Mumbai authorities will rue the demolition of the real estate industry

On February 5, 2020, I wrote a column titled ‘Mumbai real estate is on its death bed. It’s time to bury it’. While I was certain about the forecast I must confess I didn’t expect the burial to happen so soon. COVID-19 has ensured even the real estate industry is forced to acknowledge that reality.

Even prior to the outbreak of the deadly virus the entire industry at a pan-India level was struggling. Data from Liases Foras, a non-broking real estate advisory company, showed that 7,112 developers from its database of 11,838 are in the category of ‘high-default probability.’ If a check is done today it will reveal that the vulnerable list has risen even further to at least two-thirds of all developers. Further 64 percent of the total supply in the market currently is under construction. In a scenario wherein projects had just commenced activity it may have been easy to fold and abandon them. However, the average construction status for projects is at a 66 percent completion rate. That means most projects are in the final stages of completion. Given that significant investment has already taken place it is likely that developers will have to cut prices, sell apartments and complete the project.

The obvious question thereafter is – how much can prices really be slashed by? The median profitability level for most developers is around 15 percent. Even if developers are forced to slash their entire margin, that would translate into a price cut of 10-15 percent.

Will that spur demand? That’s an easy answer — no. In a phase where businesses and salaries are being de-rated by a higher amount, it will be naïve to expect that a 15 percent price cut by developers will stir demand. The onus then lies on the one institution that is responsible for milking the industry dry and actually making houses unaffordable or a significant burden on the population.

In Mumbai, it is the state government and the BMC that have made homeownership so prohibitively expensive that the average transaction size over the last five years has been Rs 1.31 crore in cheque. With the assumption that 20 percent of the payment has been done in cash, that translates into an actual transaction size of around Rs 1.55 crore.

Who is responsible for this mess?

What have the authorities got in return? In the last nine years, the BMC and the state government have received a whopping Rs 120,000 crore from sale of FSI, stamp duty and property taxes in the commercial capital. Almost Rs 37,000 crore has been extracted through levies charged to developers for permission to construct more space in a project – Floor Space Index or FSI. This cost is then passed on to the buyer. Over Rs 35,000 crore has been charged through stamp duties that act as a direct additional cost to a home buyer at the time of registration. Once an apartment is purchased – the annual property tax kicks in through which the municipal corporation has received Rs 44,000 crore since 2013. (Do note this excludes central taxes like GST). In short, a home is a basic need that has been made into a luxury purchase due to government levies.

One would think that for a sector that is routinely plundered and practically funds the administration, there would be measures to revive it. Here is the challenge – there is very little that a government or municipal body can actually do at this stage. The municipal body takes most of its levies upfront so the payment has already been done by the developers. Any reduction in levies will only accrue for new development and will provide benefit only in the medium term. Refunds by the BMC towards developers are not practical while innovative solutions are beyond their imagination. The only arrow in the quiver of the state government is in slashing stamp duty down to zero. That will directly bring down the final cost to the buyer by 5 percent. If one gets more optimistic, there is a possibility of GST on under-construction properties being removed – which will trim costs by another 5 percent. The other component in the chain is the lender and it is unfair to expect that the lenders can contribute to lowering prices in the immediate term.

Cumulatively speaking there is a maximum potential of 20-25 percent price reduction on the assumption that every participant gives away everything that can possibly be waived -- builder margin, stamp duty and GST, except GST on inputs. Builders with a reputation and not completely decimated balance sheets may opt to even work with a marginal loss to see some of their projects executed fully and sold. Even with that assumption, it will not lead to a price fall of more than 30 percent for the end-customer.

Is that enough? It’s complicated – but it may manage to spur demand to a limited extent for select projects and developers. The alternative is to do nothing and watch an accidental murder unravel. The famous line from Batman Begins “Death does not wait for you to be ready” is about to ring true. Mumbai’s administration will rue its moves towards the industry that fed it.