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Will Currency Ban Prick the Real Estate bubble?

One of the most interesting aspects of the new move to ‘churn’ high-value currency notes will be its impact on real estate prices.

The real estate sector was already reeling from high interest rates, slow economic growth and a fatigue due to the constant rise in prices.

However, the new move to churn 500 and 1000 rupee notes via the banks to weed out black money could be the straw, or iron rod, that breaks the camel’s back.

Though there are ways in which people with black money will try to recover at least part of the amount that they are carrying in cash, the unprecedented move is likely to make at least 50% of the total unaccounted for cash in India totally useless.

And nowhere is ‘black money’ used as much as in the real estate sector, where it is routine for 30-50% of the total proceeds to be paid in cash.

Feroze Azeez, deputy CEO of Anand Rathi Private Wealth management said the real estate sector is likely to see a flight of capital.

“Black money was the FII for the real estate sector,” he said, reacting to the news on a TV program.

“There are eight lakh apartments in top cities that are unsold.. These buildings will now be sold at a lower price as the buying capacity with white money will be lower,” he said, adding that he expects a 20-25% decline in residential property prices in the big cities.

Real Estate prices have been rising for the last 25-30 years throughout India, and have multiplied by 10-20 times in this period.

This has made real estate unaffordable for most salaried Indians.

For example, a three bedroom house in an typical middle-class locality in India costs around Rs 10 mln (Rs 1 cr), while the average middle-class Indian couple earn only around Rs 60,000-70,000 per month.

However, just the interest on Rs 10 mln comes to about 80,000 per month.

“Traditionally, the preponderance of ‘black’ or unaccounted for monies in real estate – largely by way of cash transactions is seen in secondary market transactions and supply chains related to primary markets viz. land, material, labour etc,” said Sachin Sandhir, Global Managing Director – Emerging Business, RICS.

“Secondary markets would be affected as unaccounted cash payment would no longer take place leading to some dips in sale process for assets that are sold or purchased in the short term. However, with progress of time, it will not be surprising to see prices go up as sellers come to terms with the fact that capital gains tax has to be paid on monies. Sellers are likely to factor that liability into the sale price.

“A closer look at the primary market would indicate that there are several components of informality within the production chain – such as purchase of land for onward development of a project.”

“Twenty-four (24) hours earlier, a landowner could enter into an agreement with a developer where part of the consideration paid would be unaccounted. Now, since the landowner can no longer do that – he would either sit out on the land, stalling the entire development project, or charge a higher premium to maintain the same cash margins after tax. The same principle also works between developers, contractors and sub-contractors. All of this included, the input costs of developers will go up, and the only way then can respond will be by raising prices – which will affect a market already strained,” he added.

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