Unreal estate…Manic buying before a likely panic collapse

We have heard enough that derivatives are weapons of mass destruction. These weapons appear to have entered the real estate now. Is it a prelude to a crash?

October 18, 2010 2:59 IST | India Infoline News Service

Many years ago when IIFL had just got into broking services, I visited a prominent Mumbai builder and suggested he do some asset allocation in equities too. An eloquent speaker that he is, he shot back saying that if the value of equities fall there is nothing one can do but if the value of the house purchased falls, you can still stay in it like before. The current interest in real estate these days seems to be more trading oriented rather than driven by a desire to stay. The recent splurge of advertising seen by real estate companies is akin to the last leg of the dot com boom. One dot com had managed to change the front page of none other than The Times of India then. Times have changed and so has advertising. Soaring skyscraper, roaring advertisements and too good to resist offers; that’s the recent splurge on real estate advertising being seen in newspapers and of course hoardings especially in Mumbai.

One of the biggest beneficiaries this Dussehra has been the Times of India group as they have multiple and newer sources of full page advertisements. During the dot com era similar advertising frenzy was created to build brands and attract eyeballs. In case of real estate companies, surely just brand building is not the agenda; actual sales is the motive and they have been pretty successful at that. My good friends informally divulge that these schemes are a big hit and companies have indeed managed to sell flats.

Something more popular than 20:20 cricket seems to be the 10:90 schemes being floated by real estate players. Simply put it means pay 10% of the flat value now and remaining 90% on possession. And its not just India Bulls, which is offering this scheme, it seems to be a common practice among the builders developing the central Mumbai area (which is conveniently called Parel, eastern Worli or sometimes upper Worli). 

Major banks like ICICI Bank and HDFC have to analyse the credit risk of the buyer. They will of course do a proper home loan evaluation of the buyer and ensure that the potential buyers fulfill the criteria of salary declarations, debt service coverage ratios and conform to the available multiple of the monthly take home salary. I reckon even though salaries have improved in recent years, still not many really could qualify to buy a 3-bed room flat costing roughly between Rs4.5 – 5 crore.

So how do the builders benefit?  The builders are able to obtain bookings for their flats and they are able to ‘prove’ to their lenders that there will be people ‘committed’ to take delivery of the same. This enables them to get cheaper funding. Normally, one would pay upfront money and depending on the progress make further payments. Collection of such payments is a tiring task, which includes debating with customers and proving to them that a certain amount of work has been completed. In the 10:90 cases, it is easier for the builders to coordinate with the banks instead of sending hundreds of mails & reminders to individual customers. The builder also enjoys a considerable benefit with lower interest rates as real estate construction financing is usually at a considerably higher rate.

The bank also benefits as uncertainty of sales is partially removed by getting pre-sales done. Execution risk is anyway on the books when it does construction finance.

The big uncertainty is cancellations. In any projects, cancellations are a function of execution and price movements. In a typical real estate bear market, one sees slowdown in sales, which causes receivables problems which in turn causes execution delays which adversely affects sales. That is why, those who invest in under construction flats look at the track record of the builder. This explains why builders like Rahejas are able to fund their working capital requirements comfortably; they enjoy a good track record of construction, both delivery and quality.

The 10:90 schemes have got such a good response. Buyers of such real estate projects have now become investors or rather traders. They are paying 10% upfront and buying a call option. If prices collapse, they will have to simply write-off the 10% they invested. We have heard enough that derivatives are weapons of mass destruction. These weapons appear to have entered the real estate now. Is it a prelude to a crash?

From the builder’s perspective, the scheme works because he gets potential buyers into the system. The supply which is coming in central Mumbai is huge, just look around the Parel landscape and you will get an idea of the number of buildings that will come up in the coming years. Kamala Mills, where our office is located, is in the epicenter; the world’s tallest tower is coming up on one side and world’s greenest tower launched by DLF is on the other. There will be about 13,000 apartments which could cost anything upwards of Rs4 crore each coming up in the central Mumbai area. To put it in perspective, in the last five years less than 6,000 apartments of somewhat similar quality have been sold. So we are talking about 21 pricey flats being sold a week over the next four years, which I think is too ambitious. Informed people tracking the real estate market say property prices overall will have to cool from these levels.

If at all prices remain high it would be due to failure by some builders to deliver their projects on time, which would reduce the supply in these areas. If all the supply materializes, then some builders will be forced to cut down their amenities and luxuries and make the prices more affordable to sell their flats.

We live in times where almost all asset classes seem to appreciate or depreciate at the same time. People leverage and put their hands into different assets hoping one may hedge the other. Sadly, this is not the case. With equity markets near their highs, gold shining like never before, Indian currency appreciating and real estate prices at their fanciful rates people are just going head over heels. It won’t be long before booking high and selling low (or in the case of 10:90 writing off) becomes Ghar Ghar Ki Kahani.

Also read: Amar Ambani’s blog “Housing in Mumbai - Helter skelter for shelter” 

Invest wise with Expert advice



Open Demat Account

Invest wise with Expert advice

By continuing, I accept the Terms & Conditions and agree to receive updates on Whatsapp