Willy nilly, it looks like the pandemic will bring about an accidental reform in Indian real estate
26-Oct-2020 •Dhirendra Kumar
One of the (few) good things about the pandemic is that a healthy and long overdue dose of realism has been injected into the real estate market of India. As far as I can see, this has happened both to developers as well as well-off individuals who consider real estate to be a good investment. There's plenty of news from around the country of sellers reconciling with the fact that it's better to sell off their goods at lower prices than to wait indefinitely. Of course, the usual suspects are presenting this as an unmitigated disaster and a sign of severe business and economic conditions and so on. Maybe it is all of these, although not to the degree that they are claiming.
However, if there is one savings-and-personal-finance-related area where we, as a country, need an adjustment to our mental models, then that's real estate. At the heart of this whole problem, which has afflicted house-buying for almost two decades now, is an old mental model of real estate which has been handed down from generation to generation. While this model was correct in the decades before that, it was short-circuited by the new way in which real estate developers work.
Here's a brief description of what used to be the older model of real estate investment. There are perhaps five sources of gains in the price of property, and your final profit is a product of all these. One, the original change in usage from agricultural or barren land to residential or commercial. Two, the coming up of physical infrastructure which makes this land usable for the new purpose. Three, the improvement in residential or commercial viability as the area gets populated. Fourth, the periodic booms and busts that afflict real estate. Fifth, the general economic development and inflation of the economy that together increase demand and prices and thus become an indistinguishable part of the nominal change in the property's price.
In the days of your parents and grandparents, the individual house builder could capture the value accretion in three or four of these five stages, sometimes all five. Starting about 2000, the real estate developers tried to capture all five. Oftentimes the developer also tries to capture future value of the fifth stage by talking up the price that might be justifiable in the remote future. Remember, I'm just talking about the honest developers who are not in the game of just taking your money but actually have an intention of delivering something in return.
In our parents' generation, the way to build a house was to identify a yet undeveloped or underdeveloped area and buy a plot of land. Once that was done, not much could go wrong and the rest just happened. Nowadays, the rules are different. Unlike the good old days, you can't buy cheap land on the outskirts and then start building the house a decade later, one room at a time.
Instead, you have to risk your financial future to the dreaded EMI monster, all at one go. That means that the new rules are different. Here they are, in a succinct form:
One, buy just one house in which you will live, and which will save you rent. Do not even think of buying any more just for investment. Two, don't stretch yourself. No matter how much you'd love a fancy house and how great the hype is, the EMI should not be more than one third of your family income. And that's the UPPER limit. If you can get by with less, then please do so. Three, buy a house, not a promise. This factor is improving with new real estate regulation but this is an industry that should always be treated with caution. Remember, the biggest source of real estate financial problems for savers has not been houses that cost too much but houses that have not been delivered.
Each new generation of house buyers tends to make the same mistakes. Perhaps with the financial caution that the pandemic is inspiring, things will change.