALLY. Once the Bubble bursts; the situation may remain grim for years and even decades as in Japan.