Post-Covid, we are witnessing a revival of the real estate market but several challenges must be met to restore its growth
The Indian property market is experiencing a revival after experiencing a prolonged slump. The decline in interest charges, the government’s encouragement of affordable housing, the boom in the IT sector and the enactment of the RERA have certainly been drivers of growth. The terrible impact of Covid seems to be slowly fading away. But does that mean the revival is lasting and we’re back to the Roaring Twenties we saw in the first decade of this century? This will only be possible if we address some key challenges facing the industry.
One problem is that real estate as an investment option has become unattractive over the past decade. In India, rental yields from real estate have never been attractive. They are only 1 to 3% in the residential sector. Even that is taxed with very few tax incentives for owners. The property tax is high and money has to be spent periodically on renovation. On the other hand, the interest you pay on mortgages has fallen but remains at 7%. So, as an investor, if you took out a loan to buy a new house and rented it out, you would lose about 5% every year. And if you just kept money in the bank as a deposit, you would earn 7%.
In contrast, in most other economies, interest rates on home loans are about 2-3% lower than the return you get from renting the apartment. In the past, in India, there was double-digit capital appreciation and that attracted the investor class. Now, that seems to have disappeared, and investors’ share of the homebuyer market has fallen sharply. It has become purely an end-user market, which is never good for any market.
One way to incentivize investors to buy homes would be to reinstate the old provisions of the Income Tax Act that provided for the offsetting of interest paid on home loans against all other income, including wage income. This provision had been there for a number of years but was removed by the Modi government as soon as it came to power. This was actually one of the reasons for the collapse of the high-end housing market. It is always good for investors to be in a market because it gives the size and liquidity that the markets need.
The other side of the rental market is interesting. The baby boomer generation valued security and it was unthinkable for a married person not to own a home. Now millennials have a different attitude. They prefer renting accommodation rather than committing to a long IME payment commitment that can span 15 to 20 years. Job uncertainty is also an important factor. Covid was a nightmare, as the urban working classes faced pink slips. Even those who managed to hang on faced pay cuts. With this uncertainty about which jobs to worry about, people in their 30s and 40s think twice about adding a long-term commitment.
Property prices in India are still high relative to the country’s income levels. A two-bedroom apartment costs as much as Rs 75 lac in urban areas and probably more in Mumbai and Delhi. Median wage income is around Rs 10 lac per year and a married person probably saves Rs 1 to 2 lac per year. It therefore takes seven to eight years of stable income and savings over 30 to 60 years to own a house! In foreign countries it is much less. So the only way to break this lock down of income not supporting high house prices is to reduce apartment prices by at least 30-40% from current levels because I don’t see income increasing in India with great speed.
And this leads to the main reason for the high cost of urban housing in India and that is the exorbitant price of land in Indian cities. In some projects, the cost of the land represents more than 50% of the total cost of the apartment. In other parts of the world, these rates range from 10 to 25%. An obvious solution is to allow more “FAR” (floor area ratio), as has been done in Hong Kong and other cities. Some measures have been taken, but in my opinion, skyscrapers are a good way to reduce the land price component. The other is that the government frees up huge plots of land that belongs to it, for the construction of houses. In Delhi, for example, if the army and the railways were to hand over even 10% of the land they own, apartment prices would drop dramatically.
In addition to the cost of land, taxes related to real estate are also very high. Stamp duty levied by state governments for property registration ranges from 5-8%. Apart from this, the government has introduced GST on apartments and with this, the taxes associated with buying a property in India are the highest in the world. This hurt the demand for properties and also resulted in a large cash component in the sale price. A lower tax regime will surely stimulate demand and the government will eventually collect more taxes. It will also reduce the undervaluation of property and the prevalence of black money in real estate transactions, which is one of the dark sides of the Indian property market.
It’s obvious that even though a house is a necessity, most middle-class people find it difficult to own a house in a city and deal with EMIs. It is essential that this change and it can only be done through a combination of government initiatives. Reducing mortgage rates, incentivizing investors through tax measures, increasing land availability by selling surplus government land, and increasing FAR is the way forward.
The author is an investment banker and political commentator; his Twitter handle is @pnvijay
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Posted: Thursday February 24th 2022, 02:30 IST