There had suddenly been a deafening silence when the RBI Governor Dr Raghuram Rajan recently asked the real estate developers to reduce the home prices. However, the economist in Rajan was not making a faux pass. He could rather see a supply side of bubble in the making. Therefore, he came harsh on the sector.
Rajan even raised apprehensions with teaser loans to homebuyers. Certain banks offer teaser loans to homebuyers that are offered at cheaper rate but gets costly after 2-3 years.
The RBI Governor instead suggested banks to front-load lending rate cuts to help monetary transmission. At the same time he was curt to the demands of the developers that lowering interest rates alone can revive the pent-up demand in the market.
“I think we need the market to clear. With growing unsold stock, we need to see the ways to do it. Some of it might be by making loans easier, but we also don’t want to create a situation where prices stay high at the level which means demand can’t pick up,” Rajan said at the SBI Conclave.
Rajan’s stern take on the skyrocketing property prices make one thing very obvious. He is in no mood to bail out the cash starved developers anymore. What it essentially means that with lesser and lesser homebuyers coming into the market the funding options of the over-leveraged real estate companies are drying up. Price correction is a logical answer to come out of this self-inflicted mess of developers.
After all, the logic behind the housing turmoil does not need any economist to decode. Simply put, the end-users are not buying because they cannot afford. The lifeline of the developers – the investors – are not buying because they are no more getting higher ROI than other more liquid investment instruments. Thus, in order to make the demand-supply cycle moving the only way forward is a price correction.
“If the demand in the market does not get revived in the next 2-3 quarters many property development companies will go bankrupt. And revival does not look likely. Post Diwali there would be real crisis visible. So, many of the developers are left with no option but to off-load the inventory with price cut. They are struggling and have tried their best to hold on till now,” says a Mumbai-based property consultant, requesting anonymity.
Developers assert that with rising input cost their choices are limited. However, the market dynamics indicate that the cost of the construction is lowest in the last five years. The cost of construction for a bare shell apartment unit has been hovering between Rs. 1500-1350 per sq feet in the last over three to five years.
Moreover, most of the housing projects near completion or being completed are either joint development projects with the landowners or the part of large land parcels accumulated years back. So, even the FSI cost – that is often cited as the major input cost – of these projects is not at the present market value of the land in the given location.
However, the reason why the property price correction is imminent has less to do with the input cost. It has more to do with the survival mechanism of the developer. They have to serve the interest on debt to avoid getting bankrupt.
Many of them are today borrowing from private sources at a rate between 36-48% to serve the interest on the fund that was borrowed between 13-22%. This way they are only delaying the inevitable. This is not a sustainable business model. The developers have for long survived with a wishful thought of market revival and the tide getting over.
Now that the wishes of the developers are not coming true and the RBI and the Finance Minister talking tough, it is only a question of when and not whether.
No wonder, within 24 hours of Rajan’s tough talk, real estate stocks had then dragged down. The BSE Realty Index fell as much as 4% with DLF losing 6.6% and IndiaBulls Real Estate losing 10% in intra-day trade. The BSE Bankex also fell 2% with SBI shedding 2.5%, Bank of Baroda 5.2% and PNB 4.5%. This clearly shows the way forward as far as sentiments in the housing market are concerned.