Is the Indian housing bubble a myth or a reality?
It would be easily the most scrutinized topic in any casual or serious discussion of recent times; the real estates are tooo hot in Chennai. The prices seem to have consistently risen over by 30% every year for the past three years. There seems to be a mad rush for apartments and individual properties in every damn place in the city, in fact the real estate prices have skyrocketed in any corner where there have been signs of economic activity.
There are innumerable theories floating around to explain the recent spike in prices
- The builders are artificially constraining the supply of apartments and hiking prices till the prices spiral up to desirable levels.
- There is too much NRI money, estimated to be around $15Bn, which has been infused into the system and that has lead to the speculation of the prices.
- There is hot money chasing properties which would be sold out once there is a desirable appreciation.
- The Morons in IT industry/new economy jobs have higher income levels and can’t stop the mad rush for home loans irrespective of interest rates.
- There is a supply side shock and if we consider the demographics we need millions of homes and limited land supply.
Every reason seems to be possible, I thought, I'll give a shot at this. There is gonna be some finance in this post and non finance reader have to pardon me. I would try to explain the concepts in a common man's perspective. Here we go
I have collected the prevailing rental prices and the flat rates in the city and have summarized the same in the table below
Now, I would try to value the real estates considering them to be an investment option. Suppose I borrow some money from the bank and invest in real estates. I have to pay my EMI's (Equivated Monthly Installments) to the bank. I can always rent the flat to somebody and use the rent to pay a partial portion of my EMI.
Are you shouting tax benefits for the home loan you have availed?. I am coming there. Of course the Indian Government gives a capped tax exemption of 2.5 lacs (Principal (Max 1 Lacs) + Interest (Max 1.5 Lacs)).We could essentially avoid paying Rs.75000 in taxes for the income spent towards paying home loans.
The valuation summary has been presented below
You might have understood the first two columns, monthly rent (per Sq.ft) and yearly (per Sq.ft) rent which are quite straight forward.
Then what is this thing called PV of Rent. It is in the present value of the rent, which I would get from the asset in financial terms. It is essentially the current worth of the monthly rent which I would get every year. i.e getting Rs 60(current year)+Rs 60 (next year)+Rs 60(year after that) and Rs 60 in eternity which is worth Rs 895 now.
It is not worth Rs 1200 (Rs 60 *20 years) because the value of the money decreases due to inflation (rate at which my purchasing power decreases) and it has some adjustment for the risk in the asset (I am not going to confuse with risk adjusted expected returns so on and so forth) .Just get the concept that it is gettin an mothly rent of Rs 60 is worth only Rs 895 now.
It is assumed that the investor would expect at least a return of 10.5% (current floating home loan rates). The net rental present value is computed after considering a 3% annual maintenance expenditure of the annual rent .it is assumed that the annual rent would increase by about 4% year on year.
Suppose, we demolish the building, we may loose the rental income but there is always this value of the land that we can get. On an average the land price is at least 60% - 70% of the flat cost. So if we buy a flat for 10 Lacs, the land price is at least 7 Lacs, to be precise. If a Sq.ft cost about Rs 1000, a healthy proportion of about Rs 700/- can be easily apportioned towards the land price.The present value of the land essential captures this component of the price paid towards the flat price. The land price is assumed to be around 65% of the existing price while valuing the properties.
Now we need to compute the current worth of the tax benefits. We can avail a waiver of around Rs 2.50 lacs and save ourselves about Rs 75,000 every year. I have assumed the exemption amount to be around Rs 2.0 lacs (the interest component in the EMI is expected to decrease over the period) over the loan period.The current worth of the tax benefit is expected to be around 5.0 Lacs which translates to an average tax benefit of Rs 374/ Sq.ft (Rs 494 -1000 Sq.ft; Rs 353 -1400 Sq.ft; Rs 274 -1800 Sq.ft ).
The present value of the asset (6th column) is computed based on the expected future income (rent), land price and tax benefit.
The current price is based on the regressing the current market prices of rent and land prices. The equation turned out to be
Market Land Price/Sq.ft = -983.4 + 574.1 * Market Rent/Sq.ft
Current Asset Price = Market Land Price/Sq.ft * (1+Registration charges)
The government registration charges are usually about 10% of the Land price.
For all people who thought the Indian housing bubble is a reality we have to reconsider it, the calculations say that the asset prices are trading at a discount of about 10.8%.
There is more incentive for people to buy small homes which are in the suburbs where the assets are at a discount of about 25%.
If you were a frenzy fan of real estates and you wanted reasons to invest in the real estates, you can be sure that the real estates are not in a state of bubble. If you were skeptical of the valuations (Actually I was not convinced at that point) and need to cross check various scenarios,here we go.
we would try to take the worse case scenarios to the various variable that can signigicantly affect the valuations.
Upward bias on the Land Price
There could be a current upward bias in the land prices due to higher rentals which have been prevailing in system due to supply constraints of apartments. The other thing could be that the rentals could be on the higher side compared to the prevailing land prices. For instance, parts of velachery demands a rent of about Rs. 8/ Sq.ft, whereas land prices float around the Rs 2800 mark. We can test them right way
The housing starts in sub urban areas, redevelopment in the existing areas and the SEZ (Special Economic Zones) can put the prices down as the demand would ease in the future. The demographics of India however suggest that the housing demand isn’t going to stop in the mid term. The demand rentals are expected to be in the upper spectrum as there is a constant movement of labor in the country towards zones of higher economic activity.
Concerns on Interest rate moving north
The next concern is about interest rates, the home loan rates have been increasing in the recent past and are slated to be high in the mid term (that is what the treasury yield curve seem to suggest).The table below kind of summarizes the premium or discount in the property if the interest rates increases or decreases.
Limited Tax benefits as the Property value increases
The next issue could be that a segment of people who buy the flat may not have the tax benefit and the tax benefit is capped to the people who buy properties of higher value.
The table below summarizes the premium or discount in the asset according to the property value purchased..
Conclusions
The real estate prices are fairly prices considering the current prices. However we can expect the real estates to rally deep north for the next two years. The prices would become expensive going forward. The premium which the buyers can pay depends on how fat their purses are.
It depends, as to what propostion of the disposable income one can spend towards real estates, However it also depends on how debt struck one wants to become !!!.
One more thing, the bottom of pyramid can never afford a real estates and would be the most affected by the recent spike in rents and land prices.
Labels: economics
Dei aenda neeyum naanum endha vishaiyathulliyum othae poga maatomoaada?????
Machi, while I have some reservations about the data that you've used, I am not coming to it. But just couple of points.
Point 1 - Frankly, rentals for domestic purpose hasn't gone up much. My analysis, comparing the real estate rentals in Chennai suggested that rentals have grown only by a modest CAGR of 7%. However rentals for commercial purpose has grown up drastically. Again, now a growth in commerical rentals cannot be considered for evaluating a purchase of flats since it is meant only for residential purposes.
Point 2 - Let me used the perpetual discounting model - Given the cost of capital of 10.5% (am taking it from your blog and am not adjusting for interest rate risk) and a CAGR of 7% your flat prices can only be approx. 30 times the annual rental or 360 times the monthly rental. Given this scenario a flat that yields a rent of 4000 bucks can cost only around 15 lacs. Remember, I am using perpetual model, so there is no need to worry about the residual value of land.
Posted by
Viswanathan M B |
12:19 am
Dude...
As U rightly said, I didnt understand the tables completely although I could get a feel of the things happening around...
I wish to know, how costly these real estates could become with time. Could you extrapolate your findings to find solution for this Q.
Posted by
Balamurugan B |
12:20 am
Sorry dude, but I am opposing you once again and I afraid that my criticism might get bigger than your blog. Thappa eduthukaadha and its all in the game.........
Coming from the order in which a point is mentioned in your blog
- Firstly, a minor criticism (not affecting the thesis). You have taken a simple average instead of weighted average to conclude that average rental is Rs.9000 per BHK.
- I am really unsure about your assumption that building contributes to about 60-70% of real estate price. With all those 8 and 10 floor flats hitting the city, I am certainly not convinced that land is so less leveraged.
- Even, if we were to accept that land constitutes 60-70% of the cost, you are valuation is wrong again because you are considering that land is always fairly priced and which is not the case (Use a perpetual DCF model)
- Coming to talk about taxes, while you are including tax benefit on interest repayments as an inflow you have grossly ignored the tax liability on the rental income.
- Again, principal repayment of housing loan is only one of several investments that are eligible for deduction. In case, investments in other avenues like MF, ULIP etc. exceeds that 1 lac mark then the marginal tax benefit on principal repayment is just a big zero.
- Hence your analysis should've been on a pre-tax basis rather than post-tax basis. This is notwithstanding the fact that alternate tax treatment for other investments do affect your returns.
- One another issue (not affecting the thesis) is present value is adjusted for opportunity cost and inflation is only a part of it and not the whole of it.
- In short, the two major criticism I would site is your assumption about the proportion and fairness of the land prices and your partial treatment of tax. So, to conclude - analysisa theripi poi uzhunga pannitu vaa da.
Posted by
Viswanathan M B |
6:43 am
man u really have done some powerful analysis.. really vetti i guess....anyway gotta analyze in detail and let u know the flaws;)... cause even i have the hypothesis that real estate is over valued :)
Posted by
Sudarshan |
6:53 am
I started doing it...then got a little tied up in between so left it....havent read it fully..will comment once i do :)
Posted by
Jeyamurugan DG |
7:38 am
Real estate pricing as you very righly said is fairly priced in second tier cities and even suburbs to an extent. But take example of Gurgaon where neither land nor built-up area is a constraint and prices seem to rise there at the same rate as say Delhi (which is not growing anymore in area). Now how do you explain this? PowerMyLoan
Posted by
Anonymous |
1:45 am
Am totally lost on the calculation of the PV Rent (Minus). What is it?? Are you calculcating your returns for 20 years???
If yes, then where is the interest calculation on the invested capital??
Posted by
Anonymous |
1:50 pm
@annam
Sorry for the error the tittle is actually truncated It should have been PV of Rent Minus Maintenance .
As I am trying to calculate the present value of the loan, I need not take into consideration the interest part (the PV of the EMI which includes interest and the principal @ the homeloan rate is nothing but the loan amout)
Pl let me know If you have any more queires, It would give a better clarity to the concept which I have posted.
Thanks
Sara
Posted by
Sara |
9:23 pm
@ Viswa
I know we have fought hard over this for hours together after I did that post.
I'll kindo of summarise the issues and my views
Viswa
-The present value of the land is essentially the present value of the future rents and the land value would decrease as the land is shared by more peopl(in a flat system)
-The pretax return need to be considered whil evaluating the realestates
-The risk/return need to be adjusted for other factors
My counter arguments
1)
-The rent value can represent the land value only when the rents have stabilised
-I am majory pitching on the demographics of India about 50 % (50 Cr )of the people are in the age group( 20-45)( who buy houses).
-The families are moving from a joint family structure to a nuclear family structure.
-As years move on the demand would grow exponentially (1 Grand Father = 2 Sons = 4 Grand Children).
-On a Global average people sepend 20-25% of their income towards mortgage interest.As disposable income increases and the middle class become fatter,the demands for houses would become higher)
-About 60% of the population would be in the urban areas going forward
-India has one of the highest densities in the world(16% of the world lives in 3% of the land)
2) Most of the people who buy the flat invariably pick up a home laon and I had to make this assumption although Corporate finance asks us to seperate the funding and investment option.The investment and funding are closely realted in the case
3) I defintely accept that It needs to be adjusted but I need to learn Credit Risk Modelling for that
Sara
Posted by
Sara |
9:41 pm
@Bala
You know what kelvi ketkurathu rombaa easy.
I am going to answer like a typical economist
It all depends on how bouyant our economy can be
In my view there is still a upside in the realestae prices
Posted by
Sara |
9:58 pm
@powermyloan
I guess its the same story with all the metro cities worldwide.The prices becomes very very expensive and it is justified by the amount of commerical activite that happens there!!
Posted by
Sara |
10:00 pm
Guys,
Consolidating and listing my ideas below in 3 parts....
1-----------------1
The average price of home and apt in areas like velachery, thoraipakkam, manapakkam, porur, pallikaranai is rs3000/sq ft. individiually within these areas prices go upto 4000/sq ft.
Now a 1500 sqft home at 3000 can cost like 50 lakhs (45 lakhs + registration + broker commission + furnishing)
If you take a 30 lakhs mortgage, the EMI is 35000 rupees per month. The average rental income in these areas are like 8000 to 10000 per month, thereby reducing the EMI to 25000 per month.
assuming the person pays out the loan (30 lakhs is close to 80000 USD and not a small amount by any means) in 5 years, the total he emi he has paid in 5 years is (25,000 * 12 * 5) = 15 lakhs (as he pays off the loan earlier most of the money is in interest and with the pre payment penalty, this amount can go little higher also)
so the home in effect in 5 years is 65 lakhs which is like 4333 rupees per sq ft.
with NRI's buying nearly 50% of apt/homes, for him/her to make money in 5 years, this home has to be sold for 85 lakhs (20 lakhs profit in 5 years @ the average of 4 lakhs per year). now the 1500 sq ft home priced 85 lakhs the price is 5666 per sq ft. (65 lakhs for the money paid + 20 lakhs in profit)
(note that in 5 years, the already old home - lets take average already 5 years old - will depreciate in building value to a total of 10 years and only the half ground or one ground on which the building stand will have full value)
this is a huge money for anybody particularly NRI's. the local software pro has no way of putting this money as the EMI will be shooting up.
this boom in chennai, blore, hyd and cochin (I am not aware of other places as I dont track RE there) is driven by NRI money and right now the prices are beyond taste even for NRI consumption.
I call it NOT the 'housing bubble' but 'NRI housing bubble'. I strongly expect 20% price correction in areas mentioned in first para in 2007. Meaning 3000 per sq ft will be coming down like 2400 per sq ft very soon.
Most of homes/apt (i would put the figure 60% for Blore, 50% for Chennai, 70% for Cochin, 70% for Hyd, 60% for Pune) being purchased are coming from NRI's and once they stop based on above figures, the 'NRI created housing bubble' will pop.
99% of nri's want a return on investment from 5 to 10 years of investing and 99% of nri's dont ever return to india (we take a vacation once in 3 years remember!!!) and as such we can lot of ghost apartments/houses (just like in pune, blore) that will flood the market.
(note that I am also patenting/copyrighting the term 'NRI housing bubble', 'NRI created housing bubble', just like our Donald patented/copyrighted his 'You are fired' term!!!)
Now as you digest above info please read http://www.thehindubusinessline.com/...0904320600.htm
He said the growth of mortgage finance, which is the largest contributor to the retail portfolio, had also fallen due to a rise in property prices. "The number of transactions in the property market has now hit a plateau. However, the average ticket size of loans has increased from Rs 12 lakh last year to Rs 15 lakh," he said.
The share of home loans, which stands at 30 per cent of ICICI Bank's loan book, will shrink as a percentage of incremental business, he added. ICICI Bank's home loan outstandings stand at Rs 60,000 crore.
i want to add a personal story to the above. in 2006 beginning i saw a property in thoraipakkam for like 3000 per sqft for a 2000 sq ft home (65 lakhs was the total after all things considered). i hestitated and then checked back in 2006 oct, the property was still there and now the price was 4000 sq ft. i left it again and then i checked back last week, the property is 4300 per sq ft.
the owner is a nri (a friend of my friend) whose parents are leaving chennai and immigrating to US for good. the price is too way high. for speculating purpose we can quote any money, but once the amount hits the ceiling there will no buyers. this is the story of the bay area, boston, florida and las vegas condos. chennai, blore and pune will be no exceptions as it is a nri driven boom.
so for the thorapakkam home i saw, we can even quote 5000 or 6000 per sq ft but alas there will be no takers at all since a 3000 per sq ft, the home crossed the NRI ceiling.
the nri is planning to rent this home for a partly 10000 rupees per month and i have renewed my offer of 2600 per sq ft . my collegue home in thorapiakkam fetches a HUGE rent of 8000 rupees per month and he bought the home for 40 lakhs one year back!!!
2------------------------------2
3 years back it was a different story. in 2001 all world markets got slammed because of dot com meltdown and india's IT took a huge hit. in 2002 it started rebounding thereby starting a RE boom.
2002, 2003, 04, 05, 06, the prices have gone like 400%. assume you had bought for 800 rs per sq ft in thoraipakkam it is now an artificial 4000 rs per sq ft.
that's what i call it ceiling. once it has hit the ceiling, it wont go up, because lot of home buyers can't afford and NRI's wont come in because the ROI is very poor. in bay area and florida the market has tanked because of this and note that the job economy is booming in both places.
know people who earn 40L+ in chennai/bangalore who are also investing. this is my opinion. in another 20-30 years indiapopulation will increase further and there will be need for more residential/commercial properties. my policy is get one/two apt to live and buy plots as investments.
How many people in India earn 40L. only probably director's and above. How many directors are there. the majority of boom is fuelled by NRI money.
ANd also land is plentiful in India. In south, for example in Chennai, Hyd and Blore there are huge amounts of land outskirts and these places are already expanding. Mumbai is a different story altogether as the land is less due to the island topography.
in adayar it is quoted at 8000, but bookmark couple of those homes and call after 6 months, they will be still be quoting. quoting (speculating) is one thing and real buying is totally different thing. my thoraipakkam experience shows that.
3------------------------------3
i agree some part will go to principal. but nri's and affulent indians will be trying to close the loan as soon as possible and assuming it is 5 years, the emi part will be more and the principal part will be less. so only my figure of 15 lakhs. but assuming the emi is 15000 (and principal 10000) per month, it is 9 lakhs and that means shaving only 6 lakhs from the 85 lakhs appreciation full figure which brings the total to 79 lakhs.
in 2007, a 1500 sq ft home bought in say manapakkam or porur or thoraipakkam will have to sell 79 lakhs which is still 5300 (approx) rupees per sq ft in the year 2012.
is this a cheap amount in 2012?
If manapakkam or porur is 5300 approx, then is velachery, pallikarnai (near to omr place) like 7000 in 2012? will adayar/beasant nagar then be 10000 to 12000? will anna nagar then be like 12000 to 16000 per sq ft??
( i calculated the above based on current increments on these places).
i think the 'nri bubble' is big enough to cool down and flatten like bay area and florida and san diego(www.dqnews.com).
Posted by
Anonymous |
7:19 am
@anon
I have simply qery although I doubt doubt on the methodology?
What is the source of info that 50%apartments are purchased by NRI's..
because it is the pillar the analysis
Posted by
Sara |
6:38 am
You can visit
www.vishwathefinanceguy.blogspot.com
Posted by
The finance guy |
3:44 am
Enna kodumaaa Saravanan ithu!!! Just kidding daa -- good post!!
chandru
Posted by
Anonymous |
10:20 pm