Nov 12, 2016

The move by the Government on Nov 8 night to de-recognize current notes of Rs 500 and Rs 1000 is a monumental move, and was done for the second time at such a scale in India after 1978, when the Janata Party government had done the same. As per RBI Statistics, total cash in circulation is Rs 17.7 trillion (1 trillion = 1 lakh crore, 1 followed by twelve zeros). Of this 17.7 tn, 85% value was in notes of Rs 500 and Rs 1000. This 15tn has been de-recognised on Nov 8 night, with a window to exchange it in banks in a transparent manner. A good part of this 15 tn is with banks, another part with people in their wallets, and the last component stashed away as black money. This black money in cash would have arisen from two sources – Government officials taking speed money from companies for getting their tenders passed and from ordinary people to get their work done. And the second source would be shop-keepers and small Businesses getting revenues in cash, and not declaring part of that to avoid paying corporate tax on that. Even if 5tn out of the 14.4 tn is in black, and gets returned into banks with 50-60% penalty or gets burned (100% liability knock-down for RBI balance sheet), the amount will be equal to knocking out one year’s fiscal deficit of the government, no mean feat!

Coming to the Real Estate sector – the immediate reaction from majority of the Press and Analysts was that it will have a huge impact on the Real Estate sector, and prices will fall, some experts throwing up a number of upto 30%. I think this is a myth and Real Estate prices are not going to fall drastically all of a sudden. I shall try in this article to dispel this myth through 5 key rationale points.

1. Majority of the sales of new apartments (primary sales) with Category A & B developers in Top 9 cities have become all-white transactions over the past 3-4 years, thanks to the increasing IT scrutiny, computerisation of records, public listing of large companies, and Private Equity funding requiring cleaner books. 80% of Primary Sales of India happens in Top 9 cities, and 70% happens through Cat A/B developers. Hence, majority of Primary transactions DO NOT involve cash and things will continue as usual. Primary Sales may slow down by 5-15% in the next 3-4 months because of the slow-down in tier 2 cities and in smaller developers, arising from slow-down in transactions which would have been paid for by cash not happening now. Some or most of this will be compensated by movement from resale to primary, as explained in a point below.
2. Real Estate Developers may be currently paying in cash for getting approvals, and for paying last-mile labour. All material supply companies like cement, steel, elevators etc have acquired scale in past 10-15 years, and need to show clean books of accounts for them to accept too much cash. Going forward, contractors will have to get paid in their bank accounts to make payments to their labourers. This will increase service tax pay-out, and cost of construction will go up to some extent. The other aspect of Institutional rent-seeking will find some innovative non-cash way of pay-outs. In any case, both these measures will increase cost of projects for Developers, and hence Developers will be in no mood to reduce prices. In fact, they would like to pass on these increases to the consumers.
3. In the consumer-to-consumer transaction of buying and selling used apartments (Resale), people want cash for their apartments so as to avoid Capital Gains Tax. This corruption of the moral fabric at mass level is a national tragedy, but that is beyond the scope of this article as of now. Some of the future resale transactions will become all-white with sellers not wanting to take cash in small denominations, or in newer smarter notes. More buyers will take loans (upto 80% of apartment value). As the charm of saving tax through paying for resale apartment in cash reduces, some of these buyers would move to Primary market. Few ongoing transactions will not happen at all since buyer may not be able to get same amount in white. Hence, we may see reduction in number of resale apartments going forward. I would hazard a guess of fall of 15-25% in monthly number of resale transactions over the next 2-3 months, as ongoing cash transactions get cancelled, and then number increasing to some extent to settle at a 10-15% lower number than today, part of that loss being permanent as people with black money reduce and part of that through movement to Primary market.
4. Neither the Resale market demand reducing by 10-15% or Primary market reducing marginally (and in some scenarios increasing from resale migration) will cause mayhem in Pricing strategies of either of the two markets. The owners of old apartments have typically purchased the apartments at higher prices of 2007-2013, and as in stock markets, no one wants to sell at a loss. With costs increasing for Developers and with a 35-month average inventory overhang in top 9 cities, there is hardly any scope for reducing prices. I think the Developers will weather this storm out without having to make any significant change in prices.
5. Demand of Primary Units has fallen from 4.7 lakh units in FY14 to 2.1 lakh in FY16 and about 2.3 lakh annualised now. Prices have increased in the 0-7% annual range in this period. If such a halving of demand did not lead to price fall, the demonetization impact should be easily absorbed. In fact, with input costs going up, there is a chance prices will increase a bit.

All in all, I am not seeing a drastic drop in prices in apartments – new or old. Old apartments may see a 0-5% reduction in prices, but it will be very case-specific. Similarly, in new apartments, Cat C and D developers may give some discounted deals to quickly get white money to make their payments to their creditors who they would have paid in cash earlier. Buyers may purchase from such Developers only after evaluating the Project quality, past track record of Developers. For the majority of the new apartment buyers, life will continue as usual. If you are an end-user and planning to buy an apartment, cut through the noise, and focus on choosing the best apartment fitting your needs, and got for it…now!