If you think demonetisation will make property cheaper, you could be wrong. Here’s why
In the immediate aftermath of demonetisation, prognosticators were quick to warn of a collapse in prices across the Indian property market. This idea has been reinforced to some degree by reports, accurate or not, of a dip in the interest level of potential buyers of residential properties. But a thoughtful analysis based on long-term trends, as opposed to a knee-jerk reaction based on transient circumstances, points to a different conclusion. Portending a crash may grab headlines, but the more reasonable expectation is that demonetisation will exert mild upward pressure on real estate prices.
The reasons are varied and nuanced but essentially boil down to this: When costs go up, prices go up. As will be explained below, development expenses related to land, permits, and construction will rise; therefore, it logically follows that these increased costs will be passed along to end users, in other words, the purchasers of apartments, villas and plots.
This adjustment may not take place immediately or uniformly, but it certainly will occur first in “new-economy” cities-those urban centres characterised by a swiftly growing population engaged in salaried, white-collar employment. Already, these cities are weathering the demonetisation storm relatively well. Take Bangalore, for example. With its property market driven by salaried professionals in the IT and ITES sector, the long-term trend is for buyers to carry out transactions through bank loans and cheques. According to reliable local estimates, a full 95% of transactions of properties costing less than one crore in Bangalore are completely “in the white”, not involving a single rupee in cash.
quoted the head of CREDAI, a leading industry body, as stating that in the wake of demonetisation, Bangalore is one of the least affected cities in the country. This resilience stands in contrast to cities such as Mumbai and Delhi, where the practice of passing cash through hands is more entrenched.
So for new-economy cities for which adjustment to demonetisation will be relatively easy (not just Bangalore but also Pune and to a lesser degree, Chennai), what factors are likely nudge prices upward? Let’s examine some key components of development costs: land, permits and construction.
Of these three components, land will represent the most significant increases to costs. Large parcels of land for new projects can be expected to become more expensive, since landowners will now figure in the cost of taxes and thus demand higher prices. In this regard, the reduction in black money is tantamount to an increase in tax rates. And as is the norm in any industry, an increase in taxes eventually translates to an increase in the price to the end user.
Plotted developments will be more affected by this upward pressure than apartment projects. In a plotted community, 60% of more of the cost is land, whereas in an apartment project, 20-30% of the cost is related directly to land. (This figure is higher for apartment developments in CBD areas, but since those transactions tend to take place by cheque, they are less susceptible to changes brought about by demonetisation.) The net effect is that overall increased costs of land will be one factor pushing end-user prices up, especially in plotted communities.
Permits may be another factor nudging prices up. Liaising consultants are expected to begin increasing charges for their services. While this type of expense may not be readily apparent to the untrained eye, it is nonetheless expected to add to the tally of expenses passed along to the end buyer.
In a similar vein, construction costs are likely to increase. Up to now, cash transactions have been common among subcontractors, material providers and laborers. Depending on the extent to which an adjustment in construction practices takes place, these costs could rise accordingly.
The topic of construction leads us back to a more salient point. If we set aside for a moment the ongoing story of demonetisation and instead focus on long-term, fundamental trends, construction emerges as an important gauge of economic health. Commercial construction, in particular, is a leading indicator for the overall property market because it is linked to job creation, which in turn generates demand for homes.
In this regard, the outlook is especially bright for Bangalore, which was recently named in a major report by PwC and the Urban Land Institute (Emerging Trend in Real Estate – Asia Pacific 2017 ) as the #1 property investment market across all of Asia.
Property buyers and investors who avoid speculation and instead pay attention to the steady forces driving the growth of the market will likely reach different conclusions than what they read in sensationalist headlines. At the end of the day, it is always the fundamentals that matter.