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Coronavirus will do what everything else couldn’t: Crash Mumbai real estate prices

A drop in unrealistic real estate prices in Mumbai has been long overdue. The Coronavirus will ensure that outcome. 

Ebrahim Mukadam purchased a 2BHK flat in an under-construction project called Godrej Central in Mumbai around five years ago. He bought the flat for Rs 2.05 crore. Today, as he looks to sell the ready apartment, the quoted price is roughly Rs 1.80-1.85 crore. The project itself has been shabbily executed and is hardly worth a premium.

There are many buyers like Ebrahim, spanning projects and developers, who are seeing the value of their purchase decline sharply. The fallen price is a deterrent for sale though with current economic conditions and bankers breathing down the neck with monthly EMIs, it will be hard to hold on.

Most developers in India are on a weaker economic footing than an average homebuyer is. Yet, looking at the advertisements by builders over the years, it is unlikely that one would feel discounts are plenty. Conventional wisdom says builders opt to default on their commitments than drop prices of apartments. The real estate industry may be in distress, but prices have not been under distress. That is after all the history of real estate in India and more so in Mumbai.

But 2020 will however be different. And buyers will see deals thrown at them like never before. For most developers though it may be too late to opt for redemption.

Let’s understand the historical practice first when real estate was akin to the wild jungle: The developer relied on funds from a lender in the initial stages of land acquisition and approvals. Thereafter, he relied on launch and pre-launch bookings from buyers at the time of execution.

Builders typically have little capital of their own in the game. A few managed it seamlessly and everyone went happy. Most, however, failed in projecting the right demand, price or even getting the approvals. Homebuyers were left stranded. Suppliers were short-changed. And lenders were embroiled in litigation with the developer. The only thing which a developer lost was, well, his reputation. And that mattered little when practically no one had a reputation. Everything was a gamble.

Today the environment is structurally different. There is regulatory support, but the real reason for the change in landscape is the involvement of organised players. Reputation matters now.

The ones with a track record and credibility see significantly higher traction than the rest despite premium pricing. Meanwhile, liberal norms have boosted the supply of homes, creating more competition.

Problem of PlentyToday, Mumbai (Greater) has an inventory of more than 110,000 apartments. The average annual number of transactions in Mumbai registered over the past three years has been 71,042, according to IGR Maharashtra data collated by Propstack. The problem is less than one-third of the registration is for primary transactions where the builder receives money.

Keeping that in mind, there is almost a stunning 66 months of inventory lying idle in Mumbai. Locations outside the Mumbai region such as Thane, Virar, Kalyan, Panvel etc are not included in this calculation.

The bigger improvement has been in the active role of lenders and fund managers with regard to a transaction. Institutional mechanisms have set in after being bitten previously.

Kickbacks are no longer as common as they were previously. It is routine to also see lenders invoke clauses that replace the current developer with a new player to get the job done. It may happen during construction or even after completion.

Their assertiveness, however, has been largely restricted in terms of pressurising a developer to drop prices sharply to boost sales. There is some merit in their strategy for not doing it.

Most developers today don’t earn a margin of over 20 percent on a project. Pushing a developer to slash prices sharply and thereby construct with negligible profit leaves little incentive to even complete the project. (The second reason is it opens the can of collateral devaluation and contagion for the developer and lender while also demonstrating the disastrous underwriting many lenders are guilty of. The second point will be addressed in the next piece as it deserves an exhaustive column in itself)

Yet, the tale of Mumbai real estate today is of a monumental scale of ready inventory that is not seeing takers in the market. The question is – Is it a consequence of price/product/market?

In the case of a ready construction, the product cannot be altered. Market is beyond the control of any individual developer.

The only arrow left is price. And for long it has been known that at prevailing home prices, end-use buyers just do not have the capacity to absorb it.

A survey by the Reserve Bank of India (RBI) showed that buyers of residential property in Mumbai pay 43.3 percent of their income as EMIs. Throw in the monthly maintenance bill for the building and that number rises to almost 50 percent of income. With regard to investors, they ignore the Mumbai real estate market, with most projects reporting more than 90 percent sales for end-use.

What’s the downside to the move of a sharp price cut? The developer is already sitting on idle inventory and struggling to service his debt, keeping the lender on the edge.

Will a price cut boost sales radically? It’s impossible to quantify the exact impact on the basis of only pricing but it is relevant to note that developers, who have been flexible in offering sizeable discounts of as much as 15 percent at the negotiating table, have seen better volumes.

The next big troubleEnter coronavirus. No one knows the depth of the impact of novel coronavirus, or COVID-19,  on the economy, but recovery anytime soon is improbable. Homes will remain unsold even as supply rises. Capital will remain blocked. Consumer sentiment will turn even bleaker.

Builders battling to avoid default on their commitments will start defaulting. For the first time in two decades, end-users and investors will not even attempt a purchase of an apartment.

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  In earlier times, a developer would just default and scramble away. Now, many credible developers with reputations on the line are involved and they have multiple projects going on simultaneously.

Most of them are not financially healthy. Default in one project will impact the chances of the others. The only option for them and the lenders is to bring in the bazooka of a fire-sale with deals that are priced lower by over 25 percent to stimulate demand.

Lenders will take a hair-cut. Developer will have little or no profitability. But in times of a crisis, margin is a luxury, not a necessity. It may not set the cash registers ringing for everyone but it will start the engine once again.

A secular de-rating of real estate prices in Mumbai has been long overdue. Bankers, developers and investors should welcome and force this correction. The threat of contagion has only provided a slow death to all of them.

When not busy with his newstoon platform Snapnews, Vishal Bhargava is a real estate enthusiast who views and reviews new projects. The views are personal.

Vishal Bhargava When not busy with his newstoon platform Snapnews, is a real estate enthusiast who views and reviews new projects. The views are personal.
first published: Mar 24, 2020 11:57 am