Case of elusive price declines2 min read . Updated: 14 Aug 2012, 01:03 AM IST
Case of elusive price declines
Case of elusive price declines
Analyst reports about piling real estate inventory, translating into increased supply of homes, often give hope. Usually, high inventory symbolizes falling demand, destruction in value, higher cost of retention, thereby leading to a fall in a logical profit-seeking marketplace. However, when spoken in the parlance of real estate, a lot of these often accepted interpretations of inventory fall asunder.
Real estate carries a unique advantage of being a store house of value and an effective inflation hedge. Large industries, small and medium enterprises and individuals alike often tend to carry real estate in their books as a means of wealth preservation and value appreciation, albeit as an effective hedge against inflation. In a country like India, plagued with haphazard urban development and a situation of demand outstripping supply with no signs of the same getting addressed in the medium-term future, real estate takes a very different hue. It is only fair to believe that even a developer holds a rational view like any other investor, albeit with an advantage of being a creator and thereby a trader as well. To understand when a developer becomes an investor in his own stock, it is imperative to understand the economics that drives a real estate project.
In terms of proportionate allocations as a function of selling price, construction cost for the project or in other words his target for pre-sales to make his project self-sustaining ranges from about 50% in a city like Bangalore or Pune to less than 25% in a city like Mumbai. Needless to say, the lower the percentage of pre-sale required to complete a project, the lesser is the need and thereby the propensity of the developer to sell at the same price. From this point on, the tendency to hold on to prices or inadvertently increase prices is higher among developers as it serves a dual purpose of high profit realization and for the unsold inventory, to higher value accretion.
At this juncture, unsold inventory in real estate, therefore, can take on markings of store house of value, asset building for future appreciation, alternative source of revenue generation by means of rental, a relatively long lasting commodity which more often than not gets scarcer and rarer with time as cities grow. There could be exceptions where the developer may have over-leveraged, over-traded or is over-exposed in his books and thereby needs to dispose his jewels to sustain his business.
Clearly, the incentive to hold on to the inventory is higher in cities such as Mumbai, where land is scarce and, therefore, the option for redeployment with the ability to generate similar returns lower.
Finally, inventory pile-up in real estate often does not result in price decrease and instead fuels a virtuous cycle of maintaining higher prices which over time becomes the norm, benefiting the developer who hangs on to prices and the investor who if unleveraged is happier sitting on his portfolio than churning it.
Jasmeet Chhabra is chief investment officer, Indiareit Fund Advisors Pvt. Ltd.
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