Crash predicted in real estate prices
Experts have warned about a 50% crash in future real estate prices in India. The difference between the rental yield (2%) and the borrowing rate for real estate (10%) is 8%. This is one of highest in the world economy. The likelihood of rents rising is low; therefore, real estate prices need to fall significantly for the rental yield to rise.
Trip down memory lane
India shouldn't be surprised at the prospect of a dramatic fall in real estate prices. In 1997, real estate prices in Mumbai fell by 50%; prices nosedived across India-in Delhi, Bangalore, and Chennai. A comparison showed that between 1995-1997, real estate prices had fallen by 40%. At that time, Mumbai had a lot of black money; the current situation is rather familiar and ominous.
Putting the pieces together
According to RBI, in the period ending March 2014, bank lending to commercial real estate had grown by 22.4% as compared to the overall increase of 14%. Despite the abundance of unsold real estate, lending to real estate companies grew at a faster pace than overall lending. It was suggested that politicians who were behind real estate companies were forcing banks to keep lending.
What is rental yield?
Rental yield is the annual return on lending out a house. The index is achieved by expressing the rent of the house as a percentage of its market price.
The Greece in real estate
Question is, why this distorted lending to real estate? Even if politicians were forcing public sector banks to lend excessively, what were these companies doing with the money? The truth was that this continued lending allowed the companies to pay off old debt; new debt to pay old debt. Without this lending, they would have been forced to sell their inventory with slashed prices.
Is the bubble about to burst?
Bank lending to commercial real estate had increased in the year ending March 2015 only by 8.9%. For the same period, overall bank lending was 8.6%. It seemed that the trend of excessively high lending to commercial real estate companies was coming to an end. The BJP-led NDA government taking charge could be the cause of this change.
The economics of demand and supply
According to reports, home sales fell heavily in 2014 by 17%. The number of unsold units that these real estate companies have been holding increased at the same time. Sooner or later, they would have to start selling their inventory. And with the abundance of offerings soon to come into the market, prices cannot help but fall, and dramatically. It's simply the demand-supply law.