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The Real Story of the Real Estate Debacle

The reasons behind the real estate crash are much deeper and stronger than they are for other sectors

The consensus story—visible in the general as well as news media—is that real estate is in trouble because of the rise in interest rates. Real estate prices as well as the stocks of real estate companies are down in the dumps because the rise in interest rates is keeping people from buying houses and apartments and so on. The idea being that since property loans have become expensive, fewer apartments will be sold. It’s a convenient piece of reasoning, but it also happens to be only vaguely related to the truth.

High interest rate may be the last straw that broke the camel’s back, but the business was already in deep trouble. This real estate story started out quite nicely about six to seven years ago. With rising salaries and low interest rates, the early part of this decade saw a large proportion of Indians suddenly becoming capable of buying a house quite early in their lives. Given the tax breaks on housing loans, people realised that they could easily buy an apartment with a few lakhs down payment and an EMI of roughly whatever they would have paid as rent anyway. Such a situation had never really occurred in India. A house was something that Indians bought after a lifetime of hard work and miserly savings. As a result, there was a huge overhang of unmet demand.

Typically, someone earning Rs 40,000 a month could buy an apartment worth costing Rs 20 lakh taking a loan of perhaps Rs 15 lakh. Back when interest rates were around eight per cent, such a loan would mean a monthly repayment of around Rs 13,000. Add the tax breaks and it was a great deal. However, those days didn’t last all that long. Powered by the cheap and easy money that banks were pouring into real estate financing, a huge swathe of investors rushed in and pushed up prices beyond the reach of all but a handful of real users. The 20 lakh rupee apartment was now a hole-in-the-wall fifty kilometres outside the city that would not interest anyone who could pay for it. Anything that would interest a middle class buyer was now above a crore of rupees. The basic price-salary-EMI equation now implied that if a real salaried user bought an apartment that he or she actually wanted, then they would have to mortgage the rest of their lives to someone. Genuine business-owners who wanted a shop in a mall were also in the same situation.

At this point, which I believe we reached during 2005 and 2006, the real real estate market had essentially disappeared. There was breed of investors ranging from rich individuals buying two or three apartments all the way up to big syndicates with hundreds of (leveraged) crores at their disposal. These people were now buying up property either from each other, or in competition to each other. In the process, they were bidding up prices to bizarre levels. Into this morass stepped in the investor in real estate stocks, who eagerly believed in these fairy tales of fabulously valuable ‘land banks’. Today, we are in a stage when the truth is sinking in. Real estate companies were being valued on the basis of fantasy land prices. In real (inflation-adjusted) terms, those land prices will not be paid by actual users for years, perhaps decades.

The party is over, and it’s the investor who bought these stocks who has paid the bill.