June 22, 2017 12:00 pm JST
Ritesh Kumar Singh

Developer clampdown needed to revive Indian housing market

Unethical practices and focus on premium sector underlie housing slowdown

Rampant unethical practices lie behind the slowdown in Indian real estate. © Reuters

Despite huge unmet demand for housing and moderate mortgage interest rates, the Indian property market is facing a serious slowdown. The crux of the problem is that India's property developers employ highly unethical, and in many cases illegal, practices to jack up prices. Since Indian courts can take years to settle civil cases, potential buyers feel they have no effective recourse and are discouraged from entering the market. Until the industry is properly regulated, it will continue to be sluggish. Other dependent sectors, including building materials and banking, will also feel the chill.

India's property sector has been plagued with fly-by-night operators. To regulate the industry and to protect the rights of homebuyers, New Delhi passed legislation on real estate regulation that became operational on May 1. But the act allows each Indian state to appoint its own regulator and to tweak the rules framed by the central government. State governments, including those controlled by the ruling Bharatiya Janata Party, have watered down key provisions, allowing property developers to continue doing business in the same ways and to escape accountability to homebuyers. Political parties benefit hugely from funding by property companies and are keen to protect those relationships.

Despite an estimated shortage of 25 million homes, the combined sales of residential properties in India's eight biggest urban areas, including Bangalore, Chennai, Mumbai, and New Delhi and the national capital region, contracted 5% year-on-year to 61,214 units in the quarter to March, according to Liases Foras, a real estate rating and research company. At the end of March, the number of unsold homes in these eight areas stood at 471,855 units. Property experts say the backlog will take up to three years to clear.

This is a serious mismatch of demand and supply. Buyers are looking for budget homes, but real estate companies are marketing high-priced premium apartments that offer them better returns on investment. Affordable homes offer developers margins of 15-20%, compared with 30-50% for premium apartments. Until the property companies can be reined in, potential buyers will be put off.

Among the illegal practices that developers employ is artificially restricting supply. For example, for properties bought off-plan, developers hold the deeds until completion, illegally imposing hefty transfer charges to discourage buyers from selling on these properties until their own inventory is offloaded. Typical contracts stipulate that buyers pay interest rates of 15-18% per annum for any delay in paying installments.

However, these same contracts often impose fines of just 5 to 10 rupees (8 to 16 cents) per square foot (0.09 sq. meters) per month on developers if they cause any delay. In most cases, developers do not have to pay penalties because there is no recourse for buyers, given that Indian courts take 10 to 20 years to decide on civil cases. This is not a small issue: 1,879 real estate projects started in the eight biggest urban areas between 2009 and 2012 were delayed by three years or more.

It is also common for developers to manipulate the ratio of the so-called "super built up" size to the "carpet" size of an apartment even after an initial agreement has been signed, and to demand more money. The "super built up size" refers to the total size of the apartment including common facilities such as stairs, lifts, play grounds, community halls, gyms and swimming pools, while the "carpet" size reflects usable living space. 

Government regulations are also skewed against buyers, including registration fees and stamp duties. This makes prices unaffordable for many. For example, Mumbai's stamp duty of 5% compares with 0.05% in Beijing.

Relative prices

India's rent-to-price ratio, an indicator that compares the cost of buying or renting accommodation, stands at about 2 -- an extreme level implying that prices are very high compared with rents. In such a scenario, the cost of buying must fall significantly to boost demand, either through a cut in asking prices or a fall in mortgage interest rates, currently about 8.5%. Otherwise, prospective homebuyers will continue to sit on their hands.

On the investment side, the strengthening of the rupee against the U.S. dollar has dried up demand from nonresident Indians who want to keep a foot on the local property ladder. A slowdown in India's IT sector and resultant job cuts is also dampening the property demand in cities such as Bangalore, Noida and Pune.

If that was not enough, the last federal budget announced a cap on the tax-free allowance on mortgages at 200,000 rupees, irrespective of the number of houses owned, from April 1, 2017. That will further discourage property investment.

Realty companies have been lobbying hard for lower interest rates to encourage a rise in demand.  The Reserve Bank of India has reduced benchmark interest rates by 200 basis points since January 2015, but that has not helped. On June 14, the RBI held rates steady at 6.25%, despite government calls for a further reduction.

Real estate companies have tried various marketing gimmicks to spur demand, including the sale of so-called "compact" homes, which are smaller and hence cheaper, celebrity endorsements and mortgage subsidies. None has worked. However, the government could try to reduce prices by increasing supply. For example, regulations could allow higher density apartment blocks, older buildings could be demolished and replaced by taller towers, and registration fees and stamp duties could be reduced. Cutting capital gains tax could also help, especially in relation to investment buyers.

Meanwhile, regulation of rampantly unethical business practices under the recent legislation will help. But the buyer-friendly provisions of the act, which could have enforced accountability on builders and real estate companies, have been deeply diluted. State governments show no urgency in creating the infrastructure needed to establish housing regulators, and those states that have so far framed their rules have seriously diluted the intentions of the central government legislation.

Yet implementing the act in letter and spirit is the minimum that state governments need to do if they are serious about reviving realty demand. Otherwise, the demand slowdown is likely to continue for some time, with adverse implications for economic growth and employment. 

Ritesh Kumar Singh is a corporate economist in Mumbai and a former assistant director of the Finance Commission of India.

 

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