10 things you need to know about Indian real estate in the aftermath of coronavirus

The negative economic impact of the coronavirus crisis is now gradually coming to the fore. One of the areas likely to be badly impacted because of the crisis will be real estate.

Let’s take a look at this pointwise.

1) As India is under a lockdown, people are only able to buy things which they need for their everyday survival, like food, medicines, milk, etc. This means that what economists call “discretionary spending” — everything from homes to cars to two-wheelers to mobile phones to TVs to ACs to washing machines — isn’t happening. Currently, even if people want to, there is no way they can buy these things.

Even after the lockdown ends, people are likely to conserve cash and stay away from discretionary consumption. Job losses along with salary cuts, postponement of the date of joining of new employees, as well as a freeze in fresh hiring are going to badly impact real estate demand.

As per Anarock Property Consultants, home sales are likely to fall by 25-35 percent in 2020 in comparison to 2019. In fact, housing sales have been slowing down anyway. According to Anarock, home sales in the top seven cities during January to March 2020 stood at 45,200 units, down 42 percent from the same period in 2019.

Of course, some of this fall can be attributed to the negative economic impact of the fear of the spread of Covid-19. But given that awareness of this came around only in the second half of March, it is safe to say that housing sales were slowing down anyway.

This basically tells us that the Indian economy was slowing down even before the virus struck. Things will continue to be along similar lines between April to June 2020, if not get worse. Once we take this into account, then a fall of 25-35 percent in home sales in 2020 seems to be a tad optimistic.

2) The current lockdown is supposed to last until April 14. Nevertheless, suggestions have been made that it might be extended across parts of the country which have been highly impacted by the Covid-19 outbreak. Given India’s fairly weak public health infrastructure, the possibility of something like this happening is very high. This will impact home sales even more.

Also, as Adhidev Chattopadhyay of ICICI Securities suggests, “residential real estate typically being a ‘touch and feel’ high ticket purchase, any extended spell of social distancing” due to coronavirus may have a further impact on home sales.

3) The fall in share prices is not going to help. In the past, when the stock market has done well, investors have booked profits and invested that money in real estate. Many people like the idea of owning something which they can see, touch and feel. This has also had a role in ensuring a steady demand for residential real estate or homes over the years.

Of course, with a rapid slowdown in demand, there is bound to be some impact on home prices. We will deal with that towards the end of the piece.

4) Anarock estimates that around 15.62 lakh units, launched between 2013 and 2019 across the top seven Indian cities, are still being built. A bulk of these units are located in the National Capital Region and the Mumbai Metropolitan Region (8.9 lakh to be precise). With the lockdown that is currently on, the real estate supply chains that ensured a regular supply of construction material supply have broken down. Even after the lockdown ends, it will take time for the supply chains to be put back into place.

Hence, there is going to be a delay in buyers getting possession of new homes. Anarock estimates that the “construction delays might run up to several months for well-funded projects, while for others, the delays may even be to the tune of a couple of years.”

Also, as Chattopadhyay of ICICI Securities points out: “Real estate projects rely on a number of imported items such as glass, marble, MEP (mechanical, electrical and plumbing) works and other finishes. With global supply chains seeing disruption owing to COVID19, construction is likely to get delayed.”

This is clearly not good news for those who were hoping to move into their new homes soon. This means they will have to continue paying rents as well as EMIs, in case they took on a home loan to finance the purchase. The impact of this delay will be even greater. As Chattopadhyay puts it: “With RERA mandating developers to deliver projects in a specified time frame, any significant delays may lead to further litigations.”

Over and above this, whatever limited trust between builders and buyers is remaining will further break down. This isn’t good news for the real estate sector as a whole. This will mean only those builders who can afford to first build homes, and then sell them, are likely to survive in the days to come. To some extent, this is already happening. Builders who raise money from prospective buyers by launching new projects are already having a tough time, given that people don’t want to buy under-construction properties.

5) As home sales will slow down, there is bound to be an impact on cash flows of real estate companies. That being the case, their ability to continue repaying the loans they have taken on is likely to get impacted. The total bank lending to commercial real estate stands at Rs 2.29 lakh crore. Over and above this, banks have lent Rs 7.03 lakh crore to non-banking finance companies (NBFCs), which have in turn lent a significant portion of that money to real estate companies.

Arvind Subramanian and Josh Felman, in a working paper titled India’s Great Slowdown: What Happened? What’s the Way Out?, write: “The bulk of formal sector real estate funding was provided by banks, but in recent years most of the incremental lending has come from NBFCs, so much so that by 2018-19, NBFCs accounted for about half of the Rs 5 lakh crore in real estate loans outstanding. This funding was provided on the assumption that developers would be able to complete their projects, sell off their inventories, and then repay.”

The larger point here being that the overall bank lending to real estate companies is much more than Rs 2.29 lakh crore, just that not all real estate loans are categorised as real estate loans. As real estate companies get into trouble, they will find it difficult to repay these loans, meaning some trouble for banks. Chattopadhyay believes: “This may in turn have a cascading effect wherein highly leveraged developers are unable to service loans”.

6) Other than lending to real estate companies, banks also lend to people buying homes. The total amount of money lent by banks towards home loans stands at around Rs 13.3 lakh crore. In fact, in recent years, home loans have been one of the fastest growing loans for banks. As of March 2018, they formed around 12.7 percent of the overall bank loans. By February 2020, this had jumped to 14.9 percent.

Over and above banks giving out home loans, housing finance companies give out home loans as well. They form around one-third of the home loan market.

As more and more people lose their jobs in the months to come, home loan defaults are likely to go up.

But even with that, banks and housing finance companies are well placed. The loan to value ratio (total value of home loan divided by the market price of the home being bought using the loan) in case of HDFC is 70 percent. This means that if the market price of the house is Rs 100, HDFC loans out only up to Rs 70, on an average. In case of public sector banks, this ratio is even lower.

There is another factor that needs to be taken into account here. Many home sales in India have a black portion, which doesn’t get factored into the official price. This means that the real loan to value ratio is even lower. Hence, the bank or the housing finance company can easily repossess the home on which the loan has been defaulted on and sell it. This will also drive down home prices given that banks and home finance companies will be more interested in recovering their outstanding loan than sell at a profit.

Also, people will try their best to repay a home loan before defaulting on it. All in all, while the banks and housing finance companies are likely to see more defaults, they should be able to handle it.

7) Real estate employs the maximum number of people in the country after agriculture. In fact, there is huge disguised unemployment in agriculture. Disguised unemployment essentially means that there are way too many people trying to make a living out of agriculture than is economically feasible. On the face of it, they seem employed. Nevertheless, their employment is not wholly productive, given that agricultural production would not suffer even if some of these employed people stopped working.

The history of economic development shows us that the excess workforce in agriculture gradually moves away from agriculture, after low-skilled jobs are created primarily in the real estate and the construction sector.

As a report authored by Anarock Property Consultants points out: “The sector creates tremendous opportunities for the skilled and unskilled workforce. It has also been instrumental in employing large masses of migratory populations that come to the metropolitan cities in search of work. As per industry estimates, 90 percent of the workforce employed in [the] real estate and construction sector is engaged in the construction of buildings, while the rest ten percent is involved in building completion, finishing, electrical, plumbing, other installation services, demolition and site preparation. Over 80 percent of the employment in real estate and construction constitutes of minimally skilled workforce.”

With home sales expected to slow down big time in the months to come, the construction of new homes will slow down as well. This means that real estate employment is bound to come down. In fact, KPMG estimates a job loss of around 30 percent in the sector. This clearly isn’t good news for India’s massive demographic dividend (basically, nearly the million youth who are entering the workforce every month).

8) The construction of homes has linkages to 250 other industries. As Keith Wardrip, Laura Williams, and Suzanne Hague write in a research paper titled The Role of Affordable Housing in Creating Jobs and Stimulating Local Economic Development: A Review of the Literature:

“During the construction of affordable housing — or any kind of housing, for that matter — the local economy benefits directly from the funds spent on materials, labour, and the like. If the builder is purchasing windows and doors from a local supplier, the supplier may have to spend money on materials and hire additional help to complete the order – examples of indirect effects. Finally, the construction workers, glass cutters and landscapers are likely to spend a portion of their wages at the local grocery store or shopping mall, which illustrates induced effects.”

A slowdown in real estate will impact everything from steel companies to cement companies to furniture makers to banks. In fact, given that the real estate sector has been rather moribund for the last few years, this was already happening. It will be further accentuated now and will work negatively for the overall economy.

9) Up until now, I haven’t addressed the elephant in the room: Will real estate prices fall? Will they fall to an extent where real estate becomes affordable for a significant part of the population?

This is not an easy question to answer.

As per PropTiger.com, nine prime residential markets have an unsold inventory of nearly 7.75 lakh homes. This is worth around Rs 6 lakh crore. In the world of theoretical economics, in order to clear this inventory, builders would have cut home prices up to a level where they became attractive for buyers, buyers bought homes, and the inventory was cleared.

But that hasn’t really happened in this case up until now.

One reason for this lies in the fact that a massive amount of black money has been invested in the sector over the years, giving builders the time and ability to hold on to the price. Also, as Subramanian and Felman point out in their working paper, “while developers could in principle tempt buyers into the market by reducing prices, they couldn’t do this in practice because lower prices would have destroyed the (notional) value of the collateral that they had pledged in order to secure their lending.”

Hence, prices have fallen in different parts of the country, but they haven’t fallen to a level where the unsold inventory of the builders could have been cleared.

The question is, will builders cut prices now? Yes, they will have to, because the fall in sales will be unprecedented and they will have to cut prices to generate some amount of cash.

Having said that, the collateral point will come up again. Also, the government will get involved. If too many builders default on loans, banks, which are already in trouble, will get into more trouble. So, there is likely to be a relaxation in the non-performing asset (NPA) norms, giving some time to real estate companies to hang on to the price, and giving more time to the bank to recognise a defaulted loan as a defaulted loan.

Over and above this, there is also some possibility of a bailout of the real estate sector, given its importance when it comes to employment as well as state of mind.

If the real estate sector has to actually revive, then people need to start buying homes. And that will only happen once homes are reasonably priced. For that to happen, builders need to cut prices majorly. In the process, many builders are likely to go bust and a few banks are likely to get into major trouble as well. Given this, the government will try to push this can down the road.

My sense is home prices will fall by around 10-15 percent on an average in the aftermath of the coronavirus crisis. Any fall over that will take time.

10) And finally, real estate as a mode of investment has been dead for a while and it will continue to be dead in the years to come. That is a given. If you want to buy a home to live in and have the money to make a down-payment and have the regular income to pay the EMI, please go ahead and buy a home. But if you already own a home, then there is no point in buying another one for the sake of investment.

What stood true between 2002 and 2012 doesn’t work anymore because the times, they are a changin’.