As five states in India go to the polls in February and early March, it marks the first public litmus test for Prime Minister Narendra Modi's government and its move last November to remove 500- and 1,000-rupee notes in a bid to crack down on corruption.
The bold step meant that, overnight, up to 86% of the country's bank notes were unusable. We've seen the reports and pictures of long queues outside Indian banks as people rushed to get their old notes deposited and receive new ones. The country was shaken by the abruptness and confusion of the process.
The demonetization announcement similarly caught the real estate industry off guard. It hit the secondary resale market in particular, as it is traditionally one with significant cash transactions. Cash makes up about 30-40% of the total sale value, and it is not unusual to see hard currency take up 50% or more in the luxury market. According to JLL estimates, sales in the secondary resale market have fallen by at least 30% for the last three months.
The primary sales markets in second- and third-tier Indian cities have felt the crunch as well, since informal sources of capital are no longer available for smaller developers. But major Indian cities remain mostly resilient to the effect of demonetization as the market is underpinned by credible, big developers.
Short-term pain, long-term gain
However, demonetization's pain points should not detract from the larger promise of reforms for the country.
As we talk to investors and occupiers, many are already discussing the upsides for the real estate industry. The curb on cash means greater transparency as more transactions will occur through proper banking channels. This will give India a boost globally as it moves toward a more transparent market. Private equity funds and institutional investors are more likely to invest in cities with transparent real estate markets. In fact, 75% of global real estate investment is in the top-10 most transparent markets, according to our latest Global Real Estate Transparency Index. Currently, India's tier-one and tier-two cities are ranked in the 30s, but on a clear upward trajectory.
Demonetization and the passing last year of the Real Estate Regulation and Development Act, or RERA, are part of greater structural change for the benefit of homebuyers, correcting the trust deficit between buyers and developers as only responsible developers can adhere to RERA's measures.
With greater regulation and a real impetus behind the cleanup, consolidation activity will pick up. Smaller developers will get weeded out or enter into joint ventures and joint developments. Companies facing liquidity issues might also end up selling their land to competitors. We've already seen that happening with big players like Godrej Properties and the Tata group launching joint projects with local developers.
Post-demonetization, Indian banks have also lowered interest rates. In early January this year, State Bank of India announced it was cutting its one-year marginal cost of the lending rate from 8.9% to 8%, while its home loans rates were slashed from 9.1% to 8.6% with several other lenders following suit. As home loans become more affordable and readily available, they make it easier for the Indian middle class to buy a home.
The bigger picture
India's bold demonetization policy was quickly pushed through just before Modi reached his midterm mark on Nov. 26, 2016. In the course of his 2.5 years at the helm, things have certainly looked up for the real estate business, with increased participation by institutional investors, greater transparency and inflation under control.
As a follow-up to demonetization, the implementation of the Goods and Service Tax to be rolled out in April, which includes tax on land and other immovable properties, will further support the development of the real estate industry. As these changes occur, we expect to see increasing participation by international investors. In particular, Fosun International, a Chinese conglomerate, has revealed plans to invest up to $1 billion in India, while developers such as Dalian Wanda Group and China Fortune Land Development are working with state governments to set a base for large-scale development.
Policies like demonetization and the GST are not silver bullets for India's real estate industry. It will take time to fix some of the systemic issues, but these efforts show the positive direction that the industry is heading toward.
Anthony Couse is the Asia Pacific CEO at JLL.