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December 01, 2008

"Real Estate Developers Seek Santa Claus"

Dhirendra Kumar of mutual funds research firm Value Research has an article describing how the current woes of the Real Estate sector are largely self wrought.
In the last three to four years, the real estate industry, with the implicit collusion of housing finance providers, has indulged in an unprecedented loot of house buyers. The 'demand-supply gap' that supposedly produced the price rise was an illusion. Here's how it was created. Basically, developers kept jacking up prices and since banks kept financing purchases at higher and higher prices, an illusion was created that there was enormous demand, no matter what the price.

The buyers were of two kinds. One, the real end-users who were panicked into buying because they were told that prices would go on rising. These people saw prices rising at the rate of 5 to 10 per cent a month and were desperate to buy before houses became unaffordable forever. The interesting part was that vision of ever-rising prices acted both as carrot and stick. They would have to keep paying enormous EMIs for decades, but they thought could also sell at a huge profit whenever they wanted. The other kind of buyers were the 'investors' who were mostly individuals with large debt raising capacity. This lot thought that they would be paying the EMIs for at most a couple of years before selling the property for a huge, leveraged profit.

Basically, this was a racket for transferring a whole lot of money from the banks to the developers. The repayment, of course, was the problem for a generation of young working Indians who have been rushed into buying over-priced housing. At some point, this debt-fuelled buying binge lulled the developers into believing the illusions they had themselves created. I think they really started believing that there were a huge number of Indians who could pay a crore or two for a 1500 or 2000 square feet flat 20 miles outside the city. Whatever cash they got from sales, they relentlessly leveraged it further in order to keep repeating the cycle, which is why they are all in such deep trouble now.

Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports. Email the author at arun@ventureintelligence.in