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The Cesspool that is Realty

Buyers pay the price of developers' and mortgage officials' malfeasance

It could just be a coincidence, but the pace at which business-related scams are surfacing now is quite amazing. In a matter of weeks, not only has the long-simmering telecom scam come to a boil, we also have a brand new real estate loan scam on our hands. While the telecom scam has been widely known for a while and is of active interest in political and media circles, the real estate scam has immediate investment implications.

The BSE Realty index hit a recent high on October 6 and is down about 30 per cent since then. The decline has actually been much sharper in an even shorter period since then. This index is down about 26 per cent since November 9th. Even apart from the scam, realty stocks go into a free fall at any sign of weakness, and this has been the case for a long time now.

Clearly, investors have no trust in these stocks. And with good reason too, as this scandal demonstrates. Even though the exact contours of the loan scam are not yet clear, the broad framework is obvious. There are many, many real estate outfits to whom all legitimate means of financing are closed. No investor in his right mind would subscribe to their IPOs. And after the horrors of October 2008, no lender would touch them either. Or perhaps I should say lenders who are worried about getting their money back would not touch them. Lenders who have been bribed are obviously a different matter.

The net effect has been that real estate companies have managed to get their hands on lines of credit to which they shouldn’t have access. They have managed to sustain criminally high prices and simulate (not stimulate) demand because they had this money to play with. Even in the worst of times, even when equity financing and most legitimate debt financing has been closed to them, they have managed to hang on to assets instead of having to sell them at realistic prices. The final impact has been on the buyer who has either not been able to buy a house, or has had to pay much more than he should have.

For investors, this episode is yet another chapter in the continued disillusionment with realty companies. I’ve suspected all along — and I’ve been saying this often enough — that there’s some sort of a genetic problem with realty companies. I think this stands confirmed. There’s a lethal combination of many elements at work here. The starting point is the huge overhang of housing shortage that has built up over decades. Add to that the tremendous demand unleashed by rising incomes and aspirations for a better lifestyle. Add to that the ease with which wealth can be generated by government actions like land-use change. Add to that the ability to sink vast quantities of unaccountable cash. Add to that an utter lack of any regulatory framework.

One would have to be a complete fool to expect any sort of an honest business environment to emerge out of this mess. Real estate is a cesspool of dishonesty and criminality and the circumstances are such that it will remain so. Investors are welcome to dabble in it — weaving their holdings in and out of scrips as the good and bad news flows and ebbs. Sure, there might be some clean and investment worthy realty stocks out there — but you need to get real about your chances of finding them and making money out of them.