Business Today
Developers pin hope on lower interest rates to boost real estate demand
Interest rate is one of the important factors that one looks at while buying a home as loan equated monthly instalments (EMI) depend on that.
Developers pin hope on lower interest rates to boost real estate demand

Developers pin hope on lower interest rates to boost real estate demand

The 25 basis points (bps) cut in the repo rate by the Reserve Bank of India (RBI) this January has brought hope to real estate companies, which are struggling with poor sales and rising inventory. Experts are predicting more rate cuts this year.

(Update: RBI surprises for second time, cuts repo rate by 25 bps)*

STEADY GROWTH

"We expect the RBI to deliver one more 25 bps cut in the repo rate in the April policy and then leave it unchanged at 7.50% because we do not expect further sustained disinflation (rather, we expect CPI inflation to stabilise in the 5-5.5% range in 2015-16). We expect gradual pick-up in real GDP (gross domestic product) growth, which should result in gradual narrowing of the output gap," says Nomura. CPI is consumer price index.

"We think this is a temporary pause. Further rate cuts are likely in April, although we maintain that the space for them is limited (50-75 bps over 2015-16)," says Dipen Shah, head, Private Client Group Research, Kotak Securities. Along with rate cuts, revised GDP numbers, which show that the economy has been growing faster than expected, have raised hope among real estate companies that the sales slowdown may end sooner than imagined. As per a Standard Chartered report, "India's revised GDP series indicates that the economy has recovered rapidly in the past two years. Sharp fall in inflation rather than improvement in volume growth likely led to the spike. We revise our 2015-16 GDP growth forecast from 6.3% to 7.7%." Faster GDP growth and declining interest rates will help real estate companies generate more sales. But is the 25 bps cut enough? We try to find the answer.

REALTY CHECK

Sale

Sale slump


Situation is dire in the country's nine biggest real estate markets-Mumbai (including Navi Mumbai & Thane), Pune, Noida (including Greater Noida & Yamuna Expressway), Gurgaon (including Bhiwadi, Dharuhera & Sohna), Bengaluru, Chennai, Hyderabad, Kolkata and Ahmedabad. Sales in these cities fell 37% in 2014 from the previous year, according to the annual report of proptiger.com, while prices rose in the range of 0-6%. The real rate of return (return minus consumer price inflation) was negative (see Price Trends).

These cities had unsold inventory of 5,51,033 units in the fourth quarter of 2014, says the report. Although this is lower than the 6,23,031 units in the first quarter of 2013, the reason for the fall is the sharp drop in new supply and not rise in sales.

New supply fell 52% between these periods. In 2014, new supply in these cities was 2,59,660 units; the figure in 2013 was 5,43,511 units. It is the new supply that has come to the market over the past few years that has remained unsold.

Citywise

Citywise break-up


"At present, only 14% unsold stock is more than three years old. A total of 69% unsold stock consists of projects that are less than two years old," says a report by proptiger.com.

"Though recovery was expected in the two previous quarters due to stable government at the Centre, yet it turns out that it will take another two-three quarters before the impact of economic recovery is visible in the real estate sector," says the report.

WILL CUTS BOOST SALES?

Interest rate is one of the important factors that one looks at while buying a home as loan equated monthly instalments (EMI) depend on that. A drop of 1% in interest rates leads to a monthly saving of Rs 3,358 on a loan of Rs 50 lakh for a period of 20 years assuming the rate is 10%. So, as EMIs fall due to drop in interest rates, the demand for houses should rise.

Quote

"Further rate cuts are likely in April, although the space for them is limited (50-75 bps over 2015-16)."

DIPEN SHAH

Head, Private Client Group Research, Kotak Securities

However, experts believe that the latest cut of 25 bps is not enough and rates must fall significantly if they have to have any impact on the real estate sector.

"The cut in rates is by itself very small when viewed in terms of the absolute impact it will have on home loan rates . But the good news is that it is indicative of the RBI's readiness to relent on its previously cautious stance on interest rates, and that it is responding logically and favourably to the fact that inflation has been successfully tamed. I expect this cut in interest rates to be the first of several to come, and these will cumulatively make a big difference to home loan borrowers. As of now, the latest cut has helped revive market sentiment," says Anuj Puri, chairman & country head, Jones Lang LaSalle India.

As per Samantak Das, chief economist and director, research and advisory services, Knight Frank, "Another 150-175 bps fall in interest rates apart from the recent 25 bps cut will boost demand." Also, it is important for banks to pass on the benefit to the consumer. Despite the recent repo rate cut, none of the banks have cut home loan rates.

"Now, it is the turn of banks to pass on the benefit to consumers. We hope to see lending rates fall to 8% in the near future," says Ajay Aggarwal, managing director, Microtek Infrastructures. "Fall in interest rates will definitely motivate people to buy," says Rajesh Prajapati, Managing Director, Prajapati Constructions.

AFFORDABILITY ISSUES

However, a lot of experts say that it is not interest rates but high prices that are keeping people from buying real estate.

"For sales to pick up, price rationalisation has to happen," says Das of Knight Frank. He says interest rate is definitely an important factor but ultimately what matters is the total EMI. "Ideally, prices should be four to 4.5 times the annual income. But in cities like Mumbai, if you take the average price and median household income, the figure is seven-eight times," he says.

This is despite the fact that prices have not risen in real terms in most markets over the past two years. They have, in fact, fallen.

"Interest rates are not the only factor. The market also needs healthy supply. One can expect more supply when the cost of borrowing for projects falls. Increased supply will moderate prices due to competition," says Puri of JLL India.

Price

Price trends


WHY DEVELOPERS ARE NOT CUTTING PRICES

If one goes by the logic of demand and supply, builders should be lowering prices and reducing new supply. This will lead to increase in demand. As mentioned above, they have brought down supply but not cut prices substantially.

Developers say tight liquidity conditions are preventing them from bringing down prices, especially as customer advances, a big source of funds, too, have dried up.

That is why it is getting difficult for them to complete projects. In fact, some are delaying projects to save on costs as banks have become more reluctant to lend and so they don't have enough cash for day-to-day operations.

"Banks are reluctant to lend to developers due to huge inventory. That is why they are unable to complete projects," says Pankaj Srivastava, COO, Maitreya Realtors & Construction Pvt Ltd.

Inventory

Inventory


"Bank credit to commercial real estate and housing sectors has gone down from 10% in 2009-10 to 8.3% in 2013-14," says an Ernst & Young report.

"The trend of creating land banks, witnessed during the pre-crisis era, has dented balance sheets of developers. Low demand has hit monetisation of these assets. The average cost of funds of developers is 12-13% and is eating into margins," says the report. The top 10 real estate companies by market capitalisation had a total debt of Rs 28,583 crore on 31 March 2014, slightly lower than Rs 29,225 crore on 31 March 2013. However, interest paid went up from Rs 3,737 crore to Rs 4,231 crore during the period.

If industry sources are to be believed, some small developers raised funds at 20-30% to buy land. As sales have not happened, the debt has doubled in three-four years, increasing the cost of projects. This is also one of the reasons why builders are finding it difficult to reduce prices.

That is where rate cuts will help. "Developers will be able to borrow at lower rates. This will give them an opportunity to pass on some of the benefit to customers," says Girish Shah, EVP, Marketing & Sales, Godrej Properties Ltd.

REFORM BOOST

The RBI, the Securities and Exchange Board of India (Sebi) and the government have taken certain steps to provide liquidity to the sector.

>> The RBI has allowed banks to issue long-term bonds with a minimum maturity of seven years to raise funds for long-term infrastructure and affordable housing projects. Home loans up to Rs 50 lakh for houses costing up to Rs 65 lakh in the six metropolitan centres are eligible under the scheme. In other cities, loans up to Rs 40 lakh for houses costing up to Rs 50 lakh are eligible.

Quote

"Banks are reluctant to lend to developers. That is why they are unable to complete projects."

PANKAJ SRIVASTAVA

COO, Maitreya Realtors & Construction

>> In September 2014, Sebi notified norms for real estate investment trusts (REITs). REITs work like mutual funds and invest in incomegenerating real estate, mostly commercial projects. The income earned is distributed among unit holders. REITs will be listed on exchanges and their units will be traded like shares. The Rs 2 lakh ticket size will make them affordable as many people cannot think of investing in real estate due to high prices. According to industry estimates, India has 200 million square feet "REIT-ready" space. REITs will also provide an alternative route of finance to builders. They will also make it easier for developers to exit projects.

>> "Foreign direct investment (FDI) inflows in construction (townships, housing and construction development) have been declining since 2011-12 due to India's weak economy and regulatory concerns. FDI in construction development declined to $1,226 million in 2013-14 from $1,332 million in 2011-12," says the E&Y report. That is why the government has announced steps to attract FDI into the real estate sector. The built-up area for FDI eligibility has been reduced from 50,000 sq m to 20,000 sq. m. The minimum capitalisation, too, has been reduced from $10 million to $5 million, with three-year post-completion lockin period; the earlier lock-in was five years.

WAY AHEAD

Quote

"Another 150-175 bps fall in interest rates apart from the recent 25 bps cut will boost demand."

SAMANTAK DAS

Chief Economist and Director, Research and Advisory Services, Knight Frank

Will an upward revision in growth numbers and rate cuts change the fortunes of the real estate sector? Given the high prices, which have made houses unaffordable, will buyers return to the market?

Though this doesn't seem to be happening, industry players are hopeful and believe that the recent rate cut is a move in the right direction. They believe that price rationalisation will happen over time. The prices have either declined or remained stagnant across majority of the markets. A rise in income with a growth in economy, coupled with declining interest rate scenario will make houses affordable for more and more people.

*This story appeared in the Money Today March 2015 Issue, which hit the stands before the interest rate cut by RBI on March 4, 2015.

Get latest news & live updates on the go on your phone with our News App. Download The Business Today news app on your device
More from Real Estate