Monday, 12 September 2016

Is this the right time to invest in real estate?

Residential real estate market is currently in a correction phase, which began three years ago, and according to experts, will last for a few more quarters.



Buying real estate is widely considered a safe bet by Indian investors, even though the market might show otherwise. Like every other market, real estate too has its highs and lows. For instance, the real estate market boomed between 1988 and 1994, and most property prices went up by over 10 times during this period. However, the bear market that followed was very challenging. By 2002, many properties were being put on the market at half the peak price they achieved in 1994. If one considers the high rate of inflation during the 1994 to 2002 period, the actual correction during the bear market was more than 75 per cent. A similar trend seems to be playing out now. Investors minted money in residential real estate during the boom that occurred between 2002 and 2013, with prices going up by 6-10 times in several pockets. However, experts caution against expecting similar returns in the future, because the maximum appreciation happened in some nascent markets like Gurgaon. "It was as an aberration, reflecting the times and the fact that markets were in a very nascent stage. It is not fair to expect that kind of appreciation in developed markets," says Amit Oberoi, National Director, Knowledge Systems, Colliers International (India).


All speculative markets move in cycles, and the real estate market in no exception. As is evident, the boom in the residential real estate market is over. It is currently in a correction phase, which began three years ago, and according to experts, will last for a few more quarters.



Lack of buyer interest
The market has witnessed a marked decline in the number of people buying residential properties. One of the main reasons for this is the fact that property prices remain high compared to the average income of individuals. "There is end user interest, but what buyers are waiting for is reasonable and affordable prices," says Sunil Sharma, CIO, Sanctum Wealth Management. "As of now, end users are only looking at projects that are priced appropriately," he adds.


Since the real estate prices vary significantly across cities, the concept of affordability also needs to be analysed at the city level. Affordability is also affected by interest rates and increase in income. Fall in housing loan interest reduces the EMI and increases affordability. Although the RBI has cut benchmark rates significantly in the recent past, its transmission was much smaller. For example, home loan rates came down only by 50-75 bps compared to 125 bps cut by the RBI, which did not result in any significant pickup in demand. The rise in income over time also failed to keep pace with the significant jump in real estate prices that occurred between 2002 and 2013.


Rental yield, which is the amount of rent paid per annum over the cost of buying a property, is another factor that determines the level of demand, for both end users and investors. If the rent is higher than the EMI to be paid for purchasing a property in a given area, people are more likely to choose buying their own home over living in a rented property. This means that the end user demand will go up if the rental yields are high. Similarly, the return for investors who buy houses to rent out also go up and this will increase the investment demand. However, rent didn't increase in tandem with the jump in capital values either, and as a result, the rental yield has dropped to a significant low, ranging from 2-4 per cent compared the housing loan interest rate of around 9.5 per cent.






Inventory build-up
As a result of the dip in the demand for property, investors and builders, who developed and hoarded residential properties expecting prices to rise, found themselves unable to sell their inventory. The unsold units in eight large cities in the country have already hit an all-time peak of 1171 million sq ft, up by 22 per cent from last year. If the current rate of sale persists, it will take more than three years to exhaust the existing inventory. "Compared to an ideal inventory level of 8-12 months at the national level, current inventories are close to 45-47 months," says Pankaj Kapoor, MD, Liases Foras Real Estate Rating & Research. However, the inventory build-up would have been much higher if the builders had not reduced the number of new projects.


Pricing pressures
The cost of construction has risen steadily over the past few years. With the introduction of Real Estate Regulator, the compliance cost is also expected to go up. However, builders may not increase the prices of units, because the large inventories they hold have cut down their pricing power. "Instead of increasing prices, developers will try to restore the sales volume first," says Samantak Das, Chief Economist and National Director, Research, Knight Frank India.


The inventory build-up and lack of pricing power has impacted the financial health of builders. This, in turn, has resulted in significant delays in property delivery. Since it has reduced the number of 'ready to move in' flats going up for sale, there has been no price correction for ready procession flats. With project completion delays becoming the norm, consumer preference for ready-to-occupy properties has also increased.


Although builders have been able to manage some price stability so far, they are now failing to sustain it. "The small fall in interest rate is not helping builders because their borrowing cost is still astonishingly high at 22-25 per cent," says Feroze Azeez, Deputy CEO, Anand Rathi Private Wealth Management.


"High cost during muted demand is putting pressure on developers to scale down their prices, and many builders are now reducing their launch prices by 20-25 per cent," he said.









New investors beware
So how should one proceed in the current market conditions? That depends on what kind of deal you are looking for. While this might be the perfect time for buyers to start searching for their dream home and cash in on good deals, experts say that investors should stay away for a few more years. "We do not think fresh investments in high value residential real estate will generate returns like it did in the past," says Sunil Sharma, CIO, Sanctum Wealth Management. Azeez holds a similar opinion. "We have held a negative view on residential real estate for the past few years, and expect it to go through two or three more years of time correction," he says.


According to experts, even if the prices witness no correction and remain stagnant over the next few years, there is no reason to invest in real estate, since there is a significant cost associated with holding property. "If we consider the mortgage rate of 9.5 per cent as the cost of holding, the total return is not likely to exceed that," says Sharad Mittal, Director and Head, Real Estate Fund, Motilal Oswal Real Estate.


Drive a hard bargain Some industry experts feel that buyers should take advantage of the current turmoil in the residential market, instead of avoiding it. "Smart people buy when the market is perceived to be weak. Since builders are offering great flexibility in pricing and payment plans now, this is a good time to buy. But buyers should bargain hard for a better price," says A.S. Sivaramakrishnan, Head. Residential Services, CBRE South Asia. Oberoi concurs with this view. "Instead of avoiding residential investments, one should look to invest now, albeit with a lot of due diligence, and wherever possible, buy at a discount," he says.

If you are aggressive investor and do decide to enter the market now, experts recommend opting for under-construction flats over ready procession ones, as the discounts on the former have gone up significantly.


"The right approach in the current market environment is to invest in under-construction projects by reputed developers, in growing locations. These developers will deliver on the promised quality as well as possession timelines," says Anuj Puri, Chairman and Country Head, JLL India. At the same time, aggressive investors also should shed their normal habit of buying real estate only in their home towns. "Investors should be slightly adventurous now. They should study the market across several cities to identify demand movement and hot investment corridors," says Puri.