The landmark move by the Modi government to demonetise high value currency notes to stamp out black money will have a far-reaching impact on the capital-intensive Indian real estate sector, where almost one-third of all transactions still involve unaccounted (aka ‘black’) money. Though initially this bold move of the government is most likely to hit the sentiment of a real estate market already reeling under recession badly in the short-term, the sector is most likely to reap good benefits from the greater transparency ushered in by the governments socalled ‘surgical-strike’ against the parallel economy and black money in the medium to long-term. An outlook.
The Indian government, in the last couple of years, has initiated a number of key reforms in the real estate sector – the ‘Real Estate Regulation Act (RERA)’, the ‘GST,’ the ‘REITs’, the ‘Benami Transactions (Prohibition) Amedment Act, 2016,’ etc., apart from the ushering in of various reforms related to Foreign Direct Investment; all of them with the one primary objective of bringing in a high degree of transparency in dealings. Enthused by this slew of ongoing reforms, many foreign investors are already betting big on the Indian real estate sector. In a recent development, global private equity player ‘Xander’ has formed a joint venture with the Dutch Pension Fund Manager ‘APG Asset Management,’ to deploy a sumptuous US$ 1 billion into real estate in India. Much to the relief of our cash-strapped and debt-ridden real estate developers in the country, institutional financing will also come with lesser risk weightage going forward from here.
It is understood that the impact of the government's crackdown on the parallel economy and unaccounted cash will be felt all the more in the real estate sector, as the consumption trends for such ‘black’ money has been high and of significant value in the real estate sector until now. A cash component of 20-30 percent in property transactions has more or less been a norm till recently, largely due to the difference between collectorate rates and the market rates of property. This has often been even higher in land transactions and property transactions in smaller cities. At the initial stage of any real estate project, it is land purchase that has the highest component – 40 percent or more – of unaccounted money. Also, payments by investors who put money into housing and construction projects at the pre-launch or early-launch stages have been found to have a considerable cash component. Cash transactions are also prevalent for building material purchases and payments made to construction workers. While most if not all secondary market transactions essentially involve cash payouts, in primary markets, however, the cash involvement is more often than not absent, especially in residential real estate – as home purchases are usually financed through mortgages. In the ‘affordable homes’ segment, xcash payments are totally non-existent as the the ticket sizes are too small to even consider cash payments. Contrarily though, the cash component is relatively high in high-end housing. It is also been noticed that developers do tend to offer offer price discounts even in in primary sales, if some part of property value is being paid to them in cash.
Now that the government is earnestly cracking down on black money, the cash component in property transactions will invariably go down significantly. The end-result of this will manifest as a drop in land prices, with most if not all land deals seeing a substantial dip. It is worthwhile noting that developers are already avoiding outright purchase of land for new projects, and instead going in for joint development agreements with land owners. They are also finding it difficult to monetize their land bank to cut down debt obligations. Debt-ridden developers will, in the short-term, face cash-flow issues. And given the currently prevalent high inventory and cash crunch scenario, they may well have to resort to price-cutting to push up sales, much to the delight of potential property buyers. Speculative and inflated pricing will take a solid beating in the secondary or pre-owned properties segment, especially in markets that thrive on speculative investments. This too will benefit home-buyers as interest rates are already showing a downtrend – with an 1.5 percentage point plunge in the last one to one-and-a-half years. Going forward, with currency demonetisation further improving the liquidity of banks, further interest rate cuts are most likely, which will indeed serve well to make homes more affordable. We can expect a boost to home sales, which have so far seen a 15 percent hike across top 8 cities in Q2 FY17. Once RERA (the Real Estate Regulation Act) becomes operational and home buyers get protection of their investment, sales will further pick up, especially the affordable housing segment, adding much heft to the government's mission of ‘Housing for All by 2021’.
Not merely top cities, but also the tier 2 and 3 cities, where the government is focusing on 'Housing for All' and ‘Smart City’ projects, are expected to gain. Many big organised players have of late shown interet in entering these cities, from their platforms of corporate social responsibility (CSR). Some of these cities which offer good job opportunities (especially in IT) and have good physical and social infrastructure are already on the radar of many domestic and global funds. Demonetisation will further boost investors confidence in the long run. And since corruption and approvals bottlenecks are major factors responsible for price inflation, demonetisation coupled with the government's next big reform move to introduce single-window clearance systems, will make property eminently affordable for masses. And not withstanding initial setbacks as the sector reorganises itself, real estate will be transformed into a more efficient, evolved, corporatised, fair and transparent asset class, well on its way on a long-term sustainable growth path.