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Even If Interest Rates Are Down, Home Affordability Matters

A lower interest rate won’t boost real estate demand if consumers do not find the market attractive enough to enter.

Tower cranes operate at a residential construction site  in the Parel area of Mumbai(Photographer: Dhiraj Singh/Bloomberg)
Tower cranes operate at a residential construction site in the Parel area of Mumbai(Photographer: Dhiraj Singh/Bloomberg)

Lately, we have seen that the rate cuts done by the Reserve Bank of India are not being passed on to the end borrower. With four back to back cuts this year, effective rates ideally should have come down by 110 basis points or 1.1 percentage points.

The monetary policy committee’s bi-monthly meetings are eagerly awaited for the direction they give to the overall economy. However, revisions made by the central bank in the past three years have not led to proportionate changes on the ground, to the detriment of borrowers and investors.

Slow Rate Transmission

Granted that the impact of the latest RBI rate cuts would be known only after a few months, past trends have shown how slowly banks transmit the benefits of lower rates to borrowers.

In June, the RBI had stated that of the 50 basis points that were reduced since February this year, banks had only transmitted 21 basis points to borrowers.

Now, the fourth straight cut in the benchmark repo rate is aimed at giving further thrust to the ailing economy. However, having worked in the real estate sector for two decades, I have noticed that except for the period spanning 2001 and 2004, the housing sector has largely de-linked from changes in interest rates.

During the 2001-2004 period, the housing sector gained on the back of affordable home prices. Lower interest rates in the early 2000s catapulted the economy and the real estate industry after the 1996-97 slump. After the FDI route was opened up for the real estate sector in 2005, home loan rates seem to have played a limited role in shaping the market.

A laborer works at a construction site on the outskirts of Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
A laborer works at a construction site on the outskirts of Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
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Asset Cost, Then Borrowing Cost

A lower interest rate regime, in isolation, cannot work to boost real estate sales if consumers do not find the market attractive enough to enter. Take the start of this decade. Even as interest rates were high in the 2010-15 period, the country also saw a construction boom.

In that time, unsold stock across the top-eight real estate markets in the country nearly doubled, from 4.4 lakh units to 8.6 lakh units. Buying activity in the corresponding period remained muted and grew only by 13 percent.

Along with high interest rates, property prices were at elevated levels as well, pushing buyers away from the market.

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Since then, times have changed and we have come full circle. The central bank switched to an accommodative stance in June. Following this, the RBI has been trying to nudge banks to quickly pass on the benefits of the rate cuts to the borrowers.

In the present scenario, for a loan amount of Rs 40 lakh to be paid over 20 years at 9.50 percent interest, a potential homebuyer has to pay about Rs 37,300 every month. Assuming interest rates are reduced to 8.50 percent in the months to come, the individual would have to shell out Rs 34,700 as the EMI. So, a 100 basis point reduction in the rate translates into savings of Rs 2,600 every month.

But saving Rs 2,600 a month on a principal of Rs 40 lakh isn’t meaningful if the borrower remains worried about job stability and future prospects. If the current economic uncertainty is prolonged, its impact is likely to be most felt in the demand for housing. After absorbing a lot of policy changes that were rolled out from the second half of 2016, the real estate market had witnessed a slight recovery in 2017 and 2018.

Making Sense Of Property Cycles

After 2005, the time when the real estate sector began to de-link from interest changes, the last 14 years can be classified into two phases.

The ten-year phase lasting between 2005 and 2015 was a period when real estate was driven by asset prices rather than production. Investors were participating and parking money in the property market for profit.

It was a highly inefficient market, where prices and supply were soaring irrespective of sales.
A model apartment at The Lodha World Towers,  in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
A model apartment at The Lodha World Towers, in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
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Beginning in 2016, the government brought in policies to curtail market inefficiencies. Prices stopped rising, policies curtailed investor participation. Accountability and transparency brought in by the Real Estate Regulatory Authority moved the production cycle in a positive direction. As prices remained muted for a prolonged period, the pent-up demand moved in with buyers who had previously been fence-sitters getting back in the market. This helped to bridge some of the affordability gap.

The recovery during this period also suggested that there is no dearth of demand. We are still a country with a housing shortage. With rationalisation in prices, end-user demand picks up.

However, will the recovery sustain in the face of the current uncertainties in the economy which is affecting credit liquidity and job certainty?

It is likely to be an extremely trying time for developers, who are buried under huge debt and inventory. This may force them to offer discounts, which could open avenues for the end-user to find a bargains in the property market. In this environment, it’s possible that despite strong pent-up demand among aspiring homebuyers, the property market may not grow as steadily. Affordability and steady employment do matter!

Pankaj Kapoor is Founder and Managing Director at Liases Foras.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.