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Indian Real Estate Bubble is starting to burst – Report

The Indian Real Estate sector is starting to unravel with prices having fallen 7-18% in India’s large cities over the past year, Ambit Capital said in a report.

“In Delhi, our meetings with businessmen who live in south Delhi suggest that prices in this prime part of Delhi are down 20-25% over the past year and transaction volumes have fallen sharply.

“In the smaller cities, the situation seems to be worse, with our contacts in Jaipur, Rajkot and Lucknow also pointing to a 15- 20% YoY correction and sellers saying that it is hard to receive bids for properties that they have put up for sale,” said the report authored by analysts Saurabh Mukherjea and Sumit Shekhar.

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Many experts have been warning of the ‘bursting of the real estate bubble’ in India for the last 2-3 years. India’s real estate prices have been going up by an average of 20% or so per year for more than a decade, while actual interest rates have been in the range of 7%-10%.

Because of this, many people have taken out loans and invested in property, enjoying the 10-13% differential. However, with prices having increased around ten times since the turn of the century, a correction is seen as natural.

As Ambit pointed out, the rental yield in Mumbai is around 2%. In other words, if you buy a flat for Rs 1 cr and give it out on rent, you will get only 2%, or 2 lakhs, per year in return.

In places like Indonesia and Philippines, rental yields are in the 7-8%.

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“In a fairly-priced real estate market, the rental yield tends to be somewhere close to the cost of borrowing,” said Ambit.

“Instead, Mumbai has a rental yield of close to 2% whilst the lending rate hovers around 10%”

The reason why people are ok with low rental yields in India is because they are not looking at rent as the return. Instead, pointed out Ambit, everyone is looking for capital appreciation – or the increase in the price of the property – for returns. So, even if you get only 2% a year as rent, if the price of the flat goes up by 15% per year, the total return is 17%.

However, given that a sustainable annual price increase is in the range of 5%, and that interest costs are in the range of 10%, actual rental yield should be around 5%.

To increase the rental yield, one has to either more than double the current rents, or more than halve the current house price.

“Even if one assumes that buyers are willing to live with only 5% rental yields (as they might have an extremely bullish view of capital gains arising from real estate in India), this would imply halving of real estate prices in Mumbai,” Ambit pointed out.

Ambit gave various reasons why it believes that the “unraveling” of the real estate sector in India has begun. It quoted various numbers — from the slowing pace of construction-job-growth to the drying up of new launches to a slow down in disbursement of loans to the sector by the banks.

It added: “Further price correction is inevitable: Whilst stated prices (prices which the real estate agents quote) remain elevated, transaction prices have already fallen by 10-15%, and real estate brokers are saying that a further correction is a must for inventory liquidation. Discounts have increased significantly in the secondary transactions market and distressed real estate liquidation by lenders (who have not been repaid by developers) is becoming increasingly common.”

Among the reasons for the bursting of the bubble are less scope for bureaucratic corruption due to the introduction of direct benefit scheme, run-away prices, a crackdown on black-money and drying bank debt.

The report also pointed out that some banks have as much as 37% of their total loans tied up in real estate and these are at high risk of financial trouble when the prices correct sharply. “Amongst the large private sector banks, the most-exposed lender appears to be ICICI Bank,” it said.

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