Why The Indian Real Estate Market Will Not Appreciate Any Longer?

The Indian real estate market has given one of the best returns for any investment class worldwide. However, these returns were only given in a particular period. The two decades from 1995 to 2015 was the time when literally everybody made money from real estate investments.

However, since 2015, the market has been stagnant. There have been rumors that the prices have even fallen in some micro markets.

Every day newspapers carry stories which bring hopes of the revival of the real estate sector. However, the fact of the matter is that these stories are actually hidden advertisements. They want the reader to believe that the real estate boom is once again around the corner.

In reality, this is not the case at all. When we look at the facts more closely, it becomes evident that the real estate boom was a once in a lifetime market. It would be a miracle if the market could simply sustain its current price level. Hoping for more appreciation might be a little bit too optimistic considering the current market conditions.

Let’s have a look at why the Indian real estate market is unlikely to grow any further.

Wrong Investor Expectations

The Indian investors have heard fables about their neighbors and uncles becoming millionaires because of a piece of land that they had invested in.

Stories of 20x price appreciation in 20 years are very common. When stated in these terms, the price appreciation appears to be phenomenal. However, the facts are slightly different.

A 20x appreciation over 20 years works out to a compounded annual growth rate of about 16%. This is nothing earth-shattering, and a lot of investment classes provide such returns.

The average Indian has been paying an interest rate of about 10% on their home loan during this period. Hence, in real terms, the appreciation has been around 6% per annum only! The real reason why some of the uncles and neighbors became millionaires is that of the illiquidity of real estate as an asset class. If they had brought shares instead of real estate, they would have exited the investment as soon as they saw some appreciation.

However, since real estate was illiquid and also since people tend to have an emotional attachment to their homes, these people continued to stay invested and hence have reaped the appreciation over a 20 year period.

The above-mentioned points explained what has happened in the past. Indian investors have borrowed at 10% and earned 16% return. However, in the future, this may not be the case. The 10% interest rate is likely to increase whereas the 16% return is likely to come close to zero!

Housing Finance Boom

Every economist knows that when too much money starts chasing too few goods, the result is price inflation. This is exactly what has happened in the Indian housing market. Prior to 1990’s the housing market was cash based. This meant that the concept of housing loan was completely unheard of.

The only way to buy a house was to pay in cash. The only way people could buy a house was by dipping into their retirement savings or if they received an inheritance. This is the reason why the prices were lower since very few people had that big chunk of cash to pay at one go.

During the 1990’s, HDFC bank became the first company to introduce housing finance to the Indian market. This was when borrowed money started entering into the market. Since people did not have to save upfront to buy a house, the market size was increased. The typical homebuyer was now younger and willing to spend more because they had access to borrowed money. This is the reason why prices went upwards.

It needs to be understood that this was a fundamental change that has already happened. Now, the market is fully exposed to the concept of housing finance. Hence, it is unlikely that another flood of borrowed money will make it to the Indian housing market.

Entry of Multinationals

Prior to the 1990’s, India was a closed economy. During the 1990’s India adopted globalization. This allowed companies from all over the world to enter India. This turned out to be a boom for the Indian jobs market.

Since the graduates were being rapidly absorbed in the workforce at high salaries, they started buying houses as well. These youngsters with high paying jobs were the customers that started borrowing money to buy homes. This was when the perception of real estate changed from a stable investment to an investment that promised to give fabulous returns in very short periods of time.

Once again, the multinational companies are already in India. There is no second way of multinationals coming. Even if they do, the prices are so high that the working class has simply been priced out of the market. Hence, what has happened in the past is unlikely to happen in the future.

Low-Interest Rates: Fortunately for the Indian real estate industry, the period between 1995 and 2015 also coincided with falling interest rates.

Prior to 1995, the average bank used to loan out money at 16% per annum. However, this changed since the Reserve Bank of India followed global trends and reduced the interest rates.

These reduced rates also encouraged more borrowing exerting an upward force on the prices. The current era is completely different. Interest rates are likely to rise all across the world. Hence, thinking about using borrowed money to invest in real estate will not really be a wise decision.

To sum it up, a lot of fundamental changes happened in the two decades when the real estate prices grew. Since these changes are unlikely to happen again, it is unlikely that the Indian real estate sector will ever see such sustained growth in the near future.