Making an investment in real estate in India? Read this first.

Real estate investors in India have had it tough over the last decade. Average inflation over the last 7 years stood at about 5% per annum and residential property prices across most major cities did not even appreciate by the same %. This was at a time when average housing loan interest rates were at 9% per annum. This chart from Knight-Frank shows this rather sad trend.

Source : Knight-Frank Research

This trend worsened as we got into 2020 as prices fell dramatically across most major cities. This chart below shows that.

Of course, this analysis is based on averages. Property investments are all about location, location & location. And no two places are the same. An investment made in Gurugram which has one of the highest supplies of unsold inventories in the country fared much worse than an investment in Panvel where Navi Mumbai’s new airport is coming up. But, on an average across the nation, any money put into real estate turned out to be one of the worst investments over the last decade.

Given, we are where we are, how should one think about real estate investments today? Should you invest in residential property?

To answer that question, we need to look at demand and supply factors that drive real estate prices. We will look at 3 demand-side and 3 supply-side factors to make a judgement call on where we are now and how these metrics could evolve over the next years and affect property prices. Dive in…

Real Estate in India - Demand-side factors

Interest Rates and Credit Availability

Interest rates are one of the biggest drivers of demand and prices. And this should come as no surprise to you. Lower interest rates lead to higher demand and higher demand leads to higher prices. Just to give you a few examples, year on year and in the middle of COVID-19 prices appreciated in Netherlands (+11.6%), UK (+5.8%), Singapore (+1.5%) and China (+4.9%).

Why? Primarily because of low-interest rates and availability of credit. As more and more people manage to secure loans at low-interest rates, demand goes up and prices go up. Interest rates in India are at a 15-year-low. This chart we published earlier shows the housing loan rates offered by SBI.

This bodes favourably for real estate and gives us confidence.

Real Estate , Naysayers 0

Income levels

This should also not be a surprise at all – As real income goes up, demand goes up. The massive property boom we witnessed in the past in places like Bengaluru and Hyderabad was primarily driven by increasing income levels in the IT sector. The only proxy we have for real income is per capita income at a country level. And how has that done? Take a look.

Gross national income per capita in India grew by 6% in the last decade. In 2018-19, income levels grew by 5% and in 2019-20, it grew by a mere 3%. Given we are in the middle of one of the worst economic slow-downs in history, it is safe to assume that income levels aren’t going to grow rapidly over the next few years. But more concerningly, if job losses increase in the economy (some are saying it could), people will postpone buying decisions till they have more visibility of future earnings. And that could lead to a total collapse in demand.

Real Estate , Naysayers +1

Urbanisation

The third factor which drives property demand in cities is the migration of our population from rural to urban areas. But studies after studies have concluded that people mobility from rural to urban areas in India is one of the lowest in the world amongst comparable countries. Several reasons have been postulated – low wage gap between cities and rural areas, the loss of community and informal ‘insurance’ network upon migration etc. COVID-19 has only accentuated this problem. We have witnessed large scale reverse migration from cities to rural areas and that isn’t going to fix itself over-night.

Real Estate , Naysayers +2

While this is a trend across the country, regional differences do exist amongst the different cities and regions. So, before you go buy a property in a locality, take this into consideration – Are people moving into or out of the neighbourhood? If they are moving out, wait for prices to correct.

Real Estate in India - Supply-side factors

Low interest rates

While low interest rates increase demand for property, it also decreases supply of available properties in the market. How? Here’s how – Let’s say home loan interest rates go up to 20%, tomorrow (Unlikely, but indulge me for a moment). Your debt burden, monthly EMI and interest payments will all go up significantly and consequently you will try your best to sell the property off. In contrast, when interest rates go down, debt burden of existing homeowners also goes down. They are consequently in much less of a hurry to sell the property off. Those sitting on the edge about selling their property off, will feel encouraged to hold on to their houses given the benign interest rate environment. So low interest rates, reduce supply and increase prices.

Real Estate , Naysayers +2

Existing unsold inventory

If there is only thing that has led to very low returns on real estate investments over the last decade, then it is this – The massive amount of newly built unsold inventory with developers. While this problem is largely starting to resolve itself, cities like Mumbai, Delhi and Kolkatta are still grappling with this issue. Here is a look.

We are however starting to see some green shots – Knight Frank’s report suggests that over the last 4 years, sales have consistently been more than new launches. This actually goes a long way in clearing up the existing inventory and reducing oversupply in the country. There is more good news – Developers are starting to level with buyers by finally offering them better pricing deals both in the form of direct price discounts as well as other non-price deals. For instance Tata housing is offering its buyers home loans at 3.99% for the first year to buy their properties.

If all of this leads to lesser supply in the country, prices will finally start going up. And we are hopeful.

Real Estate , Naysayers +2

New housing development start-up

The government & RBI launched an index called the Housing start-up index in 2011 to measure the number of new residential property development launches. Unfortunately, for whatever reason, this was discontinued.

So, it is very hard to measure the level of new activity in property development. But based on what has been making news, most large developers in India like Godrej properties, Purvankara seem to be focussed on starting-up new developments in Bengaluru. Once again, this factor is very location specific and you’ll need to take into consideration if new launches are significantly increasing housing supply in the area of your interest. If they are, property prices are probably not going to appreciate very much.

No points for either of them in this round.

Real Estate , Naysayers +2

Apart from these demand and supply factors, there are two other key considerations to be made before taking the plunge.

Real Estate in India - Affordability

In early 2019, Knight-Frank undertook a survey to measure affordability of residential houses across different cities in India and how this has evolved over the last decade. And their key finding is in this chart below.

Source - Knight-Frank Research

Their research suggests that the optimal price to income ratio for houses is 4.5. Against this baseline, housing in cities like Mumbai and NCR are less affordable (more expensive) and property prices in cities like Kolkatta and Ahmedabad are more affordable (less expensive). The general rule of thumb in finance is to buy cheap and sell expensive. And the fact that in India as a whole, property prices are once again starting to become more affordable compared to income levels is positive for real estate investments.

Real Estate , Naysayers +2

That house you had in mind, how does its price stack up against the average income of people in your region/age/employment group? If it is too expensive, stay out of it.

COVID-19 and International considerations

COVID-19 has made a serious impact on the residential property market worldwide. Hopefully, we will have a vaccine soon. But the key trend we are observing is the mass exodus of people from cities to sub-urban areas. Employers are going to keep the option to work-from-home for a long, long time to come. And this means that staying in the centre of the city, close to activities of commerce and offices is no more a necessity.

This outward movement of people from cities has led to increasing vacancy rates in rental properties. Tenants in cities like Sydney and New York are starting to re-negotiate rentals with their landlords. But more importantly, while property prices in cities are stagnating, they are increasing in sought after beach towns, nature reserves and all the places where the quality of life and well-being is better.

India does not have much of a sub-urban living culture. But COVID-19 could change that. And if it does, property investments in some of the most expensive and sought after city-centre localities like Lavelle Road (Bengaluru), Kilpauk (Chennai), Jubilee Hills (Hyderabad) and Tardeo (Mumbai) will do terribly. Watch out.

Real Estate , Naysayers +3

To sum it all up

In the short term, lower interest rates will encourage more people to come out and buy properties. This, combined with the trend we have seen of reducing unsold inventory will provide cushion to property prices that have been falling or at least failing to appreciate for the last decade.

But the economic impact of COVID-19 needs to be dealt with. And we need to start seeing resolution to some of the structural issues in our country like low growth in income levels,  low-affordability of housing in cities like Mumbai for there to be a meaningful appreciation in prices.

Our conclusion is this

A buyer looking to purchase his/her first or second home might find really attractive deals over the next few quarters. An investor buying a property now to make a killing in the real estate market will be sorely disappointed.

Where to buy real estate in India?

If you are still reading and you still want to buy a house, here are our top picks for the most promising spots to make a real estate investment in India. We have arrived at this list after looking at metrics like affordability, the existing supply of unsold inventory, the trend in new launches, the growth rate in property sales and age of inventory. Take this only as a guide.

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