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Incredible India: A Bubble About to Pop?

February 19th, 2010 Leave a comment Go to comments

Can you imagine being able to rewind time and watch the U.S. real estate bubble as it’s about to pop? While none of us has the ability to time-travel just yet, I did have the opportunity to witness something remarkably similar to the U.S. real estate bubble while on a recent trip to India with my family.

Just like tech stocks were the talk of the late 1990′s in the U.S. (everyone from your barber to the grocery store clerk had a winning stock pick and was a market expert), real estate is the current hot topic of conversation in India. This in itself, in my opinion, is indication that a growing bubble is afoot – when everyone from the professional investor to the gardener is talking about how to make lots of money in a particular asset class, the prudent investor should start looking for an exit.

Another factor supporting the not-so-distant decline in Indian real estate prices is the excess leverage in personal balance sheets. Just as we saw in the U.S., residents of India are now taking out mortgages that they can just about afford. The availability of credit and the shifting mindset in favor of borrowing (traditionally Indians like to pay for everything, from groceries to housing, with cash; this trend is rapidly changing with the younger, more affluent middle class opening up to mortgages and credit cards) is creating demand for housing, and pushing up prices. The opening up of credit is actually a good thing. The issue is that people can barely afford their mortgages. So, when the Indian economy slows a bit and people lose jobs, their mortgages will immediately be at risk, just as was the case here.

Excess foreign invesment also plays a significant role in Indian real estate prices. It’s a well known fact that investable assets chase returns. In this instance, NRI (Non-Resident Indian) assets that had, until recently, been invested in the U.S. and European stock markets, are migrating to India. This is natural; older Indians living abroad have accumulated a lot of wealth, which was parked in cash, gold, and financial markets. With the collapse of equity markets around the world and the drop in interest rates, there aren’t many good places to park cash. In such an environment it’s no surprise that these assets flow into housing “back home” in India. The older Indian population applies the following logic: “Should I chose to move back home once my kids are settled, I’ll have a place to live. If I choose not to move back home, I can always sell the investment in Indian real estate for a handsome profit since the market is so hot”.

The net effect of these factors is that real estate prices in India have about tripled over the last three years. This is an alarming rate of appreciation given that I see no sustainable demand for real estate. Yes, it is true that many corporations are moving to India and the economy there is growing at a brisk rate. However, the jobs created by these actions aren’t enough, in my opinion, to support the kind of national real estate price appreciation India is experiencing. Rather, I’m concerned that there are too many speculators in the market, which will result in an inevitable, and painful crash. In addition to the foreign speculators I mentioned above, there are also the domestic type – those buying a house with the hope of selling it in the next six months to a year and turning a profit (much like what we saw in the U.S.). In one conversation I learned that about 40% of the purchasers in a new subdivision that was being built were investors; they wouldn’t actually be living in the house. 40%! That’s huge! 4 out of 10 homes will sit empty when built – either awaiting immediate sale by a domestic speculator, or awaiting an NRI family that, in a few years, may live there or, in the more likely scenario, will sell the home to turn a profit.

The risk of this speculation is clear. As soon as the Indian economy slows and those young, affluent borrowers face difficulty paying the mortgages they can barely afford now, there’ll be panic, fueled by memories of what happened in the U.S. This panic will be further exacerbated by the immediate dumping of homes by investors who fear the loss of capital experienced in 2008-2009, creating a snowball effect in the decline of real estate prices. Though I can’t say for certain when this will happen (if I could, I’d have made millions on it), my intuition is that it’ll be within the next 3-5 years.

Though the issue in India is certainly not identical to what happened in the U.S. (high risk mortgages aren’t as prevalent as they were in the U.S. and the secondary mortgage and derivatives market is no where near as large as it was in the U.S.), there are many alarming similarities. That being the case, the prudent investor should be mindful of the similarities and be aware and history can very well repeat itself.

  1. December 31st, 1969 at 18:00 | #1
  2. Avni Adhvaryu Bhatt
    February 21st, 2010 at 00:00 | #2

    good article. makes sense.

  3. February 21st, 2010 at 10:34 | #3

    good article. makes sense.

  4. Vivek
    February 22nd, 2010 at 14:25 | #4

    I agree.

    A couple of years back when i went back i noticed people were no longer able to buy real estate in areas that were close enough to the place of work and were instead renting houses and buying real estate in the outskirts of Bangalore. It will be interesting to see Price/Rent ratios in india if that of data is available at all. this metric is a good indicator of out of whack fundamentals generally.

    Another interesting exercise i undertook was the trying to understand the return on real estate in India. I was trying to understand what portion of the return is real and what was due inflation (pretty high in India). I used the real estate my parents own in Bangalore as a proxy due to laziness… It turns out the real return over the long run is somewhere around 2% which makes sense since supply is elastic in the LR. It will be interesting to see how what kind of returns real estate brings in the SR.

  5. yrao
    May 23rd, 2010 at 08:37 | #5

    good article. I hope there will be a pop (so I can buy some property :) ), but i don’t think it will crash like US. There are some differences between US and India real estate transactions. Corruption and non-transparent transactions play big role in Indian real estate. Even though easy credit is available, banks are more rigid than US banks. People who bought houses probably rich enough to afford those houses – unlike in US where a taxi driver could get a loan to buy half million house. Many of the properties probably bought by tax evading people so they are not in a rush to sell .
    so prices may come down little bit but will not crash.

  6. November 10th, 2010 at 11:27 | #6

    U r dead right…
    Please forward this article with little bit of modification to econimictimes.com

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