Real Estate Investments- Will the prices drop?

Has this question kept you on the fence of investing in Real Estate Project in the past? Every one knows that one uncle or one friend or one colleague who was sure that after ILFS crisis real estate prices were going to drop... but they didn't. Then came GST, RERA and they were again sure that prices will drop but they still didnt again. Now again we hear prominent politicians and the stalwarts of industries other than real estate shout on National TV's and webinars that Real Estate prices will drop post Covid 19. Crisis after Crisis, we get pseudo experts on real estate coming out and giving reasons  for real estate prices to drop with those sure shot predictions that have never come true. 

 So why are the rates not dropping? Will they drop going forward? Should I continue waiting for the right time to enter into the Real Estate market? If these are the few questions you needed answers to then let me tell you the insiders track on real estate pricing through todays article.

What makes me sure of my analysis is that I have been working with Real Estate firms since last Twelve years and have gone through every major crisis that this industry could be hit by. Let me start by summarising the conclusion..PRICES DO NOT DROP IN MOST INVESTMENT GRADE AREAS. The only result of these crisis has been that those fly by night unorganised one time developers have gone away from the market for good.  Lets answer the basic questions in John Oliver Fashion, How are Prices Determined? Why do they Increase Every Year? Why would the Promoters not reduce rates to sell more units? and what is the way forward trend in real estate prices?

Lets start with the basic, How Are Real Estate Prices Determined?

You all must have heard of Ready Reckoner Rates. They are rates determined by your State Government for charging stamp duty on your Apartments, offices etc. Though this should be a scientific data driven exercise, our government ignores the real on ground status of rates on the projects and has been following a philosophy that every year the ready reckoner rates are increased by 5%-20% range and in difficult years they are kept stable. Now the same government officials who want the rates of real estate to drop have never once given a thought of reducing these rates in last 15-20 years. Why is this important you ask? Well, even if a real estate developer is willing to sell you an apartment at lower rates he cannot afford to go below ready reckoner as selling below ready reckoner means being charged tax on the difference between the selling rate and ready reckoner rate, being subject to detailed scrutiny by tax authorities who further assume you are dealing in cash and long drawn legal battles with the tax authorities which in most cases are decided against the Developer.  Further You end up paying 6%-7% stamp duty on your purchase value which further adds to cost of your apartment. And if you dig a little deeper, even if the Developer is willing to sell you at below ready reckoner rates you will still have to pay stamp duty at ready reckoner rate. 

The Developer does not determine price of his units like any other business. He does not have freedom to decide the cost he input in the project plus addition of a reasonable profit to decide the MRP of his unit. In turn his prices are benchmarked first by the Government and then comes the Landowner. Unless the developer himself has been holding the land historically, land is acquired by Landowners who decide their rates as a function of ready reckoner rates of flats. So if an area has ready reckoner rate of Rs.6000 for residential flats. The Landowner reverse calculates the construction cost and the profit he presumes is reasonable for the Developer and the difference then becomes the land cost. Ask any developer and he will tell you that they are happy to reduce rates if they are allowed to go below ready reckoner or if ready reckoner themselves are brought down. Instead of customers demanding real estate developers to drop prices have we ever demanded government to reduce the rates of stamp duty. Imagine if you could register your dream apartment at 1% stamp duty only, wont that bring down costs?

Lets answer the Second question now, Why does it seem that Real Estate Prices Increase Every Year?

Please browse through this  The Hindu newspaper article- https://www.thehindubusinessline.com/companies/steel-prices-to-go-up-by-1000-a-tonne-in-jan/article30395465.ece. Steel, Cement, Bricks and Labour are the most essential ingredients in constructing a building. A cursory glance of last 15 years trend in raw material prices will show you that these essential raw materials for constructing your apartment have not only risen in prices but have become exponentially expensive. If you compare even the last five years, steel prices have grown year on year by atleast 20% where as your apartment cost has not even risen by 5% in most cases. These prices are not only a result of increased raw material cost but also greater incidence of GST at rate of 28% in most cases, increased cost of transport and the strongest industrial lobby of the world. How can a sane person ask a business man to sell his good at lower rate when his cost of raw materials have increased? Will you ask Apple to sell its Iphone at lower rates than last year when the chip costs keep increasing?

Second reason for rates never going down is the Government themselves. When they reduced VAT, they introduced LBT. When the reduce GST rate, they deny input credit to developers. Government has not given thought to why developers are unable to reduce rates and has never disected the real cause of stable or growing real estate prices. Third reason is the rate of interest offered to developers for loans from banks. Did you know a manufacturing company has access to loans at as low as 5% to 6% per annum with little to no collateral security requirements. However a real estate developers, even Cat A developers get funds of not less than 12% per annum and in most CAT B and CAT C developers average rate of borrowing is 18% and above. If the Interest costs, Taxes and Raw material costs are high, whom do you think the Developer will recover the costs from? Obviously you, the customer.

Now lets answer the question that is on everyones mind right now,  Why don't the Developers reduce rates to sell more apartments?

If you have read through the above paragraphs and still not figured out why the Developers are unable to reduce rates. Let me spell it out for you, because of external uncontrollable factors beyond their control. The profit margins i.e the Sales less Cost margin of developers in most cases is not more than 15%-20%  if they are lucky and good at planning. This is earned across the period of 3 years on average per project they do. Though absolute numbers may be big any finance person will tell you this is a thin margin to work with. Any contingency or external factor can wipe out their entire profits anytime. Now though as customers I do subscribe to the ideology that what a seller makes is none of my concern, what I pay is my concern and if he does not make profit in those rates it is his problem. This though a fair assessment leads us to a unique situation, imagine if we move to a model like China where all housing is government controlled. No choice in apartments and no private competition. We loose out on our most favourite blessing-"Choice". Unless the private sector makes profit there will be no incentive for them to innovate or do new projects and if that happens we as consumers will be entirely dependent on Government providers like MAHADA or big corporates like TATA's both may not lead to the outcome best for customers. Imagine if your employer told you to reduce salary while your expenses remain the same would you be able to absorb that?

CREDAI, NAREDCO and many developer associations have been asking government to reduce incidence of direct and indirect taxes so that they could pass on the benfits to the consumers by reducing rates. You may read up on their petition to the Prime Minister which was sent recently by doing a mere google search. We as consumers need to voice concerns and ensure that there is support towards these initiatives so that the benefits be passed on to the us. 

Lastly lets answer, The Way forward for real estate prices?

In my informed opinion I believe that Real estate has presently reached the bottom prices at which it can sustain. Any developer who further reduces his prices to sell may be too desperate and eventually may not be able to complete his project. The only reason why he may be dropping prices is to reduce ongoing debt and other liabilities which is not a sustainable model. Just like in the Stock market there is a glass ceiling, that if when broken, tells us that the share no matter how cheap is not worth buying. Same in my opinion applies to Real Estate. Its a time when consumers can demand better service, better value for their monies by asking developers to be more time bound in their delivery and deliver better quality apartments. Rate reduction may not be conducive and good developers with sound planning will not reduce rates as any more reduction will lead to heavy losses.

This article was written with a perspective to give the reader an inside track on real estate rates. I would love to hear any other perspectives that you may have on this issue in the comment section. This is Part 2 of the real estate series that I am writing. you may read the first part by clicking on this link:- https://casaransh.blogspot.com/2020/05/real-estate-investment-101-always.html

written by- 

Saransh Dey

FYI: this article is a result of recent comments by Hon'ble Piyush Goyal ji. you may read up on in on this link https://www.livemint.com/industry/infrastructure/piyush-goyal-tells-builders-to-sell-homes-at-realistic-prices-11591201385509.html