Real Estate headed north? Or is it a feeling?

Real estate is going North?
Good news has been swirling around all the markets lately. GDP numbers, employment numbers, real estate numbers are all being flaunted at you saying: “Ha the recession is over”.
However if you are a Chartered Accountant by training and have been in consulting, being skeptical comes easy. Once upon a time one Life insurance company gave me very rosy figures about their claims settled ratio. In fact it was too impressive. Even the time taken to settle on an average was stunning. So I spoke to somebody in operations to find out the truth behind the numerator and denominator (ratios hide too much!). Sadly it included pension plans too!! Removing some of these jokers made the number look far less impressive. Thus I have normally been careful whom to ask about what. Like Warren Buffet says “Do not ask a barber whether you need a haircut”.
Sales of new U.S. homes surged 9.6% in July. A week before, the National Association of Realtors reported that previously-owned home sales in July jumped at the fastest rate in 10 years.
Impressed? Well best thing to do is take an excel sheet and draw a graph. You will see that sales have risen for four consecutive months. Thanks to low interest rates and government incentives, they tell us, prices will soon be heading back up. I am still skeptical. I do not still believe in the US ‘revival’ story. So I probed a little more (thank you Google, I love you!). I asked a few Indian friends in the real estate business in reputed companies and companies with horrible reputation. Asking them  whether prices were likely to head higher was like asking a fund manager whether it is a good money to invest in HIS fund! Come on, his bonus depended on the AUM!
The answer was a foregone conclusion.
In many ways, this is understandable. Brokers need transactions. Those transactions are less likely to happen if potential buyers think prices will fall. So there is a strong tendency to put a positive spin on things. At least in equities you can ‘buy’ put options. In real estate it has to be a ‘buy’ side story.
Sorry but let me give you some more facts from the USA.
Only 36% of all real estate sales in recent months involved “non-distressed” properties. The negative way of saying this is “64% of the sales flaunted to you is actually ‘distressed’ sales! This with Obama converting all the gree wood to greenback!
Of these non-distressed properties, only 31% were “unforced or optional.”
OOPS I got my numbers wrong! 70% (read again 70%) of the sales were FORCED! If I were a sales guy, I would hush up the figures, not flaunt it.

Let us put things in perspective. If 70% of people in a shop are coming in to buy because there is a gun on their head, it does not say much for ‘customer satisfaction’ right?
That is a figure you like to hide, is it not?
Ok it gets worse. The Mortgage Bankers Association said that the number of homeowners behind on their mortgage payments is pretty high. More than one in eight homeowners are delinquent or are in the foreclosure process! That means sales will go up for sure, but the prices are likely to head South, not North.  With all my efforts I could not find what percentage of home owners owe more than the actual worth of their houses. However frankly in certain geographies in the USA prices have fallen as much as 50%! That should be mouth watering even to skeptics like me. However I hate averages especially when it comes to a mass of data. One builder in a Mumbai suburb made me an offer at 50% of his peak contracted price – that is attractive. Averages numb me, so will not comment on the American situation.
Ok that is in the USA. What about India?
In the Indian conditions withdrawal of tax benefits by the Direct Tax code will perhaps act as a dampener. Bankers too have sobered. Many of my friends who bought with 99% financing are getting calls from their bankers more frequently – and interest is not being reset – to make them pay faster! Sober bankers (remember they were also 22 pegs high!) tougher credit standards, higher interest rates (discounted rates are only for loans up to Rs. 20 L)  and big down payments are set to hit the high end of the market. Add in the death of home-trading, new tax regime, shrinking bonuses, and people questioning ‘God does not make it anymore’ philosophy, I think prices are headed South here also. Rents are still a very small fraction of the cost of the house. In a Mumbai suburb where you can buy a house for Rs. 55 lakhs (read EMI Rs. 55,000 a month for 20 years) can be rented for Rs. 8000 a month. (20 year cash flow for buying is Rs. 1.32 crores + maintenance + tax + term insurance risk cover costs) and for renting is less than Rs. 20 lakhs. Of course ignoring taxation and inflation! Obviously something is wrong and may not remain so for a long time. Till then have fun.

However if you take a trading outlook – there are many opportunities – available. Do a deal close to the cost of construction + cost of land. Go with a good builder, enter the project at the start – and be the ‘early bird’. Leverage sensibly. On a salary of Rs. 30 lakhs – it is all right to borrow Rs. 30 lakhs and buy a flat for Rs. 35 lakhs. Complete the payment in a maximum of 30 months – your borrowing should be for say 5 years. Hopefully because you are starting at the prices could double in 3-4 years. If you get money at 12% and your property appreciates @ 20% p.a. – the whole deal is attractive FROM AN NETWORTH accretion angle – even if not from an equity vs. real estate angle!

Like always “Save in a house, invest in equities”.

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One Response to “Real Estate headed north? Or is it a feeling?”

  1. You and I will keep telling our ‘clients’ (we feel good advising them, they listen when it is convenient! :-D) ad nauseum that real estate is not for investment but for consumption (self-use) but the holy trinity of rapacious builders, slippery brokers and gullible buyers will keep at it till they get gob-smacked and learn a bitter lesson!

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