As you pass through a beautiful museum at an airport on the way to your flight, you would stop to admire the sculptures, the paintings, the wall art and murals that make for such compelling beauty and atmosphere. But a former Airports Authority head once stopped me midway in my appreciation of this wonder to burst the beauty bubble. When project costs are mapped closely, art is a great way to inflate costs. Who knows how to value art, he said succinctly. Then it is a matter of connecting dots to figure out what he really said. The cost of expensive infrastructure is paid by the users finally in different ways. One way is the “user development” fees, which ranges from a few hundred to a few thousand over the past years. The latest rates are here.
We know intuitively that we pay for corruption in many ways, but the cost of graft in anything linked to real estate has the potential to cost not just a few hundred rupees to those who have the capacity to afford a flight, but far more. The worst hit is the roof-over-the-head-seeking homeowner who gets priced out of the market or thrown to distant suburbs with poor amenities. The story of residential real estate can be summed up in three words: stuffed or starving. In the premium segment, there is an oversupply, and in the affordable housing segment, there is a demand overhang estimated to be about 10 million units in 2019 and a supply overhang of about 13 million units in the premium and luxury market. What people want they don’t build. What they build, people don’t want. The key to the story is the price.
Why is real estate so expensive in India? For what it costs to buy a flat in a tight by-lane of Mumbai that takes the luxury car 30 minutes to navigate the mess just outside the gilded gates, you can buy a town house in London or a spiffy apartment in Manhattan. How do we know it is expensive? The yields (annual rent divided by market price) are between 1% and 2%. Mature market rules of thumb look at buy at 10% and sell at 5% yield. Read this old piece for more on valuations.
To see why real estate is so grossly overpriced in India, we need to look at the way this asset has been used by the system to garner undue wealth. The story starts at the release of land for residential purposes by the state. When the land use rules change, there is usually a small group of insiders who get to know in advance (or trigger the change in laws) and buy up the land at throwaway prices. An exponential price escalation begins the moment the land use is changed. Once the builders come in to bid for the land, the next round of machinations and circle of graft begins. Once the developer get the land, a feeding frenzy starts with court cases to stop the project. The builder has to pay off the noise makers or wait for the glacial judiciary till he runs out of money. He has borrowed money and is sitting on a running meter—he needs to build and sell fast. The next round of feeding happens with those who hold the stamps of approval for the many clearances a project needs. The builder, politician (or families of politicians) and babu triangle gouges enough out of the project that unless the builder prices it at a certain rate, he won’t make money. One World Economic Forum estimate puts the cost of graft in real estate at 10-30% globally (read here). This number is likely to be much higher in India—closer to 50%.
If you ever thought why it took till 2016 for a real estate regulator to be born, and why four years later, it remains stillborn, you just have to look at the loot possible in this asset’s sale, development and resale to find the answer. Without political will there will be very little change on ground in affordable housing in India. Prices have finally begun to fall after more than a decade of flat prices as the holding power of the builders and investors begin to wane. But real estate needs the sort of political will that the Aadhaar-PAN link drive has seen for a major price crash that the valuations say must still happen.
I happened to read financial analyst Vishal Khandelwal’s 2012 blog (read here), in which he said: “Economics tells me that realty prices should go down, but politics (which has always had a heavy hand in India) tells me that this is not going to happen. I see India’s real estate to remain a massively corrupt industry. This coupled with the ever-rising demand will keep this industry in a bubble… always waiting to pop!” It was true then. It is true today.