Real Estate Investment in Patna: - A CONTRARIAN VIEW

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Most people in Patna are convinced that real estate is a great asset. More caution is in order. Real estate investment in Patna is not a guarantee of profit. Real estate in Patna is hard to be diversified, and illiquidity hampers portfolio structuring. Most important, the outlook for supply over the medium term in property in Patna implies that there is no great upside from here. 

Too many intelligent people in Patna believe that one can never do wrong by investing in real estate in Patna. Some facts will help bring more sense.

Consider investing in the best commercial real estate of Bombay -- Nariman Point -- in 1994. The price was Rs.35,000 per square foot. Today, almost 20 years later, the price is Rs.25,000 a square foot. Over this period, Nifty produced returns of 362%. Inflation ate away 272%. Net of inflation, Nifty delivered an average annual return of 1% while Nariman Point commercial real estate; one of the prime commercial properties in our country;  delivered -9%. 

This is, of course, just an anecdote. Many individual real estate investments in Patna have done very well and have occasionally outperformed equities. Our point is a limited one. We should not mindlessly assume that real estate is always a good investment in Patna. We should not assume that real estate will always outperform equities -- as the above example shows things can be as bad as underperformance (compared with the Nifty index fund) of 10 percentage points per year over a 19 year period. 

Why did Nariman Point underperform over this period? The answer is, “new supply”. That is the heart of the problem of real estate in Patna as an asset class. There is no long term returns in owning steel or bricks. Every time there is a real estate boom in Patna, it triggers off fresh construction. This supply quenches the boom. 

In Patna, the case against real estate is stronger. The government is slow to build roads and water supply and police stations in outlying areas. But with a lag, these facilities do come about. Ultimately, when the price of structures exceeds the price of bricks and steel, new supply emerges, which is bad for real estate prices in Patna. The rise of a professional real estate industry, coupled with access to formal finance including foreign capital, has increased the scale of supply and given bigger and faster corrections in Property in Patna. 

Some claim that Bihar has a large population and there is a shortage of land. A little arithmetic shows this is not the case. If you place 10.2 crore 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 a very small percentage of land area assuming an FSI of 2. There is absolutely no shortage of land to house the great Bihari population. 

The biggest story about the future of real estate prices in Patna is the FSI. In most of Patna, the FSI is around 2. This is an abysmally small number by global standards. All over Asia, FSIs are above 5, going up to 20 or to no limit. In the long run, politicians in India will see the light and FSI will rise. A higher FSI results in lower rental rates for households and firms, as was seen in Hyderabad which was a pioneer in FSI reform. When FSI goes up, this will unleash supply on a big scale. As an example, if Patna moves from an FSI of 2 to 4 -- which would still make it worse than the FSI seen anywhere else in Asia -- this would trigger off a doubling of supply. 

These arguments are not specific to Patna. While datasets about real estate investments in Patna over long time periods are not easy to come by, academic evidence is slowly building up of fairly poor returns to real estate. Net of inflation, real estate tends to produce roughly nothing over long periods, while equity indexes produce significant and positive returns after inflation. 

Finally there are the practical difficulties of diversification and liquidity. Most people are not rich enough to buy 50 properties spread across Bihar. Buying and selling involves very large transactions costs and delays, and generally involves black money. 

Skepticism is in order. If less than 5% of the land area of Bihar is built out, this is enough for the entire population. There is no long-run return in hoarding bricks and steel. Real estate booms the world over are quenched by supply. The prospect of holding real estate in Patna is worse because FSIs are tiny. In the future, FSIs will go up, which will further fuel supply. Households investing in real estate in Patna are also hurting on account of inadequate diversification, illiquidity and the use of cash.