Real Estate Bubble in India

Indian real estate prices are one of the highest in the world in terms of affordability as median real estate price to median income ratio is almost 300, in India’s economic capital of Mumbai. There are a number of reasons given by real estate companies in India to justify the high prices of real estate in India. These reasons are reiterated even  by seasoned investors and analysts. One of the stupidest reasons I keep hearing is that real estate prices never fall. This was the same reason that led to a mortgage bubble in the US. However real estate prices do fall and can keep falling for a very long time after a bubble bursts. This painful reality can be seen in Japan where land prices fell for 21^st year in a row in 2012. Japan too saw a historic real estate bubble with the peak seeing a parcel of land in Tokyo being equal in price to the whole state of California.

Reasons for Indian Real Estate Bubble

1) Corruption, Opaque Regulations, Use of Black Money – Real Estate in India is a Cesspool of Corruption and even India’s Prime Minister has also accepted it saying that high Stamp Duty on Real Estate Buys result in the preponderance of Black Money in Real Estate Deals. Due to the massive price appreciation and huge valuations, Land Scams have become quite common with Chief Ministers, Generals, Top Bureaucrats all involved in the murky environment of Real Estate in India. There was a scam related to bribing of top public banks officials in the LIC Housing Finance Scandal which again put a question mark on the fundamentals of the industry. Valuing the industry and making a real estate investment remains one of the most difficult investing tasks in the Indian Stock Market. Even Fund Managers are staying away from the Sector due to lack of trust in the Financial Statement given by the industry.

2) Global Real Estate Bubbles – One of the reasons for the sharp price rise in Real Estate in India is that Real Estate in many parts of the world are a bubble. Allowing Foreign Money into Real Estate in India has made these PE investors pay the same valuation for properties in India as outside. Note many of these “Real Estate” Private Equity Investors have yet to recover from the fall in property prices in the 2008 crash though many have been saved by the Bernake reinflation.

3) Tax Laws and Policy Stupidity – India’s Tax Laws impose high capital gains on land that is sold and not reinvested back into real estate again. That keeps the huge sums from gains in the real estate to be funneled back again. Otherwise a lot of the money would have gone elsewhere bringing the Real Estate back to earth again. India also allows an exemption of Rs 1.5 laks ceiling on interest payments on Real Estate Payment giving an impetus to investing in RE. Note such misguided laws were a leading cause of trouble for the Real Estate in USA.

4) Local, State Laws on Real Estate prevent Market Forces of Demand/ Supply to Operate – India’s Local and State Laws dealing with Real Estate are as bad if not worse than Laws at the central Level. These Laws in most cases prevent the normal working of the Market Forces of Supply and Demand.  The biggest proof of this is the fact that the Rental Yields on properties in India are way lower than if you took out money from selling the real estate investment and putting in a safe government bond. People in Mumbai, the biggest real estate bubble market in India have stopped buying houses and going for rental leases.

5) Peer Pressure, Cultural Factors – A lot of people buy real estate seeing other people buying at inflated prices. Not exactly a classical economic argument, given that it assumes people are rational and make decisions based on value. It has become acceptable to pay a huge amount of income as EMIs seeing other people do the same. It does not matter that the benefits are hardly worth the costs. Cultural factors like buying real estate preference also have played a big role. In India people avoid stocks, bond but prefer real estate and bank fixed deposits.

Marketwatch

Japan’s residential land prices suffered their 21st straight year of losses, while commercial land prices also fell, though both drops moderated from the previous year, Kyodo News reported Wednesday. The report cited Land Ministry data as showing that average residential land prices fell 2.5% during the year ended July 1. While residential prices have yet to rise this century, the fall was less than the 3.2% in the 2010-11 year. Commercial land prices, which have fallen for five years straight, also moderated their losses to 3.1%, slowing from the previous year’s 4% fall.