Monday, November 9, 2009

Indian Real Estate - a bubble?

This is my first post on investment other than equities. I am living in Pune and for the last two years, I feel the real estate prices in and around Pune are inching stratosphere. The prices in the area I live in were quoting around INR 3000 per square feet in 2006. A 2-BHK (two Bed-room, one Hall and one Kitchen) flat cost INR 3 million + parking space of INR 0.15 million + MSEB charges of INR 0.075 million. The total cost of buying the flat would be INR 3.225 million. On top of that there are 1% registration charges and 5% stamp duty making the total outgo at INR 3.4185 million. Consider the cost of basic amenities mentioned below in the table:

AmenityCost (INR)
6 Fans6500
14 Lights2000
2 Geyser8000

This and other costs would add another 0.1 million to the cost and the flat would cost INR 3.5 million without any furniture.

Now come to present and the price have moved up to INR 4000 per square feet. The total cost of making a 1000 square feet flat livable comes to around INR 4.6 million.

The average income of a salaried employee across various industries with age of around 35 years (the average age at which an Indian male buys a residence) can be about 0.8 million (just estimate, no official source of this figure available). This makes property prices out of reach of a common man with ratio of property to income at 5.75. Looking at some charts at CR, we can see that in US, it went above 5 and created a bubble during 2006-2008.

Even the rent is not able to justify the price. The rent in the area is around INR 15K per month yielding 180K per year. The rent to price or rental yield is 3.91% and after taxing at the highest slab, it comes to just 3% 2.61%. This is justified provided the interest rate remains at the levels they are right now. A one year fixed deposit provides around 6.5% but after the taxes of highest slab, it comes down to around 5% 4.35%.

All this calculation does not mention about the expenses incurred on maintaining a property. Monthly society maintenance is around INR 1.5K. The property taxes are around INR 6K. And I assume there will be other expenses, like painting every few years, internal maintenance of the flat etc... adding to a total of INR 30K per year. Thus the actual income from rent is not INR 180K but just 150K, which makes the rental yield goes down to around 3.26% and just 2.5% 2.18% after taxes if you count it in the highest tax slab.

Consider the counterexample of a flat in 2002-2003, which was selling for INR 1200 per square feet in the same area. The total cost with all the charges was just around INR 1.5 million. The rent at that time was around INR 75K yielding 5% before tax and 3.85% 3.35% after tax, this compares with the 3.91% and 3% 2.61% respectively that we calculated above. The only difference at that time was that the fixed deposits were earning anywhere around 9-11% per year.

The consequences of the burst of this bubble will be really bad.
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Mahesh said...

I did a similar analysis as I was thinking of investing in real estate. Your are dead correct in your analysis.

Problem is real estate market in India is not an open market, you have not idea of volume and price at which transactions take place.

Individual investors are unlikely to sell at prices lower than what they have bought, so there is huge unoccupied inventory. In the area where I live if you go for around in most posh localities at around 7 pm you realize that most houses are not occupied.

I personally know many people who have made down payments and are still to get occupation due to finance problems or the project is stuck due to litigation.

Expect a lot of properties to get auctioned in next year after RBI starts raising interest rates and installments could become unaffordable especially due to lower disposable income, courtesy rising inflation.

abhishek said...

I agree but,
In India Most of the property market in Governed by BLACK Money, Except few mammoth builder appreciate deal in white money.

I personally know few people, who bough 50 Lakh properties like anything. Lot of Black money is involved, So price are stable, if not rising.

Thats is one reason WHY property price will not go below certain level (may be ~20%) even if there is bubble burst

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