Real estate is a sector that captivates everyone, be it investors or consumers. Given that every Indian aspires to own their own home, most people generally monitor real estate as an asset class.
Off late, a spate of new launches by various real estate developers has emerged. Is this because of high consumer demand? Or are builders and developers attempting to capitalise on the positive sentiments in the real estate sector?
When you dig a little deeper, you will realise that overall real estate sales have begun to decline. A closer look at the decline in real estate sales reveals five important factors:
1. In recent months, the IT sector has seen a slowdown, with several start-ups laying off tens to hundreds of employees. Given that the IT employees sector is a major driver of real estate demand, a slowdown in the sector has impacted the real estate market.
2. On 30th March 2022, we predicted that the interest rate would rise, which invariably did by 190 basis points. The subsequent raising of interest rates has affected borrowing costs for builders and purchasing power of consumers' (EMI).
3. During the Covid months, real estate sales were poor, with inventory piling up—there was supply, but demand was minimal. As lockdown norms eased, pent-up demand helped real estate companies clear their inventory. But the pent-up demand is now over. With offices opening, the necessity to work from home has also eased. And with that, demand for larger houses has come down.
4. Many states provided concessional stamp duty to boost sales, which is no longer available. This, too, has been a contributing factor. Real estate has the most expensive transactional costs among all asset classes, including GST, stamp duty, registration, and brokerage fees.
5. Another major factor influencing real estate demand is the implementation of the RERA (Real Estate Regulation and Development Act). Buyers and developers in the unorganised sector have found it difficult to adjust to and comply with the new rules and regulations. This helped organised players, while unorganised players found it difficult to cope.
According to Anarock Capital Market Research, new unit launches in the top seven cities increased by 14% to 93,500 units in the September 2022 quarter, up from approx 82,100 units in the June 2022 quarter. The supply has been greater than the demand in the sector, resulting in a mismatch between supply and demand. We are unsure why real estate players are optimistic and rushing to launch many projects.
BSE realty index underperforms over the longer period
Another interesting market perspective is that the BSE Realty Index, which began in 2007, well before the global financial crisis, is still down by 5% as of today. So, while the overall market increased, the real estate index did not.
This clearly shows that, while real estate as an investment avenue appears promising or exciting in the short term, it does not provide meaningful returns to investors in the medium to long term.
Impact on the higher rate
Higher interest rates affect not only the consumer but also real estate players. This is because they also borrow money to build or develop a new property. As a result, the cost of construction rises.
For consumers, when it comes to EMI, there are two options: If they have already borrowed funds and taken out a housing loan, housing companies will usually need to extend the loan's term. However, that option is not available to a new home buyer. As a result, his motivation to buy or his ability to afford a house suffers. The second thing we realised is that the yield or net of post-tax is not very high in the housing real estate market.
Post-tax housing rental yield is less than two percent
Consider the value of a home at Rs. 1 crore in a pre-rate hike scenario. Assuming a rental income of Rs. 3 lakhs per year, an annual maintenance cost of Rs. 30,000, and a net annual income of Rs. 2.7 lakhs, the income tax at 30% comes to Rs. 81,000. In this case, the post-tax income comes to Rs. 1.89 lakhs and the post-tax yield is at 1.89%.
When you look at capital price appreciation in many markets over the last couple of years, it averages out to 4-6%. In other words, your annual net gain from real estate is approximately 7-8%, compared to the equity market, which yields 11-12%.
As a result, some HNI investors using this as an investment vehicle to park their real estate have started to move away from it. We believe that people will shift from physical to financial assets in the future. If that happens, the demand for real estate will continue to fall.
Today's generation is also wary of purchasing a new home. They would prefer to live on a lease because they do not know when their next job will be. They could be in Mumbai today and three years later in Bangalore, Chennai, Hyderabad, New Delhi, Gurgaon, or Kolkata. As a result, they are hesitant to invest their hard-earned money in real estate.
Keeping all these factors in mind, we believe that publicly traded real estate companies, as well as the BSE Realty Index, are likely to underperform. I made a similar prediction on March 30, 2022, and the realty companies and the realty index have continued to underperform.
Sunil Damania is the Chief Investment Officer at MarketsMojo.
Disclaimer: Sunil Damania is the Chief Investment Officer at MarketsMojo. The views, thoughts and opinions expressed in this publication are contributions in his personal capacity and do not necessarily represent the views of MarketsMojo or the management.
