Detais about How real estate market can cause a blow to the Indian Economy
We've seen subprime in US, we've seen similar problems in European Countries, and the very latest at home, State Bank of India was downgraded by one of the rating agencies in a reported stress test because of its NPA's (Non Performing Assets) which are suspected to increase from the present 3.4% to a high of 12%, in case of a stress test situation as reported by CNBC news channel.
Still, we all sit with a belief that nothing will go wrong in India. India offers cheap labour options from unskilled streams to highly skilled IT streams so outsourcing will never stop to India. So it is OK to take loans for house, cars, etc. and live peacefully under the assumption that job will stay, economy is tightly controlled by government so nothing will go wrong.
However, one simple issue takes no time to become a nation-wide problem. Let's see how the real estate market of India (sometimes called over-regulated, sometimes uner-regulated) can cause problems to the economy.
First, is the real estate sector over-regulated as quoted by many builders? The answer is yes, but this yes is limited to only getting various permissions from multiple authorities to get into and continue the real estate business.
Is it under-regulated? Again, Yes (in fact a big YES), because there is absolutely no control on prices quoted or randomly raised by the builders. Take this example, a friend of mine in Pune has been looking around for a 2 BHK apartment since last 7-8 months. In an area like Balewadi which is like the western outskirts of Pune with no proper infrastructure, the prices have risen from a low of 3700 to 4500 in a matter of 7 months.
Who controls these prices and what regulation we have there? Absolutely nothing.
So, the rates keep going north, for few months, few years. Everyone believes its all looking good and assumes that it will all remain good, so people take loans. Not just the private banks, even government banks are willingly offering loans freely. No one ever dares or takes any effort in questioning the rationale behind the high property prices. Builders want high price, Banks want high interest high amount loans, and who is left at the other end - its you and me, the common man - highly talented, service class, worked hard for studies, now toiling hard in the MNC job, and will continue doing the same to repay the EMI's for the rest of his life for his dream house or dream car.
And this is where the problem lies - Since no one questions why there has been a steep price rise, say from 3700 to 4500 in a matter of 6-8 months, and banks keep awarding loans, it might turn out to be a problematic situation for the bank.
Assume this - X started looking for a home 8 months back when the rates quoted were 3700. He thought its high, so he waited and explored more. However, instead of rates coming down, they sky rocketed, for no reason, to 4500. After toiling hard in search of home, X finally gives in and books an under-construction flat at high cost of 4500, whose possession is promised to be in 2 years time. So his Home Loan EMI's start. Since the flat is not ready, he is paying rent also. It's hitting him double hard, and this will continue for atleast 2 years till he gets possession of his own flat when he can start saving the rent.
Now comes the problem - The builder has constructed all the 12 floors of the building in 1 years time. X is happy seeing this progress - he is even assuming that since all 12 floors are ready in just 1 year, he might get possession early. However, even then there is a lot of work left in the building. Water connection, Electrical wiring, Electrical supply, Gas supply, plaster work, windows, etc. etc. etc.. The bad part - the builder might even stop the work because of his own reasons or delay it further.
And then comes the worst part - there is a downturn in global economy. X looses his MNC job or his salary is reduced. However, his EMI's are continuing and so is his rent because his flat is not yet ready. After remaining jobless for 6 months, X cannot afford anymore payments anymore and decides to give up. He moves back to his native town/village foregoing whatever he paid as pre-EMI's and downpayments. Now, the bank is left with a property which is under-construction. Since X is no longer in scene, it now taken over by the bank (an under-construction property). It is now the bank which is going to take the hit because it is the one which has given the loan money. X is out with his foreclosure, Bank is now liable. All that the bank is left with is a not-ready property on paper which it has the right to sell.
But where can it find buyers? When there is global economic problems, there are lots of layoffs, high interest rates, then there are no buyers. And note that it is an under construction property. Who would buy an under-construction property from a bank in such a time? Ultimately, the banks take the hit.
Another scenario - X does not loose his job but interest rates keep rising. X took home loan at interest rate of 8% and now it is at 12%. It has caused a big rise in EMI for X. X may not be able to afford it and the bank is not willing to increase his lona tenure considering his age. So ultimately, X may default. It's again the bank which is left with such a property which may not have much value.
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It is these kind of global/local scenarios which lead to a complete and big set of problems for the banks. As long as there is no one to question the random real estate price hikes, as long as the banks (both private and government) freely lend out loans to individuals without considering the actual price worth of the mortgaged property, these problems will continue. The home loan provider banks simply pass on the liability to the individuals. All that is based upon the understanding and assumption that individual will be able to keep on bearing the cost of high interest rates, longer loan durations and higher EMI payments.
Unless there is some proper regulation in place to check the menace of abrupt and high cost prices quoted by builder lobby, the risk of real estate on national economy will always remain
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