The Worry Of Rising Property Costs

The Gujarat economy has been growing at a healthy rate. Today, the state government has been in the forefront in providing conducive environment for both large corporates and SMEs. As a result, the business sentiments have been positive and encouraging and the state economy has been witnessing a spurt in demand not only for consumption needs but also for real estate for both residential and commercial properties.

The market has witnessed new projects for both types of properties being launched across the state at most of the urban and semi-urban centers over the past couple of years. It appears that the demand for the residential end product is real. However, the speed with which the real estate prices have been rising over the past 12 to 18 months is certainly an area of concern. In fact, the prices have almost doubled during this period. For an ultimate consumer of residential property, a much stable price movement is preferable where he is not put under pressure to preplan his decision solely out of the fear of steep rise in prices.

If one was to look back at the last boom in the real estate prices a decade back, and the slump which followed, then many of the ultimate consumers of the end products did not experienced any kind of appreciation until the recent spurt in the real estate prices. The second outcome in this regard was that many developers did not complete the projects and left them incomplete. Not only did the developers came into the financial difficulties themselves but also put their customers and also the lenders in the lurch to complete the projects.

The commercial property market also then experienced excess supply with office premises going in the price band of Rs.700/- to Rs.900/- per sq.ft. after having touched the price level of Rs.2500/- or more. May be the supply of commercial property is also more than the demand even today and if the demand is not sustained, then it is anyone’s guess as to what will happen to the current price level of commercial properties.

Yes, there have been factors responsible for the increase in the input cost of construction but the land cost seems to have gone up at a rate not witnessed ever in the past decade. We therefore believe that may be a speculative element could be present in the land deals being done. May be this is being fuelled by the demand for land for large commercial projects and malls but, certainly this cost is being passed on to the end user of both residential and commercial properties and putting the ultimate consumer in the quandary to balance his means of financing the property purchase. The price level therefore has to stablise at an acceptable level.

Coupled with the rising cost of land and other input costs, interest rates have also been firming up pushing the overall costs for the end product from the developers’ point of view. The regulator – RBI therefore has rightly signaled a bell of caution by increasing the risk weights on financing of real estate properties. This has also been one more reason for the lenders to increase the interest cost since their cost of capital has moved up steeply on this count apart from a rise in interest rate levels across all instruments and maturities in the country’s money market.

Therefore, we as lender are more comfortable with a more steady price movement in the real estate market. However, in the present scenario, a prudent lender will be more inclined to see higher proportion of borrowers’ equity and lower proportion of loan component in financing of such high price properties so as to provide for depreciation in the value of the properties.

As regards, new customers for home loans, the current level of interest rates of 9.50% to 10 % is yet at a very affordable levels considering the tax breaks available on home loans; both on principal repayment and interest payments. In fact, the effective rate of interest for the ultimate home loan customer is 5.80% to 6.25% (on a home loan of Rs.15.00 lakhs to Rs.16.00 lakhs), considering the fact that interest payment on home loans up to Rs 1,50,000/- is fully deductible and principal repayment up to Rs.1,00,000/- is also eligible for tax rebate. So as long as tax breaks are available on home loans, interest rates on home loans even up to 12% levels would not deter ultimate consumer from buying the residential property. We have seen the ultimate consumer taking home loans and even servicing the loan at an interest rate of 15% to 17% in the early 90’s.

For existing customers of home loan, the increase in interest rates on their existing home loans has been a point of worry but their cash flows have yet not come under a stress since most of these customers have extended their loan tenures assuming that rise in their income levels will enable them to close their loans earlier than the extended tenures.

The worry of the ultimate consumer today is not of increase on interest rates on home loans but the rising property cost at a phenomenal rate.