Enough evidence points to an emerging real estate bubble about to burst

Since 2010, there has been a severe credit squeeze in the market accompanied by haunting inflation for the third year running, eroding real incomes. Yet, real estate prices in most of India’s urban and semi-urban regions continue to climb up. Logically, unavailability of credit should have translated into shrinking margins for realtors. But the larger real estate firms, which have declared their first quarter results, have actually shown operating margins in excess of 40 per cent. Take Shobha for instance, a listed real estate company that has seen an increase in average price realisation of 26 per cent in the first quarter, on a year-on-year basis. So what really is triggering this real estate boom? Are there buyers at inflated prices, as the recent market rush seems to suggest, despite the prevailing high interest rates. The only difference is that these buyers are not entirely credit funded and are not impacted by price increases or credit squeeze. That brings us to the fact that real estate is a sector for parking funds. The OECD has an exhaustive handbook on the subject that describes how front-enders buy real estate on behalf of their patrons, funded through loans. On the face of it, this appears to be a legitimate transaction. How many of the loans advanced by housing finance companies are front-ended? There are reasons to believe that this is the case for a substantial quantum of the loans advanced by the financiers. At least, there is evidence pointing in that direction. Right now, banks have tight loan-to-value ratios, prescribing the quantum of funds that they can advance on the value of asset. At present, the average ratio that banks and housing finance companies are expected to maintain is 80 per cent. But public sector banks insist on a ratio of 60 per cent. This means 40 per cent of the funds have to be brought in by the homebuyer upfront. With prices upwards of Rs 3,000 per square foot in tier-II cities, a buyer would have to typically cough up Rs 10. 8 lakh as margin money for a 900-square-foot apartment, while incurring equated monthly instalments (EMIs) of Rs 23,000 for at least 10 years. Strangely, realtors claim that most growth has been in categories where prices are upwards of Rs 30 lakh. Given the pressure on household incomes for the past two years, in the wake of soaring food prices and school expenses, very few people can afford such high level of expenses. That itself is clear signal that the current real estate boom is either a bubble or a vehicle for money laundering.

Source: wrd.mydigitalfc.com