Real estate prices set to fall?

Current real estate prices are driven by speculation and are unsustainable , writes A.Srivathsan

“Rupees six crores worth sales in one day,” screamed the headline. Project sold out - all apartments booked on the first day of ground- breaking, said another. Such news and claims were common last year this time. Land prices reached dizzy heights and there was no end in sight to the price rise. It was like a gold rush, but waiting to take a downward turn. And it has now - Chennai’s real estate prices are falling. The prices of land have come down by 15 per cent and so have the apartment prices.

Plots on the Vandalur-Kelambakam road were selling thick and fast a few months ago. Prices went up every week. What started at Rs.8 to 9 lakh per ground (2400 sq.ft) rose to a quick Rs 15 lakh per ground in four weeks. The promoters enticed the undecided buyers and cautioned them that if they wait more, the prices will only rise. This week, not only are plots still available, the prices have also come down to about Rs.10 to 11 lakhs per ground. If things continue to stagnate, they may even come to where they began - Rs. 9 lakh per ground.

Six months ago, far beyond the Padappai- Kancheepuram road, land was priced between Rs.4 lakhs and Rs.15 lakhs per ground depending on how close or far it was from the main road. Rice merchants and other traders in Padappai, Mudichur and Tambaram overnight turned part-time realtors.

Friends, who had lands in Velachery, demanded Rs.1 crore per ground and refused to entertain offers that hovered around Rs 8O lakhs per ground. Surfeit of IT parks were promoted and rent as much as Rs.50 per sq.ft was promised.

On the OMR, Velachery and Tambaram roads, apartments were priced nothing less than Rs.3,500 a sq.ft. At Rajakilpakam, a suburb far beyond Thoraipakam, land was priced at Rs.35 lakhs per ground.

Absence of schools, good roads and public transport never mattered. Lack of sewage connection and water supply was not a major deterrent.

Land and buildings were considered as solid investments and sought after. As prices shot up, the middle class and poor were totally excluded from this land rush

Slowing down

In the last two weeks, things have slowed down. Plots on the Padappai road priced at Rs.12 lakhs each are not entirely sold. Many plots are still available near Sriperumbudur and on the Vallakottai road at prices around Rs.5 lakhs. The prices are negotiable, assure the local brokers. IT parks are no better. Rents have come down. The current rentals are about Rs.25 to Rs.28 per sq.ft, a far cry from Rs.40 and Rs.50 that was offered a few months ago. A promoter near Navalur, off the OMR road, is struggling to sell apartments at Rs 3250 per sq.ft. The salesperson says the prices are negotiable, and admits that about 50 per cent of flats remain vacant.

The price to earning ratio (PE) of Chennai properties was never encouraging. The PE ratio is an indicator to measure the value of the property. This is arrived at by dividing the cost of the property with the earnings. Imagine an apartment of 1500 sq.ft costs Rs.50 lakhs. This would fetch say a rent of Rs.15,000 per month. If you had paid 20 per cent down payment and taken a loan for the remaining Rs.40 lakhs at 11.5 per cent interest, then the outgoing would be about Rs 46,800 per month. To this you add the maintenance and other costs of Rs 2,000 per month. The outgoings would then be about Rs.48, 800 per month. Now divide the outgoings by Rs.15,000 which is monthly rent. This will give a PE ratio of 3.25.

Any figure more than 1 is not considered a great investment and certainly 3 is not a sustainable figure. If you add the interest to the 20 per cent down payment the figure would get even discouraging. If you take the route of interest calculation, for a Rs.50 lakh investment the annual returns are about Rs. 1,80,000. This is about 3.6 per cent. Compare this with a minimum of 10 per cent the bank deposits guarantee.

What drives the prices is not such simple calculation of return. After a few years it is hoped that the prices will increase many fold and that would offset any short-term loss in returns.

But the current level of prices is less promising. How much more can a residential property get? Will it be possible for individuals to buy land at Rs. 1 crore and expect it to soar to Rs.2 crore in a year?

Flow of funds

The prices have increased to high levels not because of lack of supply. It is also neither due to stringent land use regulations nor development control rules. It appears the rise is primarily because of unconstrained flow of funds into real estate.

Ever since real estate has turned into an investment possibility and a commodity for speculation, the prices have only gone up. Even a cursory look at the land parcels in the city suburbs would show that most of them would never be built for a long time to come. They are meant to be only investment options.

Similarly, apartments priced at Rs.3, 000 per sq. ft. and above are aimed at, apart from the small number of upwardly mobile and IT employees, as investment option. As studies show, what is happening is not a correction in physical cycle of real estate.

There is no fluctuation in the demand and supply of built spaces. Instead, the correction is only in the financial cycle of the real estate.

Kumar of Navin Housing and Properties (p) Ltd welcomes this fall in price. He thinks that the hype is over. The speculators will phase out and direct end users will benefit, he says. He disagrees with any prediction of further fall. Mr Prakash Challa, Managing Director, Srinivasa Shipping and Property Development Ltd, estimates that about 20 million sq.ft of IT spaces will be added to Chennai by 2008 and it may put pressure on rentals. He too confirms the reduction in prices and would look at it as a correction.

Many agree that the land price and interest rates have been the two main reasons for this situation. A.V.Ramaswamy, Chairman, Builders’ Association of India, Southern Centre, also concurs with this.

He cautions that any further rise in price will not only affect the buyers but also drive the small builders out of the market. Big developers with deep pockets might monopolise the supply of houses and that may not be good for the city, many builders say.

This 15 per cent fall in price will not bring great cheer to many. Properties are still highly priced and many middleclass, first homebuyers have to wait for the land prices to fall drastically by another 40 per cent.