5 People. 1 Story. Reality of the Indian Real Estate

This is a guest post by Shyam Shenoy. A software engineer who is passionate about value investing. He believes that one of the major reasons for the real estate prices reaching unrealistic levels is the Indian IT economy.

You may or may not agree to that, but he has an interesting story to tell you.

So over to Shyam…

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Reality Indian Real Estate

There is absolutely no doubt that Housing is one of the 3 basic needs of life. You need a house. I need a house. And for all practical purposes, we all need a house.

Thousands of articles have already been written about why owning a house makes sense. And even if you don’t read such articles, people around you will try to ‘somehow’ convince you that it does make a lot of sense.

Now housing is a need. And every need… costs.

And for regular people like us, every cost… counts.

Having said that, the cost of a house is probably the single biggest expenditure that a person incurs in his lifetime.

So there needs to be a solid thought process behind the decision to purchase a house.

Now Stable Investor is a site about investments. So here, I am talking from the perspective of prudent money utilization and not from house-is-a-basic-need-so-we-should-buy-it perspective.

In this post, I want to share a story with you. The standard disclaimers apply. 🙂

Disclaimer: Any Resemblance to Actual Persons, Living or Dead, is Purely Coincidental

 

The Story of 5 People

There were 5 people in a small town:

  • Ajay an IT engineer
  • Bob the builder
  • Charan a corrupt Government Employee
  • Daniel a banker
  • Edward who was engaged in small businesses

All of them had close to zero money to start with.

Now a businessman named Peter (who owns a big IT business) comes by and offers Ajay (the IT engineer), a job for Rs 15 Lac per annum.

Immediately, Ajay has levelled up and is going to be rich. And the other four people take notice.

Bob (the builder) now sees an opportunity here.

He approaches Ajay and lets him know that he could build a house for him for a price which he would let him know later. Ajay agrees to it in principle, as he is still not committing anything.

Bob gets down to work. As per his calculations, it would cost him about Rs 30 Lac to construct the house. If he adds his profit of Rs 10 Lac, he can sell this house to Ajay at Rs 40 Lac.

Charan (the corrupt government babu) has years of experience in dealing with approvals and permits. For lack of a better phrase, he can smell money in this transaction too. Being aware of Ajay’s new found income source and about Bob’s construction plans, he tells Bob that he will give approval for his construction project only if he gets his cut. A cut of Rs 20 lac in a suitcase so that he can ‘legalize’ and ‘approve’ this construction.

To sweeten the deal, he assures that he will also bring in Daniel (the banker) and influence him to grant loan for construction.

As you might have guessed, Bob is forced to add Rs 20 Lac more to the selling price. The house will now cost Rs 60 Lac. Adding more for registration costs, stamp duties and other miscellaneous items, the final price for Ajay comes to around Rs 70 Lac.

Bob lets Ajay know that the price of the house would be Rs 70 Lac – ofcourse in a combination of black and white 😉

Daniel (the banker) is ready to offer Home Loan to Ajay at 10% per annum.

Ajay feels that luck is favoring him again with these good deals. After all, it was him who found a job that pays an annual salary of Rs 15 lac whereas other four people still don’t get much.

He accepts Bob’s offer and takes a home loan from Daniel.

If you are aware of the mathematics of home loan, then you would agree that for a long-term home loan of Rs 56 lac (assuming 20% downpayment by Ajay from some other source – may be from his father’s retirement corpus), what Ajay is probably tying himself to is a loan repayment schedule where principal + interest would be around Rs 112 lacs or Rs 1.12 crore (approx.).

But that is Ajay’s headache. 🙂 Let’s move on.

Edward (the 5th person) sees all this and does his own biddings…. starts a school, hospital, shopping Mall and what not…

So what is the current situation?

Bob certainly makes a profit of Rs 10 Lac. Charan gets his ‘black’ Rs 20 lac. And banker Daniel gets his Rs 56 lac interest on the home loan. There is no real estimate as to what Edward is making. No one except Charan is doing anything illegal (maybe Edward too is doing something as he got huge investments to build those hospitals and schools etc.)

However, Bob, Charan, Daniel and Edward have cleverly exploited the situation.

The money ‘travelled’ from Ajay’s hands to others and Ajay is at maximum risk.

Bob and Charan have already made the money and left. Edward obviously is stinking rich and can afford to sit and wait for things to work out.

Now comes the interesting part…

Try imagining thousands of Ajay(s) and other fours. This becomes the case of an exponentially growing city. Now imagine lacs of such people and it becomes the situation of the entire economy.

Now suppose that Ajay has four friends (colleagues) – Amit, Ashok, Ali and Antony.

They come to know that Ajay has bought a beautiful house. Now, these friends get into the herd mentality. They feel that since Ajay has bought it, it must be good. They too want to buy a house (obviously loan funded).

The opportunities for Bob’s construction business are plenty. So other builders, bankers and establishments also join the party. All are happy. Since people like Charan (the corrupt government official) have very few competitors, more and more people like Ajay and his friends make him richer and richer.

If you see the bigger picture, it’s a clear case of a mad rush to make money at the expense of people like Ajay and his friends.

As more builders enter the fray, Bob is facing stiff competition. He starts making houses out of substandard/inferior raw materials. He also engages real-estate agents and brokers to whom he pays a small cut – to bring more and more unsuspecting buyers to him. Some of the builders like Bob have already started absconding without even completing their projects.

Charan starts approving all the projects blindly. Lands near city dumps, toxic lakes, far away places, agricultural lands, lake beds, flood plains, encroached spaces and lands with no clear titles. Charan is busy signing approval papers and has no interest whatsoever in construction standards, roads or infrastructure.

Daniel is giving out loans like never before. All which can and might turn into NPAs. But he is too busy to see all that. He has undercover and shady links to loan recovery agents.

As for Edward, he starts raising prices of the services he is providing through his schools, hospitals and malls. Prices everywhere are going skywards.

Obviously, this cannot continue forever. The flip side starts showing up slowly but certainly.

Depleting land leads to land mafias. Depleting sand leads to sand mafias. Depleting ground water leads to water mafias. There are no proper waste management systems and nearby rivers are being filled with lakhs of litres of polluted water daily. There are laborers pouring in from all around the city and living in slums with a desire to get employed in this fast growing town.

Can the situation be reversed back?

Almost impossible.

Even if Charan suddenly decides to turn into a good man and stops accepting illegal money. Why would Bob reduce his price from Rs 70 lac to Rs 50 lac all of a sudden? His competitors will not be doing so. No one will quit as long as the party goes on. The houses already constructed cannot be demolished, given the scale of constructions that have taken place.

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So that was the story.

But in spite of me claiming it to be an imaginary one, even you know that it’s not completely fictitious. 😉

Now I am not arguing in favor or against the idea of purchasing of real estate. It all depends and differs from one person to another.

Buying a first house (your primary residence) is sensible. But investing more money into real estate is another question (read this). And remember, you need to consider many other things:

  • Are you really getting your money’s worth when you are investing in property?
  • Is the quality of the house reasonably good? Do you know it or you are just assuming it?
  • Most of you will take a home loan to buy the house. Are you fine being chained to the loan repayment cycle for life (ok not life but a decade or two) and thereby compromising other financial goals to a larger extent?
  • Have you considered how you would pay EMIs in situations like job loss, health deterioration, etc.?
  • If it’s an investment, do you feel you will really find a buyer at the price that you wish to dispose of your flat in case of an eventuality?
  • Now, this is not an easy one to digest. Aren’t you enriching other people with your money by buying houses at exorbitant prices? If so, don’t you think it makes sense to stay in a rental house?

Think about it.

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Written by Dev Ashish

Founder - Stable Investor Investing | Personal Finance | Financial Planning | Common Sense

15 comments

  1. There’s another one. Can you just rip out and sell your kitchen for your daughter’s marriage – when the time comes?

  2. Quite reflective of the industry. But not entirely correct to assume the risk even if high, will materialise. Everybody assumes risk based on his appetite. Housing would not be a worry if there could be very very long term and predictable lease arrangements. Unfortunately not so and hence the need for one’s own house. Going beyond risk appetite is like aggressive derivatives exposure…till the music stops and the leverage unwinds. This is what happened in 2008. People bought 2/3/4 houses and started flipping on the greater fool theory.
    Besides, just because others in the industry are making money off you does not make the entire industry bad. This is where due diligence comes in.
    It’s not a perfect world.

    1. Hi Sameer,

      There are 2 angles to your post. One is Mathematical angle and other is a Business angle. The first one – assuming perfect world, it is beautifully and mathematically explained by Dev in his article here: https://stableinvestor.com/2015/06/mutual-funds-vs-real-estate-investing-india.html. Many comments to this post also echo different thoughts of the readers.

      When we are talking about business angle – the principle of ‘demand and supply’ kicks in. It is perfectly okay to have this in economics and people do make money off you. It is does not make industry bad. Agreed. But what makes it bad, is when the demand is artificially created, quality and legal angles are compromised at many levels. People try to make money ‘somehow’ end up in situations which their moral conscience wouldn’t have otherwise allowed them, if it was in a due course of clean and normal business.

      Real estate is a fertile market where transactions involved are in huge chunks and the money can be made (or lost) proportionately. Most of times one’s life-time of savings are involved in the buying. I have talked to few friends couple of years ‘after’ they purchased the real estate and are paying EMI. Some claim they are happy (and take the ‘chaltha hai’ approach). But many are are frustrated with the builder as they went back on their promises or amenities. Some water dampness/ hairline wall cracks/ substandard sanitary/electrical fittings/ builder cheated on the building lift. etc.. Some of them during purchase had to withdraw (white) money from bank and pay cash (black) to some offices. Some have frustrations with Banking/Financial firms who lend them money – about hidden costs here and there. Many crib that they are cheated/ now chained to job / lost financial freedom. The feeling that it is their ‘hard earned money’ is getting wasted strikes them hard. They are in continuous mental stress. This situation happens many times – Even if the ‘other risks’ do not materialize at all.

      Just a story, to be mindful of the value and worth what you are paying for.

  3. You may not agree at first read, but the primary role of a real estate is to make money ill-liquid. The wise are wary of liquid cash, and have this sense of urgency to to “freeze it” before it vanishes into the nooks and corners of ones desires. Liquid money possess magic, like a witch amidst you. It generates needs and desires. It gives a strange high.

    Buying a real estate, not only freezes your wealth, but also allows you to make it your permanent residence. This gives a soul reaching satisfaction of having a permanent residence for you and your loved ones. Moreover, the owner of this possession gets a status upgrade in the society. This allows him to get fine suitors for his sons/daughters.

    And all of this happens, while the real estate silently increases in value with each passing year.

    Being able to buy a real estate is nothing short of a divine blessing. What more can one ask for: Several life goals find an inevitable fulfillment by taking one simple and a commonly taken decision.

    All Indians are aware of this phenomenon and, hence, buying real estate is deeply etched in the Indian psyche.

    1. Aman, Moral is: ‘Price is what you pay, Value is what you get.’ Like the way Buffet puts it.
      If the home buyer is satisfied for the price he paid and value he got, It is simply excellent!

      This story points out existence of potential price-value mismatch, herd mentality, sustainability etc. If you go into cost accounting, there are lots of ‘dirty profits’ (legal, illegal, disproportionate) that others make from home-buyer’s money and deliver him a lesser value product in a compromised environment.

      The bullet points towards the end of the article, are things buyer can consider – especially since price he is paying is not a small sum (on an average) usually.

      1. Hi Shyam,

        We can sum it as – “house is for living. Please don’t invest. For growing your wealth use equities. For hedge against market use some gold. Keep it simple.”

  4. Very realistic presentation of current bank NPA and reality industries. One of the best articles that i have read recently.

  5. Very good article which clearly explains how a ‘perceived rich’ IT Engineer has been exploited not just by Real estate but also by CBSE schools that charge a million for play-schools, colleges, hospitals that takes one life to save another, hotels, multiplexes, malls and what not?
    Sadly IT engineers have unknowingly created mountains of black money in the system. As for the builders, the fact that they sell 25% flats in a project to break even and then sit on the rest of the inventory unsold without a care in the world shows how much overpriced the flats in this country.
    An IT downturn currently underway could probably trigger a sub-prime crisis pretty soon.

  6. A house is a need. Similar to vegetables and groceries. If somebody makes money by delivering it to your home and charges a convenience fee, is that also wrong?

    1. Mahesh, This is mentioned right in the beginning. “There is absolutely no doubt that Housing is one of the 3 basic needs of life.” How much of “convenience fee” are you willing to pay. And are you ready for any quality vegetables for what you pay ? Will you not check them ? Would you consider alternatives (bullet points towards end of article) to meet this need. etc.. It depends entirely person to person. There is no right answer here, Mahesh.

  7. Good, but too simplistic. Reality is realty is more complex than IT engineer buying a place and causing a boom. Probably in Bangalore.
    Go out of Bangalore and there have been booms in realty even before IT. Economic growth, population explosion, social-cultural (breaking up of the joint family) changes, “locked-up” land with the government, limited infrastructure – some of the factors from the top of my head that have had more of an impact on realty in India than IT.
    Appreciate the questions (the first 5) posed at the end of the post.

  8. WHAT SCIENCE say there is cause & effect of any thing from 1996 after privatization all land around cities in 40 km range acquired by black money from top people who want to make money.

    assume 1000 sqft flat x by construction cost 1400 it will be 14 lakh + 20% land cost equal to 16.8 lakh

    same flat you are purchasing for 50 lakh due to builder & govt nexus

    means you are paying 33 lakh which you dont need to pay.

    Kiran
    8655242229

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