Monday, May 01, 2006

Housing prices: Are we building castles in air

Last week I read an insightful article in The Economist on the Global
housing boom and the high probability of impending crash. I was quite
interested to get some information about real estate market which is
not my home turf. Though the analysis of housing market in India is
difficult task due to lack of information, lack of transparent legal
structure to support property rights and an inefficient market, I
would still like to initiate a discussion about housing prices in India.

To my mind investment in the Real Estate is like any other investment
with risk and rewards associated with it. But the majority of people
do not think about the risks in investing in real estate because they
think the prices will always go up. They usually base their arguments
on the fact that the supply of land is limited and the demand keeps
growing. However history doesn't back this argument. ( In the links to
the articles you would find some instances of sever crashes in real
estate prices and the reasons why it happened)

As an investment real estate investment has some interesting
characteristics. At least till your first house, the home acts both as
an investment and a consumable commodity. In that sense if you live in
a house you own you would not be in particular hurry to sell it just
because prices are falling.

But to reverse the argument would you buy a house just because you
have enough money to buy or enough cheap loan available to buy it.
Without giving any recommendations I would give you an interesting
scenario of my own rented flat. The rent is 14,000 p.a. with 5%
increase per year. If I want to purchase the house I'll have to pay
approx. 40 lacks.

If I use discounted cash flow model to determine how much time it
would take for me to break even with the rent saved at this price and
using risk free rate of 7.5%, it would be take me 36 years.

For obvious reasons I'm not interested to buy this house(or any house
for that matter, even though I afford one and I need one). So this
equation is simply not adding up. To make LHS= RHS one of the
following has to occur.
1. The rents will go up by more that 5%
2. The long term interest rates will come down
3. The price of the house comes down

The option 1 is rules out unless the prices in entire city move up. At
the rent I'm paying is on the higher side and I don't think that it
can go up further.

The long term interest rate are on the lower side now and will not
move down further unless there are structural changes in Indian Economy.

The last option seems more likely (I know you would disagree!). Two
years ago the prices were close to 28 lacs. In the last 2 years the
rents have moved up by 10-15% and the prices by 60%.

My case may be one off case. I want you to do the same analysis(or
send me data) and figure out for yourself if the house is worth buying.

Now the story is same globally. People are paying more price to buy
house than the returns they can get from them in their lifetime. the
argument is the same that the prices will go up and up.

I would leave you here with the following articles. Hope that you
would send your opinions even if you don't agree with me or The Economist.

The global housing boom: In come the waves

House prices : After the fall

Beware housing bubble: HDFC Chairman

1 comment:


The housing boom is over.