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By Vivek Kaul
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What Janet Yellen’s Husband Can Tell You About Indian Real Estate
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While it takes one to do a Bharatanatyam or a Kathak or a Break Dance for that matter, it takes Two to Tango. Indian banks and housing finance companies (HFCs) have been finding this out over the last few years when it comes to housing loans.
Interest rates on housing loans have rarely been as low as they currently are. They are available for as low as 6.5% per year. They have been falling for a while now, from the double-digit levels they happened to be at until a few years back.
Why banks and HFCs love housing loans.
They are the safest form of lending. The house which has been bought using the loan is the collateral against the loan that has been taken. An individual who has purchased a house is typically looking to settle down in life and is unlikely to disappear overnight, which is possible with any other form of retail lending, from auto loans to credit card outstandings to personal loans. Hence, typically, only a small portion of housing loans tends to turn bad.
Also, if the borrower happens to miss an EMI or two, the bank or the HFC’s legal or quasi-legal system can be unleashed. This is something that is not possible when corporates default on bank loans.
Further, even if housing prices were to fall, the banks and HFCs have a cushion, which ensures that the value of the collateral they hold (i.e. the house against which the loan has been taken) continues to be worth more than the outstanding housing loan.
There are two reasons for this. One, banks and HFCs don’t finance the full price of the house. The borrowers need to make a downpayment.
Take the case of HDFC, the biggest HFC. The average loan to the housing price being financed at the loan’s origination is 69%. Two, many housing transactions have a black element built into them. Hence, housing prices need to fall dramatically for the collateral value to become lower than the value of the outstanding loan. This makes housing loans an exceptionally safe form of lending.
And finally, home loans are floating-rate loans. This allows the lenders to increase the interest rate on housing loans as soon as there is any indication of interest rates rising. Nonetheless, they are very slow to pass on any interest rate cuts to the borrowers.
So what’s the issue?
While banks and HFCs may be falling over one another to give out housing loans like vegetable and fruit vendors approaching the end of the day and wanting to get rid of the stock they had brought to the market, the trouble is that the prospective borrowers are taking it slow.
Take a look at the following table, which plots housing loans as a proportion of retail loans given out by banks.
From a peak of 53.9% as of March 2015, housing loans as a proportion of retail loans has fallen to 51.1% as of March 2021. Even as of March 2020, the proportion had fallen to 51.5%. This has happened despite the aggression of banks and HFCs through lower interest rates.
A better way of looking at this phenomenon is to look at the incremental housing loans given by banks and HFCs during a particular financial year and express that as a proportion of the gross domestic product (GDP). Let me explain this metric in detail.
In India, housing loans are given by banks as well as HFCs (like HDFC). At the end of any given financial year, there is a certain amount of housing loans outstanding. During the next financial year, new housing loans are given. At the same time, borrowers repay their housing loans by paying EMIs. When we add the outstanding housing loans as of the last financial year to the fresh housing loans given during the current financial year and subtract that from the housing loans repaid by borrowers during the year, we get the outstanding housing loans as of the end of the current financial year.
This number is then expressed as a percentage of the GDP. The idea behind this is to also take the size of the Indian economy into account, given that as the economy grows, the housing loans should also grow.
As of the year ended March 2014, the incremental housing loans to GDP ratio had stood at 1.24%. This peaked at 1.51% for the year ending March 2016. It went a little up and down after that and fell to 0.90% of the GDP as of the year ending March 2020.
There are two reasons for not considering the data for March 2021. One is that the data for housing loans given by HFCs is not currently available. This data is published in the Annual Report on Trend and Progress of Housing in India. The report for 2021 is likely to come out sometime next year. The second reason is that the pandemic was on between April 2020 and March 2021, and any data is bound to be impacted by that and won’t allow me to make the general points that I want to make.
So why have people not been borrowing despite low interest rates?
Interest rates are not the most important part of the decision to borrow. Let’s take an example to understand.
According to HDFC, the average housing loan that the company gives out is Rs 30.9 lakh. The average loan to the price of the house being financed is 69%. This means that the average price of the house being financed is around Rs 45 lakh (Rs 30.9 lakh divided by 69%). Other than this, stamp duty will have to be paid on the transaction. Further, a part of the payment may be required to be made in black and so on. So, let’s assume that the total cost of buying a home comes to around Rs 50 lakh (without getting into the money that needs to be spent to make a house a home).
For an individual to make this commitment, he first needs to make sure that he has more than Rs 19 lakh (Rs 50 lakh minus Rs 30.9 lakh) required to make a downpayment and finance other payments, over and above the housing loan. The second thing he needs to make sure of is that he can pay the monthly EMIs.
The EMI on a loan of Rs 30.9 lakh at an interest of 9% to be repaid over 20 years works out to Rs 27,595. At 6.7% (the rate currently being charged by the State Bank of India), the EMI works out to Rs 23,274 or Rs 4,321 lower.
The fall in interest rates has ensured that the EMI has fallen. Nonetheless, the more important decision remains whether the borrower can pay an EMI of Rs 23,274 every month, over a long period of time. This means that the borrowers need to have confidence in their economic future before committing to the most important financial decision they will probably make during their lifetime. And that confidence has gone missing over the last few years.
But, of course, this does not mean that the fall in EMI doesn’t matter. It does, but not as much as it is made out to be by economists, analysts, bureaucrats, the real estate industry and the politicians.
Nonetheless, there is more to the story than just this. And for that, we will have to take a slight detour.
The story of Janet Yellen’s husband
If you have been wondering where the title for this piece came from, now is the time to explain.
Janet Yellen is the current American treasury secretary (the Indian equivalent being the finance minister). Before this, she was also the chair of the US Federal Reserve (our equivalent being the governor of the Reserve Bank of India). She is the first woman to hold both these posts.
Yellen is married to a Noble Prize-winning economist George Akerlof. Akerlof wrote a paper titled The Market for “Lemons”: Quality Uncertainty and the Market Mechanism in 1970.
In this research paper, Akerlof talked about how it was difficult to sell second-hand cars due to the information asymmetry that prevailed between the seller and the buyer, which led to all used cars being considered a lemon, an American slang for a bad car.
As Akerlof put it in his research paper: “After owning a specific car… for a length of time, the car owner can form a good idea of the quality of this machine…An asymmetry in available information has developed: for the sellers now have more knowledge about the quality of a car than the buyers.”
This creates a problem. Tim Harford explains this in detail in The Undercover Economist. As he writes: “The market doesn’t work nearly as well as it should… Sellers with good cars want to hold out for a good price, but because they cannot prove that a good car is really a peach [the opposite of a lemon], they cannot get that price and prefer to keep the car for themselves. You might expect that the sellers would benefit from inside information, but in fact there are no winners: smart buyers simply don’t show up to play a rigged game.”
Basically, prospective buyers have no idea of how good or bad a used car is, and hence, they hedge themselves, and this creates problems. As Akerlof put it: “The bad cars sell at the same price as good cars since it is impossible for a buyer to tell the difference between a good and a bad car; only the seller knows.”
The main function of the market is to bring the buyer and the seller together in the most efficient way. But this breaks down in the case of the second-hand car market.
What does this mean in the case of Indian real estate?
A similar information asymmetry prevails in the Indian real estate market. Let’s take something as simple as the prevailing price of homes in any given area. How does one find that out? The information is not easily available. One can call up brokers and ask.
But brokers really don’t have an incentive of giving you the right information in most cases, given that they are likely to deal with landlords or investors in real estate on a more regular basis, than they are likely to deal with someone who wants to buy a home to stay in. Also, the prices at which deals are happening are rarely available in an easily accessible public domain, despite all the websites which have come up trying to address this problem.
In fact, there is a second-order effect of this as well. Many investors who had bought properties over the years are holding on to them in the hope of a better price. There are lakhs of locked apartments all over the country.The fact that buyers are not willing to pay the price the investors want is something that doesn’t get registered enough in the minds of investors because there is no easily accessible market price. In a well-functioning market, the market price would be easily available, published and much discussed. But, given that doesn’t happen, these investors continue to live in their la-la land.
This has led to a weird situation where there is a low demand for real estate (given the high price), and there is low supply as well (given that real estate companies and individual owners are unwilling to cut prices). I may want to buy a home, but unless I have enough money and/or the ability to borrow to do so, I am really not adding to demand. Just wanting something doesn’t mean anything.
Now let’s say you can figure out a price, then you need to figure out what exactly is the size of the house you want to buy. Tremendous confusion can prevail here as well, with multiple terms being used, though it needs to be said that over the years things have improved slightly on this front.
Many people who bought under-construction homes had no idea when will the homes finally be delivered. In many cases, homes haven’t been delivered for over a decade. There have been regular cases of builders promising to build a swimming pool and other facilities, taking money for it and then not building it.
This lack of information for the buyer ended up destroying the pre-construction financing model that Indian builders seem to have mastered. In fact, even after RERA becoming mandatory, builders are giving completion dates going well into the late 2020s.
As Nate Silver writes in The Signal and the Noise –The Art and the Science of Prediction: “In a market plagued by asymmetries of information, the quality of goods will decrease, and the market will be dominated by crooked sellers and gullible and desperate buyers.”
This is precisely how things have played out in India on the real estate front, and from the looks of it, they aren’t going to change any time soon. This is how the deep state of Indian real estate, the real estate companies, the banks and the state-level politicians, want things to be. And this is how things shall be. The real estate market will continue to stagnate.
Meanwhile, banks and HFCs can try dancing the cha cha cha. But it just doesn’t take two to tango; it takes two to cha cha cha as well.
Vivek Kaul is the author of Bad Money and was once labelled Twitter’s favourite economist. Have any feedback? Send in your bouquets and brickbats to him on Twitter.