Newton’s third law states that for every action, there is an equal and opposite reaction. Likewise, rising retail prices and inflation have started affecting the real estate sector and are likely to cast a shadow on the long-awaited recovery that is still in a nascent stage.
There are apprehensions that rising prices of key inputs like cement, steel, electrical equipment and other construction material will increase the cost of residential as well as commercial real estate projects and delays. These costs will either have to be passed on to the buyers or borne by the developers themselves. It may even result in project delays and a compromise in quality.
The cost factor
According to back-of-the-envelope calculations, construction cost constitutes about 20-30 percent of the value of the property. The cost of various construction commodities has risen by at least 50 percent, while some items have become expensive by as much as 100 percent and more over the last couple of years.
For instance, one of the major components of construction—steel—was about Rs 39 per kg a couple of years ago; it is now above Rs 85 per kg, an increase of 122 percent. The ongoing war between Russia and Ukraine has further made things difficult. The two countries together account for about 10-11 percent of global supply of coking coal, a key input in the steel industry. The conflict has disrupted the coal supply chain, leading to a rise in the price of steel in the domestic market.
Similarly, the price of cement has increased from Rs 270 per bag to about Rs 360 per bag now, an increase of about 33 percent over the same period. In fact, rates of all commodities used in the construction industry, be it electric wires, plumbing material, CP fittings, aluminium and stone, have moved northward by a minimum of 50 percent in the last two years.
The reasons for increase in cost of inputs can partly be attributed to the impact of the Russia-Ukraine war and the resultant rise in overall inflation. As per government data, retail inflation has been hovering above 6 percent, which is the upper tolerance limit of the Reserve Bank of India (RBI).
However, of more significance to developers is the Wholesale Price Index (WPI)-based inflation, which is a barometer of price rise in the wholesale market. Recent data showed the WPI inflation in February rose to 13.11 percent on higher prices of crude oil and non-food items.
WPI inflation, it may be said, has remained in double digits for the 11th consecutive month beginning April 2021, reflecting the hardening prices of most of the goods in the wholesale market.
It would be futile to think that the double-digit WPI inflation will not have any impact on the realty sector. Actually, rising cost of inputs has already started pinching developers who may have no option but to pass on the costs to buyers.
Given that the input cost of construction material has increased by at least 50 percent, this could push up the property prices by around 10-15 percent. Even if the developer decides to sacrifice some of the profits, 8-10 percent cost escalation appears unavoidable. This would delay project delivery and lead to other complications involving cost revision.
There are several reports, including by real estate consultants, which suggest housing prices are gradually moving up due to a surge in demand.
The other issues
Given the prevailing residential real estate market scenario, not every developer has the elbow room to increase prices to offset the increased costs. In such a situation, many have stopped construction work and are waiting for the war to end and prices to cool. However, this is a tricky situation and may lead to delay in the delivery timeline.
Those who have time on their hands are playing the wait and watch game. However, those projects that are already behind schedule don’t have this option. Many of these include those that have already sold a major portion of their projects and now cannot escalate prices they set at the time of the agreement. In such a case, compromising with quality can be an issue.
The silver lining
As of now, barring a few, most realtors are yet to pass on the higher cost of raw material. Hopefully, geopolitical tensions should be over soon, and inflation would ease off. The RBI’s monetary policy committee too has expressed concern over inflation in the wake of the ongoing Russia-Ukraine war. Thankfully, the central bank refrained from raising the key benchmark rate, and consumers will continue to enjoy the historical low interest rate on home loans.The author is managing director, Trehan Developers