There has been too much brouhaha in recent times over the nature of capital controls to be exercised in the real estate sector. Many people argue that capital controls will help deflate the real estate bubble and thus lead to more affordable housing. Let's have a look at some fallacies and facts:
- Real estate is an `asset class' - It is argued that there is not enough land in an overpopulated country. Therefore, as the population grows, demand for real estate only goes up. Astronomical prices of real estate in India encourage holding real estate assets in anticipation of future profits. The fact is that, there is enough dwelling land available. A simple calculation will help clarify this. Assuming 4 people per household, a population of 1.08 billion requires 270 million dwellings. Also assuming that an average dwelling is of 1000 square feet (much more than the present) therefore a total built-up area of 270 billion square feet is required. Suppose the FSI is 1. Then, the built-up area to house all of India works out to 25,092 square km or only 0.76% of India's land area. If the average dwelling area is lowered, the land area needed for housing drops even further. If land isn't that scarce, then the cost of built-up housing isn't much; it's just the cost of construction material. To think of it as an asset class would be thus a fallacy.
- Real estate bubble is a result of foreign speculators - It is claimed that foreign speculators have foreseen a price rise in the future, bought houses in India in anticipation of profits thus, resulting in the real estate bubble. In the process, they have created excess demand and pushed up prices. As the price levels have grown very sharply, this is a bubble. The fact is that, demand for housing is a function of rising incomes of Indian households. Results of one of the recent surveys conducted by ValueNotes indicate that real estate is the most preferred investment instrument by IT sector professionals. In a fast growing economy the real issue is that demand is far greater than supply, which provides room for speculators to influence prices.
- Curtailing the demand will curtail prices - This policy framework has been tried in other countries and failed. With a GDP growth rate of 9% and sharp rise in incomes the demand is bound to outstrip the supply. The demand control policy does not give people more and bigger house. The fact is that house prices can only be brought back to affordability by increasing supply as fast as possible. Greater investment in housing is the key to increasing the supply of houses. Another fact is that, politicians and existing house-owners often do not like supply-augmenting policies because that brings down housing prices. Also, when the municipality keeps floor-area restrictions tight, it has power over developers. This power can easily translate into corrupt practices.
However, there is some good news on the front. The ULCA has been repealed and many firms are now accessing public markets to obtain capital. Foreign capital and foreign firms are being allowed 100% FDI and have therefore started investing in Indian real estate sector. The CMIE executive summary for this sector shows a growth in total assets from Rs.22,156 crore in 2004-05 to Rs.53,522 crore in 2006-07. The market capitalization of listed firms on NSE in this sector is Rs.3,13,981 crore, and the high valuations given by the market will attract entry. There are about 80 firms in this sector. These are all still small numbers compared with the size of India, but it looks like serious firms are finally coming together. All of the above factors coupled with removal of controls on purchase and use of land, might be able to pull off a supply response and lead to affordable housing.
Link to the article: http://www.valuenotes.com/namrata/namrata_realestate_17Mar08.asp?ArtCd=131481&Cat=I&Id=
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