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Incredible India: A Bubble About to Pop?

February 19th, 2010 6 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.

The Power of Unity – Indian Election ’09

May 19th, 2009 No comments

Whether you’re an executive meeting in a corporate boardroom, a student in a group meeting, or an organizer planning a community event, there’s nothing quite as frustrating as having a plan to achieve a goal, but then having dissenters blocking your way. Now I’m all for a democratic approach – listening to the opinions of all those involved, contemplating the information carefully, and then making the best decision, but sometimes that just doesn’t work. There will sometimes be people who, no matter how much you may reason with them, just won’t come around. What’s more, if these people are a significant influence (a key business partner, a team leader, or your boss) you just can’t move forward until they you both see eye-to-eye. Just think of the frustration and lost productivity while you engage in a game of strategy and negotiation trying to get to an outcome that works.

Now, let’s scale up the problem – imagine you’re a country with the same problem. That was India until the recent elections. The ruling Congress Party and their Prime Minister, Manmohan Singh, won the elections of 2004 with the support of the Communist Party in India. It was clear that Congress by themselves could not win a majority, and the only way to win the election was to embrace the Communist Party. This big political hug came at an expensive (and frustrating for legislators) price – the disagreement about key issues like foreign investment, the privatization of major industries, and nuclear issues. Where the Congress Party wanted to reform and open up to the world, the Communists wanted protectionism and isolation. Since the Congress Party was in power because they had the support of the Communist Party, they couldn’t exactly ignore the concerns of the Communists and move forward with their agenda. Many initiatives that would have benefited the country were put on hold due to disagreements between the two parties. India has enjoyed much growth over the past five years, though it has indeed been stifled. In contrast, look at China. They underwent this “opening” of their economy prior to India and have enjoyed much prosperity for it.

Well, all that has changed. In a massive surprise to the common man and experts alike, the Congress Party won many more seats than expected. Yes, they did still have to rely on other parties to gain a majority, but that reliance is much smaller than last time – small enough that they don’t have to turn to the Communist Party, they can get the support of a couple of smaller parties. Now the giant roadblock that has so far limited India’s growth and success has been (hopefully) removed. The only limitation to what the ruling government can do now is their own – any issues that come up within their party, or inefficiencies in how the government is run. Prime Minister Singh can now bring back on track his plans to privatize industries, resulting in innovation and prosperity, and a reduction in the national deficit. It’s amazing what unity (in this case, of the government) can do. When all the players get behind the problem and stop bickering, a lot more productivity can be achieved and great things can indeed happen.

So, what does this mean to the investor? Well until now investors had always kept India in the back of their minds – it was interesting, but not enough so to warrant investment. There were still many political issues that had to be resolved. With these elections we have every reason to believe that the issues that plagued the country over the past five years now have a chance to be resolved. So, my opinion is (and I note the legalese that basically says “my opinion is my own and should not in itself be taken as investment advice. Please talk talk to your investment advisor before trading as investing can result in losses”) that investors should certainly move India to the front of their minds. There is a lot of growth coming and so you should get in on it now while you can. Certainly the market has already priced in some of this growth (the market rallied 17% within minutes of opening on the election news, and then was shut down for breaching daily limits on upswings), but there’s still a way to go. Use pullbacks as a buying opportunity and hopefully the unity in the Indian government will translate into strong returns for investors.

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