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Thursday, December 09, 2021

The land illusion

In Delhi,Kolkata,Mumbai and Bangalore,it seems that everybody is obsessed with the value of their home. The boom in house prices over the last year...

Written by Arindam Banik |
July 27, 2009 1:15:04 am

In Delhi,Kolkata,Mumbai and Bangalore,it seems that everybody is obsessed with the value of their home. The boom in house prices over the last year may be one of the main reasons why major cities held up better than expected after the stock-market collapsed. Needless to mention,rising prices made homeowners feel wealthier and then,with the help of mortgages,they could spend their “capital gain”. House prices have never risen so fast in real (inflation-adjusted) terms in India’s major cities. During the past four years (2005-2009),they increased at 25-30 per cent per annum.

The combination of record low interest rates and a loss of faith in equities encouraged a group of people to view homes not just as a place to live,but also as an easy way to make money — either through buy-to-let or by buying a bigger home than they need,and then trading down when they retire. But buy-to-let has become less profitable; rents in major cities now barely cover interest payments. Thus earning profits from capital gains is the best alternative.

This may be impossible to sustain — the very essence of a bubble. Homeowners are buying on the expectation of capital gains,ignoring the link between house prices and rents. Studying that link reveals home prices are significantly overvalued in India. In Delhi,Mumbai and Bangalore,the ratio of average house price to rents or income is around 35 per cent above its long-term average.

So are home prices overvalued? Low interest rates,some argue,justify higher home prices. But this year interest rates are low largely because inflation is low. Initial interest payments are smaller,but because inflation is low the real burden of debt won’t be eroded quickly; in later years mortgage payments will absorb a much bigger slice of a borrowers’ income than when inflation was higher,so buying a home is not really cheaper over the whole life of a mortgage.

Others expect a continual rise: land supply is limited,and the number of households growing. But if population growth is pushing up prices,rents would rise too. Instead,in some places they have been flat or falling. Could it be pushed by demand at all? Lower interest rates encouraged only some people to buy — those that banks thought a good credit risk. But the vast majority of the population in major cities still struggle to own his/her apna ghar because they have no credit rating. And house prices tend to be sticky downwards,because sellers prefer to stay put rather than accept a lower price.

After all,the housing market is hardly truly competitive in India. Consider Delhi. There were two routes to solving the housing problem: first,the DDA route — building flats and then selling them with attached conditions; second,the society route — allocating land to cooperative societies which would build flats and (theoretically) give them to “members”. Neither worked,partly because of rent-seeking. A fictitious society could get land; the flats built on that land are allocated to “society members”. Then,every alternate month,the allotees are shown defaulters. Thus the same flat is soon available in the market — dominated by financiers,property dealers and other intermediaries. They mostly control the supply-side,suggesting an oligopolistic market. If there are any unseen cartels in India,this is one of them. Government monitoring is largely ineffective.

So housing transactions in these “routes” appear to be valued at two levels: formal and informal. The apparent transaction may be for 30 per cent of the actual value,to evade capital gains tax,with the remaining 70 per cent in cash.

In the Budget it has been proposed that duties be extracted from both sellers and buyers.

Yet,there is little sign that the government is serious about this. If there is an incentive here to hide the actual value,the first step is to establish why it is so; only then is sensible prescription possible. Otherwise this will create confusion and corruption. There might be several ways in which the government could monitor the market; and if there is a cartel-like situation,it could attempt to break that up.

The fear is that some of the value of property ownership in India’s major cities is subject to illusion now — especially among those that buy-to-live. Unfortunately,there is little sign that the government has the appetite to resolve it.

The writer is a professor at the International Management Institute,Delhi

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