India’s real estate sector is tied up in knots

The real estate sector in the country is down in the dumps. But home prices largely continue to remain unaffordable. The Reserve Bank of India’s median house price to monthly income ratio for different cities clearly suggests that.

On the whole, the median house price to monthly income ratio has risen from 56.1 in March 2015 to 61.5 in March 2019. This basically means that in March 2015, the median house price was 56.1 times the monthly income.

This has since risen to 61.5. In the case of Bengaluru, the house price to monthly income ratio has risen from 52.2 to 56.1.

The interesting thing is that this ratio peaked in late 2017 and early 2018. For the country as a whole, it peaked at 62.7 in March 2018. For Bengaluru, it peaked at 59.3 in December 2017. Since then, the ratio has largely come down.

But even with this fall in the median house price to monthly income ratio, the home prices across cities continue to remain high.

The law of demand seems to have failed to kick-in. In a situation when a product or commodity doesn’t sell, like has happened to homes in India over the past few years, the prices come down and the demand picks up.

The kind of fall in price that the Indian real estate sector should have seen, hasn’t really happened. In this scenario, homes are not selling. With homes not selling, many real estate companies are now finding it difficult to continue repaying loans they had taken from banks as well as non-banking finance companies.

The number of real estate companies (actually companies engaged in real estate, renting and business activities) which are a part of the corporate insolvency resolution process (CIRP) under the Insolvency and Bankruptcy Code (IBC) has jumped big time from 209 as of September 2018 to 421 to as of June 2019.

These are basically companies connected with the real estate business which have defaulted on their loans. They have been put under CIRP under IBC to help banks recover the loans they had given to these companies.

The ratings agency Fitch estimates that $10 billion of real estate development loans will come up for repayment in the first half of 2020. Given that many companies haven’t been able to sell flats they have built, they are likely to default.

If the companies which have defaulted on their loans reach the resolution stage under IBC, they are likely to be sold to other companies. The money thus earned will help banks recover a portion of the loans that have been defaulted on.

The trouble here is that not many Indian real estate companies are in a position to buy the companies that have defaulted. In this case, private equity funds can come to the rescue of the banks.

This is assuming that the companies which have defaulted on bank loans are sold at knocked-down prices. The thing to remember here is that private equity funds up until now have largely shown interest in commercial real estate and not much interest in residential real estate.

If the real estate companies which have defaulted on bank loans are not sold as a part of the resolution plan, then they will have to be liquidated piece by piece. This is a time-taking process. As of June 30, 2019, of the 475 companies in whose cases liquidation had been initiated under IBC, only 11 have been closed.

Here’s the thing. If real estate companies do reach the liquidation stage, as many are likely to, given that a huge number of them have become a part of the CIRP, then real estate prices are likely to fall. In case of liquidation, the interest of the banks will be to recover whatever they get from the flats that have been built. This can lead to prices falling and real estate becoming affordable at least in parts around where these homes are located.

Nevertheless, there can be a glitch to this as well. The builder, before marketing a project takes on a loan from the bank against the land on which apartments are to be built.

What happens after that? The buyers take on home loans offering the apartments that are being built on that land as collateral.

Basically, the same asset is offered as collateral twice in many cases. This is referred to as dual financing.

So, what happens in a situation where a real estate company has already sold flats and then defaulted on a bank loan? Now, if a resolution plan cannot be worked out, and the assets of the company need to be liquidated, the flats that the company has built need to be sold as well. But these flats have already been sold to buyers.
All in all, the situation is likely to get much messy from here on. And once it reaches that stage, only then will individual solutions start to emerge. A purge is waiting to happen.

(The writer is an economist and author of the Easy Money trilogy)