Real estate, as a sector, has been one of the major dumping grounds for unaccounted money and counterfeit currency, also known as black money in common parlance. The demonetisation drive, thus, will have a far-reaching impact on real estate, especially the luxury market and plotted development, says a research report.
Liases Foras Real Estate Ratings and Research Pvt Ltd, says in its note, "Luxury housing is going to take a big-time hit as large transactions were happening in black. Developers catering to this segment are sure to face liquidity pressure. On the other hand, land has always been one of the favourite assets to park black money. In the absence of black money, hoarders will not find it appealing to purchase land and demand will be dented. As a result, landowners are likely to be more willing to negotiate prices. We anticipate land prices to witness around 20%-25% price correction. Tier II and Tier III markets and perhaps some Tier I markets, where plotted development is rampant, are likely to be most affected by this."
According to the non-brokerage research centric firm that offers data and advisory services, around 80-90% of the deals in luxury and plotted markets have a cash component of 40-50%. The total cash in the system is estimated to be Rs30,103 crore, which is 21% of the annual market.
"For the luxury market, Mumbai Metropolitan Region (MMR) and National Capital Region (NCR) are likely to be the most affected markets. In the tier I cities, Bengaluru and Pune have less than 20% value contribution to luxury sales. Amongst tier II cities, Surat will be highly affected as luxury sales form 50% of their business," the report says.
Talking about the secondary market, Liases Foras sees a huge impact on sales. It says, "We expect the secondary or resale market to be seriously hit because many transactions in that segment happen in cash, with sellers wanting to avoid long-term capital gains tax. Small-unorganised developers and other unreliable builders may be reduced to a miniscule percentage, as non-compliance has always been an issue there."
According to the report, the housing market in India clocks in sales of 8.5 lakh units a year, of which 36% is dominated by the primary market, while 64% comes from the secondary market and self-constructed houses. It must be noted that 34% of the sales in tier I cities are from the primary market, while in tier II cities it stands at 45%.
NCR leads the tier I cities in terms of secondary market contribution, while Pune has the minimum exposure to the resale of self-constructed houses, the report says.
Liases Foras says, as per its analysis, Bengaluru and Chennai would be the most affected markets post demonetisation in terms of plotted market. It says, "The plotted business segment in Bengaluru and Chennai will be most affected because the trend for the same is dominant in these two cities. Among tier II cities, Indore and Chandigarh will be the worst impacted with a plot market contribution of 29% and 14% each."
Liases Foras conducted a sensitivity analysis and studied the impact of sales in the luxury and plotted market under price correction in two scenarios, such as 10% and 20%. It must be noted that luxury and plotted markets have inelastic demand. The reduction in prices do not result in higher transactions. Both these segments are investor-driven markets and price appreciation attracts buyers to these markets. Hence, it expects the market size for these two segments in the primary as well as secondary market to reduce in the range of 7% to 22%.
Impact analysis at 20% price reduction
Leaving aside extremes, Liases Foras says if we pick the scenario with a 20% price decline, the market size contraction will be felt most in NCR, MMR and Bengaluru. About 17% of the business in NCR is contributed by plotted, luxury and resale markets. Their share in MMR and Bengaluru stand at 15% and 14%, respectively.
"We expect the price correction to happen over the medium to long-term as a result of considerable pressure on the market due to inventory overhang and other aspects. Due to reduction in prices, the number of transactions will increase, thus the value of sales will go up," Liases Foras says.
As per the research note, the straight outcome of 20%-25% reduction in land price is reduction in development cost, which would increase the margin for the developer. Prior to demonetisation, developers were not able to get significant margins but now, after price reduction, can expect better margins. The example shows a sizeable increase in margin from 10% to 32%. In the best possible consequence of this, developers will be able to pass on the benefit to the consumers through reduced pricing. Increased demand on this account will lead to better sales realisations for the developer, it added.
According to Liases Foras, there is an expectation that banks may proceed to reduce interest rates, which it feels augurs well for the end-user. Affordability will further increase by 11% in case interest rates reduce to 8.5%. Moreover, reduced pricing by developers will lure more end-users to the market. Affordability has increased by 23% in the last one year due to price stagnancy and interest rate reduction.
"Briefly, demonetisation is the quintessential surgical strike - sharp and perfectly-timed! Not only will it usher in an era of efficient pricing in real estate and increase involvement of end-users, it will also tackle deep-rooted issues of red-tape on the approval front. Developers will face reduced delays in securing approvals and this will result in faster completion of construction in the long-term. This is a bold step in eradicating black money from the financial system and if it achieves the desired outcome, real estate will be the biggest beneficiary. Ultimately, real estate is one such sector that truly reflects the face of the economy. The more transparent and strong an economy is, the better it augurs for the health of the real estate market. The efficiency that will prevail in the market will outweigh the short-term negative impact of demonetisation on the real estate market," Liases Foras concluded.