The landmark move by the Modi government to demonetise high-value currency notes to stamp out black money will have a far-reaching impact on the capital-intensive real estate sector where almost one-third of transactions still involve unaccounted money.
Though initially, in the short term, the government’s bold move will hit the sentiment of the real estate market, already reeling under a recession, in the medium- to long-term, the sector will reap the benefits of the greater transparency ushered in by government’s “surgical strike” against black money.
This is especially so when in the last couple of years, the government has initiated a number of key reforms in the real estate sector like Real Estate Regulation Act (RERA), GST, REITs and Benami Transactions (Prohibition) Amendment Act, 2016, besides reforms related to FDI, to bring in transparency. Consequent to the reforms, foreign investors are already betting big on real estate.
In a recent development, global private equity player Xander has formed a joint venture with Dutch Pension Fund Manager APG Asset Management to deploy $1 billion in real estate in India. Much to the relief of cash-strapped and debt-ridden developers, institutional financing will also come with lesser risk weightage.
As the real estate sector has significant consumption of black money, the impact of the government’s crackdown will be felt here much more.
There is a cash component of 20-30 per cent in property transactions, largely due to the difference between the collectorate rate and market rate of property. This is even higher in land transactions and property transactions in smaller cities. At the initial stage of the real estate project, land purchase has the highest component (40 per cent or more) of unaccounted money. Also, the payments by investors at the pre-launch or early launch stage has a considerable cash component. Cash is also involved in purchasing building material and in payments to construction workers.
Secondary market transactions essentially involve cash payouts. In the primary market, however, there is more or less no cash involvement, especially in residential real estate as home purchases are financed through mortgages. For affordable homes, the ticket size is too small to involve cash payments. But in high-end housing, the cash component is significant.
It is also seen that in primary sales, developers offer a discount if some part of the property’s value is paid in cash.
Now that the government has come down heavily on black money, the cash component in property transactions will go down. This will result in a drop in land prices and land deals will likely see a substantial dip.
Developers are already avoiding outright purchase of land for their new projects and instead are going in for joint development agreements with land owners. They are also finding it difficult to monetise their land bank to cut down debt obligations. The debt-ridden developers, in the short term, will face cash-flow issues. And, in view of the high inventory and cash crunch, they may well have to resort to price-cutting to push up sales, much to the delight of property buyers.
Speculative and inflated pricing will take a beating in secondary or pre-owned properties, especially in markets which thrive on speculative investments. This will benefit home buyers as interest rates have already come down by 1.5 per cent in the last about one-and-a-half years.
Going forward, with improved liquidity of banks following currency demonetisation, interest rates are expected to further come down, making homes more affordable. This will boost home sales which have seen a 15 per cent hike in Q2 FY17 across the top eight cities. And, as RERA becomes operational and home buyers get protection of their investment, sales will further pick up, especially in the affordable segment, much to the benefit of the government’s Housing for All mission.
It’s not just the top cities, even the tier II and III cities where the government is focusing on Housing for All, and Smart City projects, are expected to gain. Of late, many big organised players with corporate governance have been entering these cities. Some of these cities which offer good job opportunities, especially in IT and have good physical and social infrastructure, are already on the radar of domestic and global funds. Demonetisation will further boost investors’ confidence in the long run.
And, since corruption and approvals’ bottlenecks are major factors responsible for price inflation, demonetisation, coupled with the government’s next big reform to introduce a single-window clearance system, will make property affordable for the masses.
Notwithstanding initial setbacks, as the sector reorganises itself, real estate will be transformed into a more efficient, evolved, corporatised, fair and transparent asset class, well on its way to a long-term sustainable growth path.