The making of the Indian property Bubble
The roots of the Indian property ‘bubble’ can be traced back to 2004-08 when the economy of India was on the boom. During the said years, the GDP of India was growing at an exceptional rate of 9-10 percent every year. This extraordinary situation was exploited by some of the leading builders and developers, they started making grand plans without the involvement of their own money.
Soon, ‘they’ launched ambitious projects worth lacs of crores mostly fulfilled by imprudent borrowings. The amalgamation of such capital borrowings and ambitious plans by the developers resulted in the largest investment boom India has ever witnessed in the real estate sector. Soon, the Global Financial Crises (GFC) menaced the world’s economy. Fortunately, India came out of the situation, almost getting unaffected by it.
At most, GFC lowered the growth rate, from exceptionally good to moderate. The effect of the GFC on the companies that had borrowed a large amount of money for their big projects was negative. Unexpectedly, the real cost of the projects overran the cost in budget, and not meeting of profits as per the expectations, and it worsened the situation.
The situation deteriorated with the increased borrowing costs and the builders were hard hit by the increase of interest rates by the RBI. The condition worsened with the depreciation value of rupee vs US dollar. Builders borrowed loans at Rs 40/dollar, and they had to repay their debts at Rs 60-70/ dollar. This could have been reckoning time for them.
Despite correcting their measures, the builders started to sell houses at higher prices to negate the higher financing cost. Unfortunately, the investors, without putting in any caution, began investing heavily in these price hiked properties. This led to a further increase in property price, driving a growth in builder’s inventory. This provided a greater room for more dept.
This artificial price inflation benefited both the builders and the lenders for short term, but it created more problem than it solved in a long period of time. There were many problems with this artificial price inflation. First, this plan targeted the middle-income costumers the most, expecting them to buy a 2BHK for a crore rupee is too much. This resulted in the hoard of unsold inventory, and consequently, in between 2009-2014, the unsold inventory just doubled.
The second problem with it was the higher rents which were proportionate to the price of the property. In 2006, it stood around 6% to the total value of the property declined to 2% in 2015 (It means returns on your property as rent at the rate of 2% per year). Well, this is not a good return when you are already paying around 10% interest on the property loan.
When the Modi government came to power, the real estate bubble already got burst. The real estate sector was performing badly. The builders then started to sell their assets at lower prices to repay their debts, and this resulted in a steep fall in the property prices. This diluted their capacity to take new loans as the worth of assets turned down than before.
As the assets continue to fall, the builders began to throw up their hands, and this resulted in NPAs. Consequently, banks started denying loans to Real Estate Sector. Private Equity and NBFCs filled the vacuum and entered the scene. NBFCs share in financing the builders almost doubled in the past ten years, from 25% to 55%.
Until this time, the condition was not good, but there was not even widespread panic concerning the real estate sector. With the introduction of RERA in 2016, the pro-consumer act incapacitated the builders. The law prevented the builders from raising money from prospective buyers, and it will also penalise the builders for the late deliveries of home.
At present, many builders are selling their stakes in the company to get rid of their debts. Others are trying to sell off their non-core assets to cope up. Taking over of unfinished projects by NBCC is also under consideration by the government of India. It will be interesting to see how real estate will react to the policies of the government.
The development of real estate is significant for developing countries like India. India cannot achieve a sustainable high rate of development without having an excellent performing real estate sector. In short, real estate is the key to higher growth of a nation.