Investing In Indian Real Estate…Don’t Do It…

the-crazy-mind-boggling-indian-real-estate-bubble

An April 29, 2016 update with some anecdotal evidence to the originally published, Sept 29, 2012 write-up. Even with that, our message remains the same. Stay away…

Dramatic fall in Mumbai real estate prices is great news for the festive season. The average costs of apartments in Mumbai are falling and there may even be a dip of as much as 25% if this trend continues.“, Realty Times, December 1, 2015.

Launch prices of housing projects drop by 20% in key cities.“, Livemint, January 4, 2016.

Gurgaon housing price down by 25% in 2015, sales still down.“, Economic Times, January 7, 2016.

Chennai realty market sees 20 percent fall.“, Deccan Chronicle, February 23, 2016.

Back to the original write-up…

The key word here is investing. This does not apply to buying real estate intended to improve the quality of life for your extended family back home and even then, there are much better and safer options like for instance…RENTING.  NRI’s or non-resident Indians have a history of sending their savings back to India and snapping up real estate for investment purpose. And why not? The real-estate sector in India has been on fire over the past decade with no apparent signs of a slowdown. But caution is warranted as property valuations are so out of whack that no amount of math even comes close to adding up. A few reasons why…

1. Prices have lost touch with reality – and the best barometer of that is the rental yield one can extract out of renting their “investment” property. In a country where banks routinely offer 10% yield on a fixed-deposit (savings) account, rental yields have remained pathetically low – in the 1-2% range. The expectation then is that the difference will be patched up by the appreciation in the value of the underlying real estate but that just can’t happen over the very long-term. At some point, that gap has to be bridged by either the prices coming down or the rents going up. The latter can happen but the endless supply of new homes will keep a lid on that for a long, long time. So until then, stay away.

2. And why would anyone not take the guaranteed return of a bank account over speculating in investment real estate? Because a majority of the capital flowing into this sector is unaccounted for or to put it another way, has never been taxed. And this black money cannot be deposited in bank accounts or invested in the capital markets with virtually most of it finding its way into real estate. And you, Mr. and Mrs. NRI, with your official, taxes-paid dollars are already starting out 30% behind the eight ball as compared to someone coming in with unaccounted for cash.  This huge underground economy is the primary reason for a seemingly perpetual upward bias on real estate prices in India. With the financial system in India expected to become more and more transparent with time through digitization and other initiatives, this endless supply of black money will diminish, adding another layer of a dampener on real estate prices in India.

3. Corruption is rampant in India – this is not a revelation but it has a major impact on real estate prices. Since most bribes are transacted in cash, real estate sector ends up absorbing most of that cash. Read a story about a peon caught with a net worth way beyond what he justly could have accumulated and you uncover millions and millions of rupees worth of “investment” real estate.  The rate and scale of bribes exchanged over the past decade has increased manifold due to significant liquidity injections by the domestic and global central banks with a lot of that liquidity eventually being soaked up by the Indian real estate. But as awareness grows and as the populace gets more and more informed, this rate of corruption will come down and so will the capital needed to fuel the value of that real estate.

4. Weak to non-existing property rights – generating rental income from investment real-estate has its own issues. Rent your place out and everything seems alright until your tenant decides not to pay the rent or vacate the property. What can you do? You file a case against the tenant for breach of contract in the excruciatingly slow and inefficient Indian legal system and pray. You might never get the property back or if you do, it might take years or decades for the actual enforcement of the contract. Connections with politicians and unscrupulous elements of society come in handy in such situations and most times are a necessity if you want to invest in Indian real estate. If you are not connected, stay away.

Where will real-estate go from here? Worst-case scenario would be that prices collapse by 25% to 30% and take years to recover. Best case scenario is that prices stay flat for a decade. If that happens and with Indian inflation at about 10%, the value of that investment could go down by 60% in real, inflation adjusted rupees. And this is discounting the impact of India’s record-high current account deficit on the exchange rate between your home currency and the rupee.

If you believe in the India growth story and you have official, taxes-paid dollars to invest, participating in the Indian capital markets is a much safer bet than any other investment in India. At least the starting line is the same between you and your fellow investors.

Be careful and as always, Happy Investing.

Image credit – MirianaL, Flickr