Sunday, May 4, 2008

Real Estate and some economics

( These views are not from a seasoned economist. I am a common guy working towards a business degree. So my views are from a layman's point of view and I use simple arithmetic to substantiate my argument).

For the past couple of years,most of us are hearing these advices- " Better buy some land now or ELSE........In the next two years you won't even get to buy anything close to that". Hmmmm.. pretty clever isn't it? A great way to trick somebody into buying some overvalued crap. For real estate brokers, times have never been brighter thanks to the hype generated by the media and the real estate mafia. People who own land boast of the property value and buyers fret when they hear the skyrocketing prices. This phenomenon is not concentrated in any particular region or country but is spread across. But these prices are definitely in for a downward correction- PRICES WILL COME DOWN SOONER OR LATER. I can bet on that..

Before we discuss the situation in India, let us analyze what happened in America. Since 2005, most regions in the U.S have experienced a 10-20% dip in prices, thanks to the overinflated value tags they carried. For example, in the place that I live one of my friends bought a house for $ 500,000. ( This is the median price of a house here). Two years hence, the value of the same house has depreciated to $ 375,000 ( and a recession has not even begun). This has happened in California, the hottest place on earth in terms of immigration and jobs. Now, my friend like many others were so enthralled looking at the positive sloped price graph that he decided to take the plunge. Little did he know that the saturation point has reached for that area.

The inputs that come into play that affect the price of land/house in any area are the following: The potential of the place, market speculation ( on say some projects that may be coming up), the general state of the economy and the buying capacity of the public. All these factors have to work together to affect the value of these assets.

Now, let us look at what is happening in Kerala. Take a look at the land quotes from at least two cities Kochi and Trivandrum. Even some well to do professionals that I know of cringe on hearing the land prices in these places. As i had mentioned earlier, the main factor that drives these prices are market speculation. Many places in Kochi fell vicitim to this " speculation". Kochi is a great port city. To this day, there is practically no IT industry there since 80% of the software exports in the State is done by Technopark. There is no solid industry at the moment in Kochi , only some market speculation. Though Smart city is being touted as a big project, a lot of hype is given to this project since this is mostly in the private sector. But the fact remains that Smart city , even when it happens, is smaller than the Technopark-Technocity IT corridor in Trivandrum and considerably smaller than IT parks in Bangalore, Hyderabad and Chennai. So, why this hype.. The answer is the real estate mafia.

From various sources, we came to know the role the media and the real estate mafia played in inflating the actual prices. How they works is like this.. They overhype any project through the media- both print and electronic to the extent that most of the general public falls prey to these tactics. By this time, the so called real estate mafia would have already controlled most of the land and people will be so overawed that they would want to purchase some land from these guys ( to sell at a profit later). Here is a classic example. Some agent will inform us ( the buyers) that they have 6 cents of plot close to some proposed XYZ project. The value now is 5 lakhs/cent ( though the actual value may be considerably lower) and they may also give an example of a transaction of an adjacent plot for 5.2 lakhs/cent. The point to note here is everyone including the buyer and the seller overstates the price of property. So you never get to know the truth of the actual transaction. The agent also says that in less than 2 years time, you can sell the same property for 10 lakhs/cent. WOW, that is a 500% return on investment. What other investment in the world will yield this? Now , this poor guy shells out 30 lakhs for a mere 6 cents plot in the hope of making 30 lakhs profit in 2 years( of course not considering the interest he pays in the meantime). COMMON GUYS, do you think this is a feasible transaction. No economist will say so. Do your math- 6 cents of land is the bare minimum you need to render utility to the land ( like building a house). So, now the base line is that you purchase the land for 60 lakhs plus you have to shell out another additional 35 lakhs for building a house. So you spent close a crore for a normal house on a mere 6 cents of land. Even if you imagine that an IT guys saves Rs. 50000 per month in India and considering the fact that he puts in the whole amount as EMI for this, he will take atleast 200 months to get off this debt.. That is roughly 17 years.. That too for a mere 6 cent plot plus house in a relatively small city in India.

Is this sustainable? No. The land prices are definitely in for a downward correction. When you get the feeling that even people with considerable disposable income cannot afford these prices, there is something wrong here. What has happened in California and rest of US will happen in Kerala also. Not only in Kochi but also in other cities including Trivandrum. But in the case of Trivandrum there is a flip side. The projects in Trivandrum do not get as much media coverage as those in Kochi. Why is this? Because, contrary to Trivandrum, most of the projects supposedly coming in Kochi are in the private sector. So they need the media coverage to sell their projects. I am a development oriented Keralite. I want all cities, towns and villages to develop equally- but not at the cost of the general public. Here is the scoop- Who are the clear winners in the whole episode- the so called real estate mafia.

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