The government last month announced the withdrawal of Rs 500 and Rs 1,000 currency notes. In a country where the real estate sector is highly unorganised, with large components of cash transactions, the implications are manifold.
Nature of the real estate sector in India
The real estate sector in India has forward and backward linkages with as many as 265 industries. After agriculture, it is the single largest employer of illiterate labour, seasonal workers, women and unskilled workers and also supplements agricultural income. The contribution which real estate makes to the economy is therefore very significant. Yet, unfortunately, while all other sectors of the economy have mostly migrated to modern high-end technology and corporate good governance practices, the real estate still largely remains unorganised.
This poor state of organisation is at all levels of the industry; production, technology, transactions, financing and government interface.
Primary and secondary markets
The real estate market in India can be visualised broadly in terms of the primary and the secondary market. The primary market comprises of the supply of new properties produced by real estate developers and released into the market. The secondary market comprises of second and subsequent sales. It is believed that the volume of capital exchange in the secondary market is much more than that of the primary market. Sadly, it is in the secondary market that ‘black money’ i.e. unaccounted money is exchanged to a substantial extent.
Implications of demonetisation
As per the Central notification of November 8, Rs 500 and Rs 1,000 currency notes are no longer legal tenders. The implications of this decision are:
Flushing out of black money: Those who had intentions of investing in the real estate sector now can’t transact. This means a reduction in the business for sellers and brokers, at least for quite some time to come.
Slowdown of ongoing projects: With a squeeze in the cash available, workers are not being paid and construction works have come to a standstill.
Reduction in speculation: The general slowdown in the market and economy as a whole on the one hand and the reduction, if not complete elimination of black money from the system, would lead to a reduction in the speculative investors in the market.
Decline in prices: For some time to come, maybe a year, prices would be at their lowest.
Increased liquidity in the banking sector: Banks are flush with funds now and would be under a pressure to lend and this offload would happen more in the retail lending sector to home buyers and not so much in wholesale lending to developers.
In the long run, demonetisation is good for the industry to get streamlined, more transparent and credit worthy. However, many more steps are required and demonetisation is just the beginning and a good one at that.
Full implementation of RERA: The full effect of demonetisation can be actualised only if the state governments enact the Real Estate Regulation and Development Acts in their states, notify rules there under, create the authorities and tribunals and start functioning.
Without this, the danger is that the consumer would continue to be in the red.
Cashless property registrations: In order that property transactions become cashless, it should be made mandatory for all property transactions to be effected either by cheque or by electronic transfer. Further, to completely avoid cash dealings, the highest denomination currency note in India should be only Rs 100 so that it would be physically difficult for people to do large scale cash transactions. Further, cheque payments and e-transfers for property transactions could also be given discounts in stamp duty.
Safety measures for electronic transactions: While electronic / digital payments are being promoted, safety and security needs to be tightened so that the hard earned money of the citizens is not siphoned off by hackers and other such elements.
Realistic circle rates: Circle rates in many instances are not regularly updated and this makes it difficult for transactions as also encourages cash component transaction. Therefore, it is necessary that circle rates are periodically updated based on market circumstances so that they reflect the real market situation. This would lead to a reduction in understatement of sale considerations and consequent cash transactions.
Reduction in real estate transaction costs: One of the major reasons for understatement of sale considerations is the unrealistic stamp duties. With high stamp duties, the transaction costs become very high and the tendency is to circumvent. Stamp duties need to be drastically reduced. In the US, the stamp duties on property registrations range from 0.5 per cent to 0.8 per cent. In India, they are in the range of 6 per cent to 14 per cent.
Legislation for streamlining real estate brokerage business: Unfortunately, the Real Estate (Regulation and Development) Act, 2016, only covers the primary market and the entire secondary market for real estate is completely left untouched. This is a major gap which needs to be filled up. Secondary sales transactions are carried out by real estate brokers and a major portion of dealings happen in cash. With no entry/exit barriers, anybody can become a real estate broker in India and dabble in huge cash dealings.
This has to be streamlined urgently. The National Association of Realtors (NAR) of the US is a classic example of reform and on the same lines, NAR-INDIA has also been set up. This needs to be encouraged to streamline the business.
Making FDI happen: With transparency achieved, foreign investors would be more open to invest in Indian real estate. However, for FDI to happen, a series of hurdles at the local level need to be removed. Under the ‘ease of doing business’, a small attempt has been made.
However, this is just the tip of the iceberg. Corruption at the level of local bodies needs to be tackled on an urgent basis, or else black money generation would start again.
Inclusion of small investors through REITs: In a more transparent system, the industry would become more credit worthy and small investors can also start looking at real estate as a credible asset class to safely invest for good returns. This is another area where many restrictions need to be removed so as to make it happen. REITs needs to be top on the agenda of the government.
The menace of black money has been bothering the country right from the initial days of Independence. Way back in the 1950s, Professor Kaldor made estimates of black money in the economy. Later, in the 1960s, the Wanchoo Committee also worked out estimates of black money in the economy. Later, in the 1970s, the National Institute of Public Finance and Policy (NIPFP) also worked out that tax evaded income as a percentage of the GDP was around 20 per cent. NIPFP also estimated that for FY75-76, the concealed income at Rs 3,741 crore was mostly due to the fact that properties were bought and sold partly in white and black money. Present estimates are many times more. The White Paper on Black Money of Ministry of Finance 2012 discussed in-depth the issues on the subject. A recent estimate by R Vaidyanathan puts the estimate of black money at a whopping Rs. 70 lakh crore.
Decades ago, it was well known that black money and real estate are intrinsically interrelated and intertwined. Successive governments did precious little for containing black money. However, the present government has brought the debate once again to centrestage and has actually started acting. This is a welcome step. Added to this is the ‘Digital India’, RERA and Benami Transactions legislation and other measures which, seen together, form an umbrella of initiatives to take the country towards a cleaner, professional, ethical and global environment to development and prosperity.