Rupee depreciation and NRI investors in Indian Real estate

Dubai is known as one of the best real estate investment hubs in the world. In 2012, real estate prices in Dubai witnessed a 10% y-o-y growth rate, as per Dubai Land Development (DLD) authority’s data. Also, the real estate transactions increased by 8% to AED 154 million during this period. Interestingly, Non-resident Indians (NRIs) are among the top 5 investors in the Middle East. We can be sure that any NRI would be more inclined towards investing in his mother country, more so if he is also assured of higher returns. But the question is, how is higher returns assured.

Well, a simple answer is that no one can give you that assurity. But numbers do speak in favor of the same. Post the Global recession, Indian prices have witnessed a significant increase in property values averaging 40-42 % across all major markets as per the database of Real estate intelligence services, Jones Long Lasalle. Refer to the chart (figure 1) given below. 

Source: Real Estate Intelligence Services, Jones Long LaSalle, India

As we can see, Mumbai witnessed a price increase of 66% during the same period. But there has been a 65% slump in the real estate market value in Dubai in the four year period before 2012.

To top it all and to make real estate investment in India more lucrative for NRI investors, the rupee value has depreciated by 12% against dollar between May and June. So what? How this rupee depreciation means more profit for NRI investors in Indian real estate market? 

Let’s do a simple maths here.

Currently 1 AED is pegged at 16.60 INR. Let say a Dubai based NRI invests 10 million AED into the Indian real estate market now. Let us assume conservative 15% returns from the Indian Real Estate markets. The investor could expect a repatriated returns of 27% (15% of returns from the Indian Real estate market and 12% of currency appreciation) assuming that Rupee returns to its pre-May mean of 14.8/AED.

As we can see, merely the returns of 12% expected from exchange rate fluctuation is comparable to 10-12% of total returns expected on investments in Dubai according to the reports of DLD.        

It seems like I have painted a very rosy picture for investments in India. Now let’s play a devil’s role here. There may be no guarantee for an investor booking an under construction property that he will continue to enjoy the benefits of depreciated rupee during the payment period. It could also be argued that the political scenario is real bad in the country. There is no stability as far as the government is concerned. As a result, there is no surety of when the laws may change depending on the whims and fancies of different political parties in power. Moreover, Dubai has a world class infrastructure to top it all.

Though I am hoping that with the establishment of Real Estate Regulatory and Development Authority, there would be a better transparency and maturity into the Indian Real estate sector that has been so far unregulated.

Despite these facts the challenge still remains as far as identifying the right property is concerned. 

Is price correction imminent in Indian Real estate?

My uncle, who is a well-to-do businessman just shifted to Mumbai. He wanted to purchase a house of his own. But as fate had it, after doing a lot of research he realized that it was impossible for him to afford a house in proper Mumbai. Rather, he can only afford something in the outskirts. Today it has become impossible for even an upper income group family to own a 2 BHK flat without taking a loan and putting pressure on his future in the form of EMI. It seems like there is no end to this ever increasing prices.

Though, I believe that price correction in real estate is inevitable. I have my own reasons.

Reason 1: Top real estate companies such as DLF, IndiaBulls, Oberoi and Prestige are trading far below their Jan 2009 prices when realty index was at its peak. Companies are in desperate state to trigger sales-volume recovery and generate cash flows. Companies also want to do away with rising unsold inventory.

Reason 2: The prices have risen to such an extent that it has become difficult for people to own a house. The market has become investor driven where prices keep on increasing just because of change of hands of the property at mutually determined rates. Lack of affordability leads to low demand.

Reason 3: Until the government relaxes the CRR and the repo rates, there is no reason to believe that there would be any relaxation with respect to the mortgage rates. With the election closing in and the pressure due to inflation, this relaxation in monetary policies seems highly unlikely.   

Reason 4: With decreasing GDP and rising corruption, investments and growth in companies are considerably low. As a result, salaries have not appreciated at the same pace as the real estate price appreciation. The buying power has reduced considerably.

Though all reasons aside, it might be noticed that the prices of the properties newly launched may be held strong by the developers. But secondary market prices should depreciate. And the after effects of the secondary market will definitely show in the prices of primary market in times to come. In fact, developers in Mumbai have already started offering 20:80 subvention schemes to generate sales. Research has shown that these subvention schemes account for 10% to 12% discount of the acquisition costs.

I assume that post this price correction will be the best time for home buyers to go bargain hunting. Though, it is advised that they do a proper due-diligence before making a purchase. 

My uncle should feel happy after reading this article. He might just be able to afford his dream home. :)  

Commissions charged by Real estate agents, is it worth it?

I am sure all of us have had the experience of searching for a rented flat or for buying a house. One of the major costs incurred in the process is the brokerage charged by real estate agents which is a month rent for a rented flat or a 2-3% in case of a flat purchase. There is no denying the fact that this cost hurts more than anything. Middle men have never been accepted well in the society and it is an endeavor of all companies to do away the middle men who unnecessary increase costs for consumers.

Moreover, we know that according to a simple concept of demand and supply, whenever there is a good supply in the number of brokers, the competition should increase and brokerage charged should decline. But we don’t see that happening even though we find increasing number of brokers in every gully of our city. I think the reason is that these brokers are very dependent on each other and the brokerage charged has to be shared between the brokers involved while renting out a flat or making a sale.

If a flat is sold for 50 lakhs, the broker charges 2% from the buyer as well as the seller. Do you think this income of 2 lakhs is justified in a country where per capita yearly income is just about INR 70,000. And for what?? For handling few legal papers!! Instead it makes sense for both buyers and sellers to get in touch directly so that both of them can benefit in the process.   

Can we as customers do away with this brokerage?                                                 

https://www.facebook.com/groups/flatsandflatmates/ is a good initiative wherein people who want rented flats can directly contact those who is looking for them. No brokerage involved. More such initiatives are needed so that we can do away with the unnecessary costs involved.

Moreover I feel that the disadvantages of hiring a broker are far more than the advantages of hiring them. Brokers do have knowledge of the locality which is not visible to naked eye. Also, they can tell you about the options which you may not find online (that’s rare though now-a-days). But 2-3% commission seems a lot for the service they offer. As the commission depends on the transaction value, the broker can inflate the selling price of the house/rent rather than providing you a discount. More often than not he may conceal certain information like some defects in the house or some hidden costs until you are intelligent enough to ask all the questions.

Weighing the pros and cons of hiring a broker, it seems well in our favor not to hire one. Today one can checkout realty portals and approach sellers directly. This way both sellers and buyers save money on the brokerage. 

Comparing real estate market and the stock market

Stock market is the true indicator of financial health of the country. BSE realty index was launched in 2007 and consisted of 11 real estate scrips which represented almost 95% of the capitalization of real estate companies in Sensex. Today, Realty index is at 1442 and Sensex is at 20000. This is in stark contrast to January 2008, when Sensex was at 21000 and BSE realty index was at 13400. While the Sensex is down 5% from its peak, the realty index is down by a staggering 90%!!  

It is important to understand the risk as well as the opportunities when opting for an investment opportunity. Investment required in stock markets is very less as compared to real estate. More often than not one has to depend on home loans. EMI eats into the future lifestyle of the family. Profit margin in stocks has always been substantially higher than any other asset class. Stock market investments offer advantages such as liquidity and flexibility, which real estate does not. Stocks also offer the growth rates that the real estate can rarely match. It is also easier to track stock prices which are centrally controlled. Real estate change hands in a very non-transparent manner and often common man gets duped in the process.

Nevertheless, real estate is a tangible asset that any man aspires to possess. It provides a sense of security and satisfaction to any family. Also as discussed in previous post, capital appreciation as well as rental income provides gains to the owner. Unlike stocks which is less predictable as evidenced by various ‘Black Mondays’ and ‘Black Fridays’ on which the Sensex tanked by about 10% on a single day, such occurrence is unheard of in real estate.

Useful Read: Should I invest in Indian real estate?

I am not saying that real estate prices do not fall, but a steep decline of 10% on one day is unheard of. Ever wondered why? The basic reason that I could come up with is because an owner finds it hard to switch houses whether prices rise or fall, may be due to emotional attachment he has with his house, or due to the costs and paperwork involved, also may be due to other ties with locality such as children’s school, relatives, friends etc. Even if the value of a home drops, the chances of homeowner leaving his house and shifting to another one are negligible. (Though the same do not hold true for those who buy houses entirely for investment purpose.)

Owning a house should be more about settling down and homemaking and less of an investment asset when you are new to this asset class and you have less knowledge of how the market is performing. But does that not hold true for all asset classes!! Knowledge is GOD, either u have it or you know where to find it! 

Should I invest in Indian real estate?

Leave apart the poor or lower middle class. Even for the upper middle class today, it is not about the dream home but dreaming about a home. Property prices across India have increased tremendously to the tune of 400%+ between 2003 and 2008. We tend to purchase house assuming that in the next five years, property would again give us the same return i.e. a CAGR of 32%. Let’s see when it makes sense to buy a property.

There are two ways owners make money through property, capital growth in property prices as well as the rental income he gets when he rents out the property.

In addition to these incomes, one should be aware of a number of necessary costs. Mortgage, Insurance premium, Replacing fixtures and fittings, Maintenance, Ground rent and service charges (If the property is leasehold), Empty periods are the major costs involved.

Once you have deducted these costs from total income, you have the true or net rental yield. So if net rental income is Rs. 2 lakhs and the property cost is Rs. 60 lakhs, the rental yield is simply 2 lakhs divided by 60 lakhs i.e. 3.33%. The “house price to rent ratio” in this case works out to be 30. Generally, this ratio should be below 20 else the cost of owning is considered higher than cost of renting. Once you do the maths, you may find that the net rental income is less than the cost of your mortgage, leaving you with a shortfall. Even by investing in fixed deposits, you may get around 9% per annum. Though no ratio can be blindly applied, this is a good point to start with.

Home loan EMI as a part of your income (i.e. debt to income ratio) should be within 35% of your income. Teaser loan rates at lower EMIs in initial years would do more harm than good.

However if you have made a well-researched investment, you should also get a good capital appreciation over time. It’s strange to watch that real estate prices never come down but markets simply become illiquid. No transaction happens but still the price on paper remains high. It’s always wise to buy a property that provides you with a good rental income as well as appreciate in capital value over time. But that’s the real challenge, isn’t it!! J   

What is FSI and fungible FSI?

FSI stands for Floor Space Index. It is the ratio of permissible built-up area to the land size. For example, if the total plot area is 1000 sq ft and if FSI granted is 2, then one can construct total for 1000*2 = 2000 sq. ft. of floor space in total. If your developer is constructing more than this, then either it’s illegal or he needs special permission from authorities.

The maximum a developer can construct over and above the permissible FSI is 35% of the flat area. This additional area that the buyer has purchased is also legal. This additional space that the buyer has purchased is called Fungible FSI.

Under the new DCR (Development Control Regulations), areas for balcony, flower beds, terraces, voids, niches would be counted in the FSI. To compensate for this loss in FSI the government has allowed compensatory fungible FSI of upto 35% for Residential developments and 20% for Industrial & Commercial developments. This can be used either for carpet area or for balcony etc.  This fungible FSI will be available at 60%, 80% and 100% of ready reckoner rates for residential, commercial and industrial developments respectively.

So whenever you go to their site office and ask for the details, insist that they talk in terms of carpet area. Price quoted on carpet area is more genuine as the developer cannot dupe you then.