Why
car sales are falling but not realty prices
Car sales in February were down
dramatically, thanks to sinking demand. Sales fell 25.71 percent to 1,58,513
units in comparison to the same month last year. And with demand falling,
customers are getting discounts and freebies.
In this column on Monday, this writer argued that falling car sales is a reflection of the overall economy slowing down. People expect the bad times to either continue or get even worse in the months to come. And this makes them hold on to the money they would have otherwise used to buy high cost items like a car. It also means that they do not want to commit to an EMI right now. Given these reasons car sales have slowed down.
The question that begs asking is this: why does not the same logic apply to real estate? What immediately cropped up was that if car sales are falling, using the same logic real estate sales should also be falling and should lead to a fall in prices. If cars are a big ticket purchase, then buying a house is the biggest expenditure that most people incur during their lifetimes. Also the prices of cars over the last few years haven't risen much, whereas the prices of homes have gone through the roof, making them terribly expensive, if not simply unaffordable.
The economist George Akerlof wrote a research paper titled The Market for Lemons in 1970. For this paper, Akerlof ultimately received the Nobel Prize. In this paper he discusses the market for second hand cars (or used cars) and the problem people have in selling them.
Akerlof divided the second hand car market into two types of cars - peaches and lemons. Peaches were cars which were in a good shape whereas lemons were cars which were in a bad shape. The individual selling the car obviously knows whether his car is a peach or a lemon but the individual buying the car doesn't. So seller has what economists refer to as 'insider information' which the buyer doesn't have.
The point is that in this transaction one side has much more information than the other side. So there is an asymmetry of information. As Nate Silver writes in The Signal and the Noise - The Art and the Science of Prediction, “In a market plagued by asymmetries of information, the quality of goods will decrease and the market will be dominated by crooked sellers and gullible and desperate buyers.”
The real estate market in India is a tad like that - full of crooked sellers and desperate buyers. The sellers have all the information in the world and buyers have very little of it, almost next to nothing. And this manifests itself in situations which do not benefit the buyers at all.
Allow me to explain. Everyone talks about how real estate prices have been going up. This writer was recently told by someone that the flat he had bought in 2002 for around Rs 20-25 lakh was now going for Rs 2 crore. Fair point. But are there transactions happening at such an expensive price point? And if they are happening, how are they in comparison to the past?
The point is that just looking at the price doesn't give us the real answer. One also has to look at the number of buyers looking to buy at that price point because only that can tell us how strong the trend is.
Unfortunately such kind of information is not available to most buyers in India. Hence, people who sell real estate, all the brokers and property dealers of the world, deal with buyers from a position of strength and always try to project a scenario where prospective homes are scarce. The buyers have no clue of whether deals are actually happening or not and hence tend to believe the brokers.
A real estate index which tell us the broad direction of the market would be a great thing to have. While attempts have been made in the past to launch a real estate index, nothing robust has come out till date. Nothing of real value to buyers, at least.
There are reasons to believe that people are not buying as much real estate as they were in the past. This is not conclusive evidence but some evidence nevertheless. Try reading any newspaper article which makes a pitch for the Reserve Bank of India cutting interest rates, the CEOs of real estate companies come across as the most desperate of the lot. This tells you at some level that they are not selling as much as they are building. But how will an interest rate cut of 25-50 basis points (one basis point is one hundredth of a percentage) lead to people buying homes is beyond me.
Newspapers provide another indicator. Every week the front page of one newspaper or another has an advertisement for a new real estate launch happening somewhere, where the buyer has to put a minuscule portion of the cost of the home upfront. The money that is raised is typically used by the builder to pay off money that is due instead of building the homes that he has advertised.
A story in The Caravan Magazine makes this point by quoting a property dealer: “If these builders were suddenly asked not to sell any more projects, I'm telling you, most of them couldn't balance their books tomorrow.” So in effect most real estate companies are running Ponzi schemes where they are using money being brought in by the newer investors to pay off the older investors. As long as this Ponzi scheme keeps going, real estate prices will continue to be high. If newer investors stop bringing in money, the builders will have to start selling the homes that they have built in order to pay off people who they owe money to.
In this column on Monday, this writer argued that falling car sales is a reflection of the overall economy slowing down. People expect the bad times to either continue or get even worse in the months to come. And this makes them hold on to the money they would have otherwise used to buy high cost items like a car. It also means that they do not want to commit to an EMI right now. Given these reasons car sales have slowed down.
The question that begs asking is this: why does not the same logic apply to real estate? What immediately cropped up was that if car sales are falling, using the same logic real estate sales should also be falling and should lead to a fall in prices. If cars are a big ticket purchase, then buying a house is the biggest expenditure that most people incur during their lifetimes. Also the prices of cars over the last few years haven't risen much, whereas the prices of homes have gone through the roof, making them terribly expensive, if not simply unaffordable.
The economist George Akerlof wrote a research paper titled The Market for Lemons in 1970. For this paper, Akerlof ultimately received the Nobel Prize. In this paper he discusses the market for second hand cars (or used cars) and the problem people have in selling them.
Akerlof divided the second hand car market into two types of cars - peaches and lemons. Peaches were cars which were in a good shape whereas lemons were cars which were in a bad shape. The individual selling the car obviously knows whether his car is a peach or a lemon but the individual buying the car doesn't. So seller has what economists refer to as 'insider information' which the buyer doesn't have.
The point is that in this transaction one side has much more information than the other side. So there is an asymmetry of information. As Nate Silver writes in The Signal and the Noise - The Art and the Science of Prediction, “In a market plagued by asymmetries of information, the quality of goods will decrease and the market will be dominated by crooked sellers and gullible and desperate buyers.”
The real estate market in India is a tad like that - full of crooked sellers and desperate buyers. The sellers have all the information in the world and buyers have very little of it, almost next to nothing. And this manifests itself in situations which do not benefit the buyers at all.
Allow me to explain. Everyone talks about how real estate prices have been going up. This writer was recently told by someone that the flat he had bought in 2002 for around Rs 20-25 lakh was now going for Rs 2 crore. Fair point. But are there transactions happening at such an expensive price point? And if they are happening, how are they in comparison to the past?
The point is that just looking at the price doesn't give us the real answer. One also has to look at the number of buyers looking to buy at that price point because only that can tell us how strong the trend is.
Unfortunately such kind of information is not available to most buyers in India. Hence, people who sell real estate, all the brokers and property dealers of the world, deal with buyers from a position of strength and always try to project a scenario where prospective homes are scarce. The buyers have no clue of whether deals are actually happening or not and hence tend to believe the brokers.
A real estate index which tell us the broad direction of the market would be a great thing to have. While attempts have been made in the past to launch a real estate index, nothing robust has come out till date. Nothing of real value to buyers, at least.
There are reasons to believe that people are not buying as much real estate as they were in the past. This is not conclusive evidence but some evidence nevertheless. Try reading any newspaper article which makes a pitch for the Reserve Bank of India cutting interest rates, the CEOs of real estate companies come across as the most desperate of the lot. This tells you at some level that they are not selling as much as they are building. But how will an interest rate cut of 25-50 basis points (one basis point is one hundredth of a percentage) lead to people buying homes is beyond me.
Newspapers provide another indicator. Every week the front page of one newspaper or another has an advertisement for a new real estate launch happening somewhere, where the buyer has to put a minuscule portion of the cost of the home upfront. The money that is raised is typically used by the builder to pay off money that is due instead of building the homes that he has advertised.
A story in The Caravan Magazine makes this point by quoting a property dealer: “If these builders were suddenly asked not to sell any more projects, I'm telling you, most of them couldn't balance their books tomorrow.” So in effect most real estate companies are running Ponzi schemes where they are using money being brought in by the newer investors to pay off the older investors. As long as this Ponzi scheme keeps going, real estate prices will continue to be high. If newer investors stop bringing in money, the builders will have to start selling the homes that they have built in order to pay off people who they owe money to.
The
demand is out there. But there is a huge bubble in imaginary homes-in homes
that will be delayed indefinitely or just never get built
Another interesting number is the
proportion home loans form out of total loans given by banks. Home loans peaked
at 12.9 percent of total banking credit in March 2006. As on 28 December 2012,
they formed around 9.3 percent of total banking credit. And this in a scenario
where housing prices have gone up many times between March 2006 and December
2012. Hence, it would only fair to assume that people are buying a fewer number
of homes, at least by taking on home loans.
So if people are buying fewer homes, why are the prices still not falling? Those who work in the real estate industry would like us to believe that the cost of constructing a house has gone up. While that may be true to some extent the argument doesn't justify the astonishing levels of price rise.
The material used in the construction of a house and other forms of real estate was, and continues to be, easily available. Lumber, which is used in large amounts, is a renewable resource. Glass is made out of quartz, the second most common mineral on earth. Gypsum, which is the main constituent of plaster as well as wallboard, is a very commonly available mineral. Cement is made out of limestone which forms 10 perceent of all sedimentary rock formations on earth. (Source: The Subprime Solution by Robert Shiller). That leaves out the price of land on which the homes are constructed. We will just come to that.
A major reason for home prices not coming down despite the stagnant demand for homes is the fact that the market is dominated by investors/speculators and not real buyers who buy homes because they want to live in them. Anybody who has doubts about this can take a walk through the newer areas of the National Capital Region (NCR). Most of the flats remain empty, giving an eerie feeling of a ghost town. All these flats are owned by investors/speculators. And it is these people who keep playing a game of passing the parcel among themselves and in a way ensure that prices of homes do not fall. Also they have made so much money in the past (and given that most of it is black money) they are in no hurry to sell these homes.
The story in The Caravan quotes a property dealer to make a similar point. “There isn't a bubble of real homes...If all these apartments were actually built, and built fairly to schedule, I guarantee you that they would find real buyers. The demand is out there. But there is a huge bubble in imaginary homes-in homes that will be delayed indefinitely or just never get built.”
Also most of the black money in India finds its way into property one way or another. Most of the ill-gotten wealth of politicians is also deployed in property. And any fall in price of real estate would mean the value of their wealth coming down.
But at the end of the day there is only so much black money going around as well. What creates the illusion of real estate prices continuing to remain high is the supply of land. While India does not have scarcity of land like Japan does, the problem is that politicians control the supply of land. Every state and central politician has land held in benami. And this is the real bubble that has kept home prices high.
As Ruchir Sharma writes in Breakout Nations: “Lately Indian businessmen have been regaling one another with accounts of a leading politician from Mumbai who is known to have amassed a huge wealth through property deals. At a private screening of a new Bollywood movie, this politician asked the producer to replay a particular song-and-dance number, over and over. When the producer asked if he was taken with the leading lady, the politician said no, he was eyeing the location and wondering where the producer had found such an attractive stretch of open space in Mumbai.”
If home prices have to come down, it is this link that needs to be broken.
So if people are buying fewer homes, why are the prices still not falling? Those who work in the real estate industry would like us to believe that the cost of constructing a house has gone up. While that may be true to some extent the argument doesn't justify the astonishing levels of price rise.
The material used in the construction of a house and other forms of real estate was, and continues to be, easily available. Lumber, which is used in large amounts, is a renewable resource. Glass is made out of quartz, the second most common mineral on earth. Gypsum, which is the main constituent of plaster as well as wallboard, is a very commonly available mineral. Cement is made out of limestone which forms 10 perceent of all sedimentary rock formations on earth. (Source: The Subprime Solution by Robert Shiller). That leaves out the price of land on which the homes are constructed. We will just come to that.
A major reason for home prices not coming down despite the stagnant demand for homes is the fact that the market is dominated by investors/speculators and not real buyers who buy homes because they want to live in them. Anybody who has doubts about this can take a walk through the newer areas of the National Capital Region (NCR). Most of the flats remain empty, giving an eerie feeling of a ghost town. All these flats are owned by investors/speculators. And it is these people who keep playing a game of passing the parcel among themselves and in a way ensure that prices of homes do not fall. Also they have made so much money in the past (and given that most of it is black money) they are in no hurry to sell these homes.
The story in The Caravan quotes a property dealer to make a similar point. “There isn't a bubble of real homes...If all these apartments were actually built, and built fairly to schedule, I guarantee you that they would find real buyers. The demand is out there. But there is a huge bubble in imaginary homes-in homes that will be delayed indefinitely or just never get built.”
Also most of the black money in India finds its way into property one way or another. Most of the ill-gotten wealth of politicians is also deployed in property. And any fall in price of real estate would mean the value of their wealth coming down.
But at the end of the day there is only so much black money going around as well. What creates the illusion of real estate prices continuing to remain high is the supply of land. While India does not have scarcity of land like Japan does, the problem is that politicians control the supply of land. Every state and central politician has land held in benami. And this is the real bubble that has kept home prices high.
As Ruchir Sharma writes in Breakout Nations: “Lately Indian businessmen have been regaling one another with accounts of a leading politician from Mumbai who is known to have amassed a huge wealth through property deals. At a private screening of a new Bollywood movie, this politician asked the producer to replay a particular song-and-dance number, over and over. When the producer asked if he was taken with the leading lady, the politician said no, he was eyeing the location and wondering where the producer had found such an attractive stretch of open space in Mumbai.”
If home prices have to come down, it is this link that needs to be broken.
http://www.firstpost.com/economy/why-car-sales-are-falling-but-not-realty-prices-658909.html
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