Beware real estate mania
Business Standard, 30 September 2024
The place of real estate in personal finance
Many people are fascinated by investing in real estate. The typical middle class dream is to buy three houses: one to live in, one for a child and one as an investment. Land investment enthusiasts say The thing about investing in land is that they aren't making any.
The case for land investment is, however, a bit dubious. There aren't enough people in India to use the land area. If we generously assume each individual uses 100 sq.m. totally (across residential and commercial), the land required for the full population of 1.4 billion people is 4.2% of the Indian land area. There are not enough people in India to utilise the enormity of India, even when we have budgeted a total land use of 4600 sq.ft. per family of four and an FSI of only 1.
Most adults in India were taught about the problem of excessive population growth in their childhood. But there has been a sea change in Indian fertility. The TFR has dropped from 6 in 1964 to 2 in 2022. We do not know enough about the sources of this decline to make projections, but something remarkable is afoot. At every stage in India's history, the demographic transition has happened at a bigger pace than projected. The southern states have TFRs lower than Germany's. We should say: The thing about investing in land is that they aren't making enough people.
For personal financial thinking, it's good to remember that in the last 20 years, Nifty has gained by about 26 times. It is diversified, transparent and liquid, while most real estate investments are not. An excessive focus on real estate investment often comes from households who are uncomfortable with listed firms, accounting data, exchanges and depositories. With the diffusion of finance knowledge, one household at a time graduates to equity investing, and this induces a structural headwind against real estate prices in the future.
At a deeper level, consider a car. Can a car have a price appreciation? That's a silly idea, as any increase in the price of cars will just induce a supply surge. Once we break free of the idea that land is scarce, real estate is just a pile of bricks, steel and glass. Any price surge will kick off a supply response, which kills off the possibility of sustained price appreciation.
Real estate mania in China
This is more than just a question in personal finance. Real estate mania can exert adverse consequences for entire economies. The accent on real estate is one ingredient of the failure of the China model.
From the early 1980s onwards, Chinese households over-emphasised real estate. China never got a great period of building financial markets, as happened in India 1992-2017. Chinese households were burned repeatedly when they tried to obtain financial assets, and retreated into real estate. Global diversification for households was blocked by the government which intensified household investments into real estate. Policy makers participated in the real estate game with interlinkages into city financing. The Chinese policy philosophy is one of control, and this desire of policy makers led to repeated episodes of `stimulus' for the macroeconomy through waves of real estate financing.
For decades, thinkers called out the problems of real estate mania, but most people just focused on immediate profits. In time, things soured. The average Chinese household now has 1.5 houses, and the demographic outlook is worse than what we face in India. Vacant houses in China are now way beyond the (troubling) Bombay levels. There are entire ghost towns in China, filled with vacant real estate. All parts of the real estate game -- investors, lenders, developers, governments -- are facing adverse consequences and the real estate sector is holding back the economy. The one thing worse than a rapid bankruptcy process (that would impose massive losses on lenders and households) is a slow one, where there is a drag upon the economy for years. The problems of real estate are now a dark cloud on household sentiment in China.
Implications for Indian growth strategy
These ideas have important implications for growth strategy in India. We did well in India with a period of high capability in financial policy and institution building which gave a strong foundation of an equity market, derivatives trading, foreign investors, etc. This created a gradual process of households learning how to operate in financial assets, gradually stepping out of the old real estate ways. We trifle with financial sector development at our own peril.
The terrible home price to income ratio emanates largely from urban policy. The best environment for the people is where rental or purchase prices of real estate are low. The people should be able to easily afford low income housing at the 10th percentile of urban income. When the rental cost on the household budget is low, wages will go down, so firms will face lower costs and obtain greater competitiveness on a global scale.
To get to this, vast areas of land should go into vertical development, creating a flood of supply. This would give low purchase or rental prices. An array of policy limitations today hold back supply of real estate. Policy makers create conditions for vertical and horizontal expansion of cities. China's example shows the importance of healthy mechanisms of urban financing, i.e. a slice of the GST to the city and property tax, as opposed to linking city finance to a hoped-for real estate boom.
The stance of financial economic policy must not be to prevent lending against the field of real estate. It must be to support the financing that induces ample supply, which will keep real estate prices down. This includes removing restrictions against foreign real estate developers and foreign financing for real estate development. Capital controls on outflows must be eased so that households can diversify into global assets, which will help diminish the attraction of purchasing real estate in India.
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