Demonetisation impact: Market movements don’t indicate immediate price correction

The government’s demonetisation drive has raised hopes of a drop in property prices. Although the move may deter the flow of black money into the sector, we examine why it is unlikely to result in cheaper homes

When Housing News analysed the impact of demonetisation over the property prices, some of the critics disagreed and even took it as an endorsement of black money in real estate. Nevertheless, the theory that lesser supply and higher input cost, will leading to an increase in property prices, is based on the ground realities in Indian real estate.

There is only one economic rationale that supports the theory that demonetisation will lead to lower property prices. This theory argues that once the sector moves beyond black money, cleaner sources of funding will emerge as the dominant market force. This will compel developers to adopt clean business practices, to avail lower cost of funding.


The impact of foreign funds on the Indian property market

The proponents of this economic theory, assert that foreign funds, like the US Pension Fund and others, are scouting for opportunities in Indian real estate. Once these funds enter the market with lower expectations on ROI (as they are used to 3%-4% returns back home), the input cost of the developers towards land purchase will be much lower. However, whether these foreign funds will be interested to invest at the level of land finance, remains unclear. If the foreign funds only invest in construction finance, as has been the trend, it will not address the need for cash or black money in the sector.

Moreover, most of these funds are likely to invest only in the top 3-4 developers in each city. In such a scenario, the dynamics of demand-supply-execution, comes into the play. Most of the top developers in each of the key markets, are already over-leveraged in their scale-to-capacity ratio. Defaults by large developers, like Unitech, Jaypee Group, DB Realty, etc., suggest that more money often prompts developers to launch more than what one can deliver. Even the debt burden of DLF, has a correlation with its over-leveraging, in terms of execution target.


Removal of black money may not lower prices

Nikhil Hawelia, managing director of the Hawelia Group, points out that the final cost of an apartment, is a combination of money, material, manpower, machinery and management.

See also: Demonetisation analysis: Will property prices increase or fall?

“I am not sure, whether the foreign funds will be inclined to invest in the Indian real estate market, across the board. They will only look for the bigger players who are in the business for quite some time, are mostly listed and have a certain level of corporate governance and operate in a transparent eco-system with mostly clean money. So, it is a paradox that while more liberal finance to these developers can lead them to far exceed their execution capabilities and default, the developers who have limited resources and stay within their execution capabilities would still need higher cost of land finance,” says Hawelia.

Amit Oberoi, national director – knowledge systems, Colliers International, however, believes that in the long run, demonetisation will improve corporate governance and compliance and make it easier for foreign entities to invest in India. “It will also boost the listing of REITs (Real Estate Investment Trusts) in the Indian market. We should see a more robust institutional investment market, as retail investments in these segments will shrink,” says Oberoi. Although there is optimism that demonetisation will lead to a more clean and transparent system, its impact on property prices, remains a different story altogether.


Odds in favour of higher property prices

  • Supply constraints and high input costs, rule out the possibility of a reduction in prices.
  • Credit reliability for land finance, is limited to a few developers.
  • Most of the foreign funds are interested in construction finance and hence, clean funds for land finance will remain costlier.
  • Most of the leading developers are already over-leveraged, vis-à-vis their execution capacity.
  • A large number of mid-sized developers, who are producing mass housing, are only able to avail of land finance at high rates.

(The writer is CEO, Track2Realty)


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