The Bubble of Indian Housing Finance.

A Background :

We are surely aware of today's condition in the mid of pandemic. Our personal and professional sides are intricately woven together that this pandemic made us realize. If one side gets disturbed, the other one bears the stress. Just like all sectors, the Housing finance sector or The Real Estate sector took a major hit.

Due to the steep downfall of public purchasing power, the Real estate went deserted for a significant period of time to incur heavy losses of $ 1 Trillion over the country. This forced banks to devise a strategy that could potentially bring people to link themselves to Real Estate.

This made banks offer housing loans at their all-time low-interest rates which brought customers to their counters. The process seemed simple and predictions were very certain that real estate prices would stay stagnant and would only move linearly up if any positive changes were to happen soon.

The Bubble In Disguise :

The entire scenario has a big 'BUT'. A bank can borrow funds from another bank or lend its funds to another bank at lower interest under 'corporate' reasons.

Scenario 1: For example, bank X asks bank Y to borrow funds of 100 Crores. Bank Y agrees to lend the funds at an interest of 1.4%. Now, this part gets interesting. The X bank says to offer a loan, not at 1.4% but 0.8% in return bank X assures bank Y [lender] to provide business clients who would invest in their bank in form of business loans or deposits. Bank Y agrees and lends Rs. 100 Crore loan at 0.8% interest.

At this stage, we must know the basic factors which govern the real estate valuation process. Out of many factors 'number of housing loans granted' also decide the valuation. Suppose for Mumbai, on average 10,000 housing loans are granted per year. But, in covid the average falls to 6000; meaning valuation went down; meaning properties get slightly cheaper. But if the same average becomes 12000, the excess 2000 loans granted indicate a surge in market valuation; meaning properties would be slightly expensive.

Now let us concentrate on the Micro and Macroeconomy. just like any other economy, real estate has its own micro and macroeconomy. The micro real estate economy focuses on neighborhood developments, buying rate, renting to selling ratio, etc. in short micro real estate economy is volatile is prone to manipulations in its valuations.

Now, as Bank X has 100 crore funds which it can lend it out to its 100 customers if the loan amount is taken as 1 crore each.

But why did bank X borrow in the first place? for that to understand we must jump to 2nd Scenario.

Scenario 2: A real estate developer [very well reputed] builds a building in an area where the valuation is not great. If it predicted that valuation would not increase as expected in the next 10 years of that area, the only factors supporting its price hike would be inflation and its influence on its neighborhood; meaning a 30 floored tower would increase the area valuation of its neighboring buildings. which in fact also increases the tower's valuation since it's built in the same area. The developer gets this idea and approaches Bank X and he requests the bank to raise the valuation of the area by lending the 100 crore loan to the 100 people [1 crore each] who are indirectly or directly in contact with the developer. Those people would target the area of the developer and they will go on a buying spree over a couple of months, buying the majority of flats from that building itself, raising the valuation of the building, because more sales bring confidence in buyers that the building is worthy of getting an apartment in it. Developer gets his 70% flats sold at 1 crore price [through his own network] and it brings in actual customers, under the hood, due to scarcity of flats in the building [only 20% remaining], an indirect bidding procedure is initiated withing the customers via brokers of the developers. This in turn artificially inflates the price 10% to 20%.

Conclusion:

Now, the developer sold all his flats, at a higher rate than area valuation, it made news in the neighborhood, which in fact increased the area valuation artificially. This is not new, such scams have already taken place previously. Such artificial inflation has the highest chance to work in the outskirts of the city, meaning under or less-developed sub-urban regions.

Some developers have so much capital, that they don't even require banks for help.

Few speculate that we are currently in a bubble, and after it bursts, it shall bring a 30% depreciation in the Real estate market.

Saying goes;

Politics and Real estate seem to be independant in stage, but are husband-wife backstage.

An article by- Kedar N. Pawar.