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For many Indians, having one’s own house is an important goal in life. People with their own house are looked upon more favourably than those living in rented accommodations. It is apparently easier to get alliances for one’s children if you own a house. A house makes one feel “accomplished” in life and the chances are that you know or are one of the many individuals and families seeking this accomplishment.
In this series of articles we will seek to discuss these issues and whether all the running after one’s house and this “accomplishment” is worthwhile from the financial point of view and whether it truly is as financially lucrative as many people believe it is.
In the last 5 years, real estate prices all over India have jumped tremendously in cities, towns and even rural areas. Prices of houses have multiplied several fold and the costs of construction have significantly gone up. We are all aware of this and feel pressured to do something “now”; otherwise in the future, things will be a lot more expensive right? Let us see …
All the above is true but it is to be noted that this change in the last 5 years is due to the bigger change in India’s economy and the huge amount of wealth and opportunity that has been created. However, to assume that it will continue at this pace is incorrect. There are some fundamental factors at work.
Perhaps the most important issue is that of “Affordability”. This is expressed in terms of “How many years of monthly or annual income does it take for a person to buy his / her house?” This puts the perspective of the prices of a house in terms of time and earnings. In developed countries, one can get detailed analysis of what is called the “Affordability Index”. In India, this data is hard to come by and at best, there is only an estimate of it.
For example, if you earn 3 lacs per year and want to buy a house worth 30lacs, it would take 10 years of your current total income. Now, if the same house, say 20 years back was worth 3-4 lacs and your Dad’s total income was probably around 50,000 per year, then he would have to work for 6-8 years to get this house. Let us call this the “Time Cost” of the house.
The difference in “Time Costs” is 2-4 years (depending on the actual numbers). This is not significant in terms of a lifetime and the average number of years a person works (usually between 30-40 years of working life). You have to work just as hard (or harder!) than your Dad to achieve the same goal of owning a house. Of course, now that housing standards have gone up and people want better construction and finish, you have to pay and work more for it.
In terms of Effort and Time that people have to put to own a house, there really isn’t much difference between a generation ago and today (Feeling better? No need to worry so much!) If history is right, there won’t be much of a “Time Cost” difference 20 years ahead either. Whatever their salary and cost of the house, your children will have to work as hard as you - so don’t worry too much about them either!
Now, many of us take home loans nowadays and here is an interesting aspect to this: the link between Affordability and Interest Rates.
In the last 12 months (mid 2006 to date), interest rates have gone significantly gone up and it has become more expensive to take a loan. So what happens to “Affordability”? Well, it comes down since the bank will now give you a lower loan amount for the same monthly installment as the interest is more! Now, if you have a lower loan amount, what about the builders who want to sell you a house? You can be sure that they know that You have less money in your hands. So what’s the option for them? Large Builders know that they cannot take prices up beyond a certain “Affordability” point (and remember “Affordability” in terms of Time & Earnings; not in the price of the house).
The increase cost of loan is for everybody (not just you!), and there is nothing that you, the builder or the government can do about it. The only thing that can happen is that the housing market has to change its behaviour to accommodate the LOWER Affordability in the general public. If the Builder is interested in selling his houses he has to lower prices (as clearly, the person taking the loan cannot find more money to pay). This is exactly what has happened. Prices of houses have come down by 10-30% in various parts of India.
Another aspect: In the last 2-3 years, everyone has become a real-estate agent and a Builder! (Are you one?) This has lead to an interesting phenomenon: Perhaps for the first time in India’s history, there are more houses for sale than people to buy in cities like Bangalore, Hyderabad, Delhi, Chandigarh and many other places. How are the Builders going to sell off all their stock? Remember, they have hundreds of crores blocked in these projects and they are definitely not going to just leave it there! The Builders, like all good businessmen, would rather make a lower profit than not sell the house.
These 2 fundamental factors: (i) Increase cost of a housing loan due to higher Interest Rates and (ii) Oversupply in the construction of new houses has combined to make house prices go down.
What will happen next?
Till the interest rates and oversupply conditions stabilise, housing prices will be under pressure. The stabilisation is expected to take many months (probably till mid or end 2008). You can therefore expect house prices to be at current levels or even go down another 5-20% (depending on which area you are referring to). After that, prices will stabilise and start rising again.
Another point to note: so far, the Builders have been concentrating at the “higher” end of the market: apartments with swimming pools, gyms and all. That is where the bigger profit is and people are willing to pay higher prices. Now, with these pricing pressures, Builders will shift focus to more affordable, non-luxury, mass market housing. The profit per house is less but the number of people waiting for such houses is huge - so still a lot of money to be made by the Builders.
If you are an Investor, then the easy money has mostly been taken off in the last 5 years. Here on, real estate will give you returns like most other asset classes, so don’t expect the monthly and annual fortunes you have gotten used to over the last several years. Alas, good times also come to an end.
If you are looking to buy a house (and you probably kept postponing your decision to buy due to the ever increasing housing prices!), then you should rejoice and be happy. Plan and research carefully the areas and houses you are interested in and follow up diligently, you could be in for some very pleasant surprises and great house deals!
This is what happens when Markets are opened up and competition thrives.
In the next part of this article, we will look at: Is it really necessary to own a house? What are the financial implications? Is it better to own, rent or lease a house? What are the options and what are the factors that one should consider before putting is so much of one’s life’s earnings and savings into a house.
The author is an Investment Advisor and Financial Educator based in Bangalore. Readers are advised to do their own research and analysis before taking any actions. The author is not responsible for any consequences - good or bad. The author looks forward to and invites responses and inputs from the readers on the topics discussed. Please send your views to ivfinance@gmail.com
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