Demonetisation
Will It Impact Real Estate Prices?

27th November 2016

Prices Will NOT Fall and Here is Why

Based on routine and expected ill informed rumours and chain reaction out of misleading inputs and discussions post government’s demonetisation move, real estate is expected to be one of the worst-hit sectors, as cash is considered to form a major component in many transactions in this sector.

Many believe or predict that land and property prices could fall as much as 20% to 25% in the next 3 to 6 months.

Both investors and end users are now in a “wait & watch mode” and are waiting to see if prices will fall in the short term.

However, good news is that these assumptions & fears, can at best be called unfounded and based more on public hysteria, panic and confusion, than based on actual facts of the industry.

Further, all those knee jerk reactions are coming mostly from those who have barely or never dealt in real estate and who are not aware of both market fundamentals and various categories of products available.

Here is why quality developers and long established and leading property consultants strongly feel that there is little room for any major price cuts or correction in the organised sector of Indian real estate industry, barring the rural areas :

1. Construction Cost will Increase Significantly

  • Developers use a large amount of unaccounted cash to pay daily wage labourers on site and to pay small suppliers for construction material, etc.
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  • Now that they have to pay these expenses in white – because of lesser cash in circulation and greater scrutiny by authorities – and also pay applicable taxes on these components, the overall cost of construction will only go up.
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  • Hence, developers will NOT be willing to cut prices as their cost of development will increase significantly due to rising input costs as explained above.
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  • For example, the cost of steel and cement has already jumped by 10% to 12% in the last 3 weeks alone, post the announcement of demonetisation and builders will now have to pay for this with accounted / white money as its’ impossible to pay for these purchases with lower denomination notes like Rs 100, because the quantum of purchase is so large. Hence, this will only add to the costs of the developer which will means they cannot afford to cut prices.

2. Home Loan Interest & Fixed Deposit Rates set to Fall

  • This will make property purchase more affordable & attractive and at the same time, make Deposits Schemes in banks totally unattractive.
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  • Home loan Interest rates have already come down by 1.5% to 2% in the last 2 years.
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  • And as banks are now awash with money as customers deposited tonnes of cash following demonetisation (as on date, over Rs.6 lakh crore has been deposited into banks since Nov 8), they will be compelled to lend aggressively.
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  • To do this, they will have to LOWER interest rates further, which will make it easier for everyone to purchase property and thus help push property sales and prices up in the near future.
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  • Similarly Fixed Deposit (FD) rates which have already come down to 6.95% p.a., will come down further in next one year, making them a highly unattractive investment.

3. Shortage of Land as Cash Transactions No Longer Possible

  • Traditionally, land deals accounted for most of the cash transactions in the industry.
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  • But now, due to the massive shortage of new currency and old currency being rendered invalid, both buyers and sellers of land are finding it difficult to transact.
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  • This will lead to a drastic fall in number of new projects being announced, leading to both shortage of land in the immediate future and also faster absorption of existing unsold inventoryboth of which will lead to a steady but sure INCREASE OF PRICES.
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  • Ofcourse this is more relevant to metro and other growing cities and incase of rural belts, there will be pressure on prices leading to a temporary fall that may last a while.

4. Developers No Longer Prefer Outright Purchase of Land

  • In the initial stages of every new project, land purchase involves the highest component (as high as 50% in some cases) of cash or unaccounted money. This is one of the biggest reasons that developers encouraged buyers to pay for their purchase in cash.
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  • But a growing number of developers will now start avoiding outright purchase of land for their new projects – infact all the top developers in major cities started this trend almost 2 to 3 years ago – and instead, will opt for joint development agreements with land owners.
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  • And where land transactions happen in the form of joint ventures / joint development agreements, there will barely be any impact of demonetisation as such transactions are quite institutionalised, with involvement of little or no cash.
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  • Because of this, developers will have one less incentive to accept cash from buyers and hence this will only lead to HIGHER PRICES in the future as builder’s will now have to incur additional tax outflows on account of land and other construction related aspects – something they were previously able to avoid by paying for land and other raw materials in cash.

5. Primary Markets in Tier 1 Cities will Not be Affected

  • The primary market – or, more specifically, the market dominated by projects of reputed and credible developers in the leading Indian cities (approx 20 of India’s top cities) – will remain more or less UNAFFECTED.
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  • This is because buyers into such projects predominantly take the home loans/finance route to buy their homes – that is, sales is largely driven by the salaried class or investors with limited cash involvement – and transactions are done in a transparent manner through legal channels.
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  • For example – in cities like Bangalore, Hyderabad, Pune, Cochin or any other such growth cities, flats, villas and villa plots have always been bought with full cheque amount only and many investors (both buyers and sellers) refuse to pay or accept cash.
    In places like Bangalore, even plots in approved layouts (BDA, BBMP, BMRDA, BIAPPA or CPA approved) have always been bought by employees who take maximum possible loan (upto 70%) and they pay the balance 30% in cheque as they must declare entire value in white, to be eligible for maximum loan amount.
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  • EXCEPTION : Certain cities in North India such as Delhi-NCR, Mumbai and other major cities do witness cash transactions even in the primary market and hence North Indian cities could be affected to a larger extent where as builders in South Indian cities of Bangalore, Hyderabad, Kochi, etc have always avoided cash at all stages and hence will not be affected.
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  • This segment will therefore see at best a LIMITED IMPACT in the larger cities, though some tier 2 and tier 3 cities where cash components have been a factor even in primary sales will see a business crunch.
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  • Even the secondary market in most of the Tier 1 cities will see little or no impact as even resale transactions in these cities involve very little or no cash at all as most of the buyers purchase property using home loan where buyer has an incentive to declare entire value on paper – to get higher loan amount – without undervaluing it etc.
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  • Also the primary markets of key cities of India are driven by growth of commercial real estate – which itself will hardly see any impact on office / industrial leasing and transactions business, given that cash components do not play a significant role in such transactions.
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  • Also, a lot of small time unbranded developers who sprang up overnight and spoilt the market by offering small, substandard properties in the bylanes or cheaper parts of prominent areas (such as Marathahalli & Sarjapur Road in Bangalore, Madhapur & Gachibowli in Hyderabad, etc) at a much cheaper price when compared to established brands (coupled with their preference to accept cash, thus making their property even cheaper on paper) while compromising on quality will now be wiped out in note time, leading to a substantial shortage of new supply, which will in turn lead to higher demand for existing inventory and thus higher prices in the near future.

6. Market on the Verge of an Upswing

  • Property prices in key markets have seen very slow growth or stagnant rates in the last few years due to high home loan rates and huge inventory buildup, both of which have substantially reduced from 2014, thus readying the market and setting the stage for another boom cycle over the next 3 to 5 years.
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  • Prices are hence not likely to reduce sharply as predicted, as any immediate drop in sales will only be a temporary one, until people slowly but surely realise all that is being explained here.

Who or What Will Get Affected?

1. Tier 2 & 3 Cities & Secondary / Resale Markets will see a Correction

  • Primary Market : There might be an impact on quite a few projects in tier 2 or 3 cities where cash has played a role even in primary residential sales. However, the turmoil in this segment will settle down in a short period of time. This impact will be more severe incase of plots as cash plays a bigger role in this asset category.
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  • Secondary or Resale Market : While primary market will see a minimal impact in the short term, the secondary market will witness a bigger impact as this is where a good amount of unaccounted cash is used. Speculative and inflated pricing will take a beating in secondary or pre-owned properties, especially in markets which thrive on speculative investments.
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  • In other words, the resale properties segment in Tier 2 and 3 cities will take a big hit, unless you are with a big and reputed developer in which case prices may not be as affected unlike other smaller / unbranded properties.

2. Fly-By-Night & Unbranded Smaller Developers will Get Wiped Out

  • Smaller developers are very concerned post demonetisation as many of them depend heavily on cash transactions to “get rich quick” and scale up overnight.
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  • With most of their wealth being stored in the form of the now defunct & invalid currency notes, it will be very difficult and close to impossible for such players to suddenly clean up their books of accounts / track record and regularise their finances.
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  • It is hence very likely that a massive number of such players will get wiped out in the coming months and the industry at large will witness a much required clean-up of such fly-by-night, non-serious players.
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  • The impact of RERA (Real Estate Regulation and Development Act 2016) will further discipline the industry, which will be good for its health in the long term as only transparent players will survive.

3. Agricultural Land & Plain Land Deals Will Suffer

Those carrying out sale and purchase of plain land parcels in far off suburbs or rural areas or agricultural land will undoubtedly suffer as these transactions tend to involve significant cash involvement – sometimes as high as 80% of the transaction value is paid in cash.

Conclusion

String of Reforms Set to Clean Up & Regularise the Industry

  • There has for long been a strident demand to bring transparency in the sector for it to become more organised, and in this regard, abolition of cash dealings is one of the first and most important aspects to be dealt with, although some amount of cash WILL still remain in the system after this cleanup, though definitely not to such an extent as it was so far.
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  • The demonetisation exercise is hence a very welcome & necessary step to transform the Indian real estate industry into a more efficient, corporatised & transparent asset class.
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  • The passing of RERA (Real Estate Regulation & Development Act), the Benami Transactions (Prohibition) Amendment Act, Goods & Service Tax (GST), Real Estate Investment Trusts (REITs), FDI reforms and now the demonetisation move, will ensure that in the coming years, the sector will lose much of its historic taint and emerge stronger, healthier and capable of long periods of sustained growth.
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  • Only those developers and investors who conduct their business with integrity will survive.
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  • For those who have conducted their dealings transparently and legally so far and have dealt with quality players in the top cities of India, there is NO NEED TO PANIC.
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  • And for reasons explained so far, prices will NOT fall in major segments and surely not in projects or categories recommended & dealt by us at G&C.
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  • This is STILL THE BEST TIME for you to invest in Indian real estate – especially markets like Bangalore, Hyderabad, Amaravati, Pune, Trivandrum and many other such growing cities that are reasonably priced despite having robust and continuous demand for property.

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