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Earlier, having a house was a dream that took years to fulfil and needed a lifetime’s savings and loans from relatives and friends. Things have changed a lot with the advent of home loans. But not only are people buying houses sooner in their lives, home loans are also fuelling the appetite for hoarding real estate. The concept of real estate has transformed from just being a place to live to an asset class of choice.

The average Indian’s love for real estate is well known, and why not? In some pockets, real estate and land have delivered above average returns relative to most asset classes. However, due to lack of regulatory control, the sector has also become a favourite investment avenue for many with undisclosed income sources. Along with gold, the real estate sector has played an ancillary role as a vault of illicit wealth in the country. But the emerging trend speaks a different story—real estate may be losing its attractiveness and giving way to financial assets.

This change in trend is being driven primarily by:

• Positive real interest rates after a long period of financial repression

• The central government coming down heavily on black money. The latest in this is the proposed Undisclosed Foreign Income and Assets (Imposition of Tax) Bill, also known as the black money Act, which recommends classifying offence as non-compoundable, and up to 10 years imprisonment, thereby placing ownership of foreign illicit assets at par with criminal offence

• Elevated ownership of properties in the past few years

The historical distribution of household savings between physical and financial assets has been more or less equal. However, 2008 onwards, households increasingly allocated a higher portion of their savings to physical assets (real estate and gold) resulting in financial savings shrinking to half of physical savings. The future may be different. With inflation under control and real interest rates being positive, the returns from real estate sector are now showing signs of fatigue, which could push investors out of the sector and in to financial assets.

Positive real rates are important to incentivize investments in financial assets, but this alone cannot channel incremental household savings into financial assets; it is the thriving black money fuelled real estate market which needs to be curbed.

The strict stance of the new government has the potential to disrupt a well-oiled black money ecosystem and curb such transactions in real estate. It will also trigger movement of household savings into financial assets, thereby making cheaper capital available to the private sector, apart from lower tax burden and lowering inflation.

Measures and products such as Jan Dhan Yojana, direct transfer of benefits, strict rules on black money and others may lead to:

• Reduced leakage from government expenditures

• Reduced use of cash in deals and transactions

• Tracking of funds movement by routing transactions through the banking system

• Rules and regulations to deal with violations

India is in a strange position: It has more houses than households. According to Census 2011 data, while the number of urban households has gone up from 187 million in 2001 to 247 million in 2011 (an increase of 60 million), the number of houses has gone up more—from 250 million to 331 million (a difference of 81 million). This means there are 21 million more houses than households. Clearly, a large portion of the incremental investments in real estate was made by investors rather than by households to actually live in these houses. Arun Kumar, professor at the Jawaharlal Nehru University, and an expert on India’s black economy, estimates more than half of the economy to be illicit, split equally between consumption and savings, and a large portion of this savings invested in real estate and gold. The simple explanation for this is that many apartments will be bought and resold, and the cycle will repeat itself, but nobody ever needs to live there. And in this way, they become a parking lot for illicit money.

The pinch of slowing demand for real estate is already being felt by developers who are turning to discounts and even freebies to attract buyers. With fewer buyers, developers are faced with inventory pile up. Apartment inventory in National Capital Region, Mumbai and Bengaluru has been building up to reach the highest levels, according to data by Liases Foras, a Mumbai-based real estate rating and research firm. In Mumbai alone, the estimated unsold inventory could take five years to clear at the current rate of sales, and with the projects in pipeline, this number could reach closer to a decade to clear.

The various steps being taken to curb flow of black money are in the right direction. If the resolve remains strong, we might be standing at the cusp of an inflection point where households’ skewed investment portfolio could be incrementally favoured towards financial assets. But how things progress for the real estate sector will have a role to play in this. Realty is in for a double whammy. Not only will positive real rates gradually lead to channelling of incremental household savings to financial assets, clamp down on unreported income will further reduce the attractiveness of investing in real estate.

The message is clear: Given the emerging scenarios, financial assets such as mutual funds, insurance and banking products are positioned to yield better returns than physical assets such as real estate. And for those waiting to fulfil their dream of owning a ghar, the good times may not be too far away.

Ritesh Jain is chief investment officer, Tata Asset Management Co. Ltd.

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