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Missing Pieces in India’s Real Estate Puzzle

Advocacy Consultant
Aug 10, 2017 4:30 AM 5 min read

India's Real Estate shakedown: RERA Act to stabilise

The first implementation deadline for the Real Estate (Regulation and Development) Act or RERA passed by on 31st July 2017, leaving a lot to be desired. On the due date, only 15 of 29 states notified the rules but with diluted provisions, which included lighter penalties for non-compliant developers and various exemptions sparing ongoing projects from the scope of the Act.


Many builders are yet to register on state-specific RERA websites, with most but 6 states not having a ready website in the first place. Given that sections of the real estate lobby fought tooth and nail against RERA Act’s introduction, vying instead for being ‘self-regulated’, it is safe to assume there will more dragging of feet before the Act is fully implemented at least in letter, if not in spirit.


With RERA Act, an amended Benami Property Transaction Act, Demonetisation, and GST kicking-in relays, the real estate market appears in a state of shock. While some argue that this juggernaut has wiped out demand, many industry watchers agree with the underlying intent, if not the form.


The rise and rise of India’s real estate market has been remarkable. While house prices witnessed an upward trajectory across the world, only to crash post 2008, India’s pace was relentlessly and steadily north.


According to the Lloyds TSB International Global Housing Market Review, house prices in India rose by an astonishing 284% between 2001–2011. Urban legends abound of people who quit respectable well-paying jobs to speculate in real estate and become millionaires overnight. Economists though, have long been warning of an asset bubble. Their calculations were based on a simple logic — the rental yield is a reliable measure of a property’s true value. A property with rental income of INR15,000 per month, thus yielding 1.2% on a market value of INR1.5 Cr (as common in many Indian metropolitan cities) is grossly overvalued. Even a savings account or a Fixed Deposit would yield a much higher annual return.


The rent in turn — especially in case of urban real estate — should be closely linked to the average wage growth. An increase in peoples’ incomes should result in a corresponding increase in rent, which in turn would lead to an upward movement in the valuation of the property. However, through the early 2000s, while wages and rents grew sluggishly, the underlying prices of real estate skyrocketed, in many instances showing as much as 10-fold increase in less than a decade. Without an equivalent reduction in cost of borrowing (home loan interest rates never ventured below 8.5% through the period), what was the source of funds driving this bull-run?


The answer of course is black money — India’s notorious underground economy worth thousands of billions of dollars that found refuge in the hitherto unregulated real estate sector. The racket was complete once speculators jumped in, levering up to buy properties in the hope that prices would continue rising. Builders completed this vicious circle by using collections from unfinished projects to fund future projects.


Beginning with 2010, the glut in the market became evident when demand mellowed. Builders found themselves saddled with unsold inventories running into lakhs of units — a figure that would take close to half a decade to clear. It became clear that the market lacked foundation and was effectively acting like a Ponzi scheme.


Foreign investors recognized this structural weakness and hence were hesitant in allocating capital with the same gusto as in other more formalized sectors. Even with the relaxation of FDI norms in 2005, inflows in real estate between 2000–2015 stood at a dismal $24bn i.e. 9% of total FDI in India. The red-hot growth rates being clocked for almost a decade couldn’t compensate for the perceived risk.


Black money inflows also created a disconnect between market prices of properties and the “circle rates”, the latter being the government mandated minimum price at which a property transaction can take pace. As circle rates can’t account for any undeclared sums exchanged between buyers and sellers, an element of opaqueness creeps into the market, giving the seller an upper hand.


It was against this backdrop that the RERA Act was passed in 2016. The Act for the first time created a Real Estate Regulatory Authority that required all commercial and residential developers to register with it, while also providing an appellate mechanism to provide swift redressal of consumer complaints. The Act severely curtails cash transactions in the sector thus limiting the flow of unaccounted money that was inflating valuations.


Further it took bold steps towards redressing two of the most common consumer complaints — ambiguity over area specification and inordinate project delays. Builders commonly quoted the built-up or super-built up area, instead of a usable metric such as carpet area while making a sale, which RERA has now made mandatory. RERA also pushes builders to park 70% of project receivables in a separate reserve account, to prevent them from diverting funds received from an ongoing project to fund newer projects — one of the major reasons for project delays.


International investors have taken immediate notice of these developments. The JLL Global Real Estate Transparency Index — has seen major Indian cities jump up consistently in the rankings. The biennial index saw India’s tier 1 cities jump 4 places to move to 36th spot from 40th in 2014. Cities ranked under 30 are recognized as being ‘transparent’ (the top-10 being acknowledged as highly-transparent) while those between rank 30–67 are labeled as ‘semi-transparent’. 2016 saw the second highest amount of FDI flowing in the Indian real estate sector after 2007, which was the peak of the speculative bull run.


Going forward, the outlook for Indian real estate looks positive in the medium to long term. While the housing market is certainly not going to bounce back to the absurdly high valuations it witnessed in the early 2000s, a well-regulated and transparent market is a sign of a mature economy that investors can trust. The RERA Act is a bold and much needed step in this direction but its implementation has been far from satisfactory. Industries, which see RERA as a source of disruption are pushing hard against state governments to tone down provisions at the local level. The spirit of “cooperative federalism” exhibited while implementing a harmonized GST via the GST Council needs replication within the RERA paradigm. With absolute control over governments and legislatures at the center and most states, majoritarianism can have a new agenda.