RealTMOR Asset Mgmt LLC and RealTMOR Apartment Mgmt LLP
The Indian residential real estate market is the most sought-after investment option, for the local population, in the world’s “fastest growing major economy”. What this market lacks in yield generation, across various cities, it makes up by delivering high capital gains. As with most markets, it is NOT monolithic but a combination of micro-markets. RealTMOR’s focus on Indian real estate market covers prime residential/commercial areas of its main financial and economic powerhouse—Mumbai and the diamond capital of India—Surat. India has other major regional centers such as the technology hubs—Bangalore and Hyderabad and the national capital—Delhi, but they are not being discussed.
Macro Trends Affecting Indian Real Estate
Indian real estate, especially residential properties, tends to be more affected by local outlook versus global factors. Issues like global growth slowdown worries, strength of the US dollar, US interest rate risks, trade-wars, foreign investments in India (direct and portfolio investment) etc tend to more affect Indian equity and currency markets. These items affect corporates, the general economy, business climate, employment etc and thus have a lateral BUT material effect on residential real estate. Leverage is now increasingly used to purchase residential properties, thus local interest rates and health of lending infrastructure play a role.
Government policy and developer financing environment have an outsized effect on real estate prices. In terms of government policy, 2016 was a watershed year for Indian real estate. The Indian government passed the Real Estate Regulation Act (RERA), a much needed initiative, which attempts to streamline property development and curb fraud and other activities harmful to buyers. The property developers need to conform to various guidelines addressing misappropriation/misallocation of buyer funds, development timelines, transparency regarding regulatory permissions etc. This regulation has gone a long way in attempting to “clean” the Indian Real Estate sector. In 2016, the Indian government demonetized 85% of circulating currency notes, the stated goal being removal of illicit cash from the Indian economy. This had a negative impact on real estate prices because real estate investments were an important channel for cash use (a lot of it, questionable). In 2017, the Goods and Services Tax (GST) was implemented which taxed under-construction properties at a higher rate than before, while secondary sales are not subject to GST. The government is encouraging “affordable housing” development with direct injection of funds (national and state governments), through funding from nationalized banks and by providing other incentives. This addresses housing needs of a large population qualifying as lower middle-class and below (in the Indian context). Undoubtedly these policies have the potential of making Indian real estate investment-worthy in the long-term but will exert short-term pricing pressure.
Foreign and institutional (REITs) ownership in commercial real estate is allowed and encouraged. However, there are some restrictions for foreigners and REITs from owning residential properties. But overall trends of the Indian economy are towards more inclusion and openness. Another headwind currently faced by Indian real estate is the “failure” of IL&FS, a big government-owned infrastructure lender. This has affected many developers and real-estate lenders (called NBFCs in India) and created liquidity issues in financial and real estate markets. However, this failure potentially shines a light on developer financing and, in the future, could make things less risky and more transparent.
Current State of Mumbai Residential Real Estate:
Mumbai residential real estate is a VERY ATTRACTIVE ASSET but the current outlook is uncertain. Mumbai is the financial, economic and entertainment (home of Bollywood) center of India and owning a “piece of Mumbai” still holds “aspirational value” for most Indians. The Indian Rupee is not fully convertible and legal cross-border funds transfer, for Indians, is still subject to some restrictions (although not herculean). Hence, many wealthier Indians use Mumbai real estate to deploy large amounts of their savings into a “less risky” store of value. Currently, Mumbai has an affordability issue, buying an average property in South or Central Mumbai would amount to 17+ years of income for even a highly paid professional with a Masters degree.
Capital Gains: Mumbai’s residential market has had an uninterrupted upward move from 2000-2015, total capital gains (in Indian Rupees) have been 550%+/-, based on various sources, which translates to capital gains CAGR of 14%. Factoring a 2% annual rental yield, Mumbai’s residential market provided total returns CAGR of 16%+/-. Analyzing the gains in US Dollars, tempers the numbers since the Indian Rupee depreciated 30%+ from 2000-2015. In US Dollars this translates to 400% capital gains, with capital gains CAGR of 10% and total returns CAGR of 12%+/-. From 2000 to 2018, Mumbai’s capital gains have outperformed residential real estate capital gains of Shanghai or Sao Paulo, in local currency.
However, since 2015, Mumbai real estate is experiencing a “time-correction” and prices have remained flat or decreased. Historically, India’s inflation rate has been around 6%+/- and the current risk-free rate is 6%-7% (mortgage rates–10%-12%). With the low rental yields in India, high cost of debt and attractive rates on bank deposits, this 3-year time-correction is especially painful. Another interesting fact for US real estate investors is that, on a long-term basis, Indian real estate is somewhat negatively correlated to US real estate (-30% to -50%). This provides US investors with some ability to protect their capital losses during a US downturn. As an illustration, at the time of the US real estate bubble burst (2006-2008) and the subsequent down phase (2008-2012), real estate prices in Mumbai were up 2.0x-2.5x. The current downturn matches with the upswing in US markets.
Non-Price Parameters: currently, there is an oversupply of properties for sale in A and B categories (premium and middle-range). Analysts estimate that Mumbai currently has 5 years of “for-sale” supply. Unquestionably, there is significant demand for housing units in Mumbai, but in the affordable housing space. Additionally, Indian developers are currently facing financial stress because of their past diversion of construction funds to acquire land-banks, high rates of interest, liquidity crisis among the traditional lenders and regulations (RERA) that place limits on allocation of buyer funds. This current stress will make developers more dependable, credit-worthy and “cleaner” in their dealings with buyers, going forward. Wastage, fraud and other malfeasance will be reduced in the system and the asset class will have the opportunity of being competitive at a global level and attracting disparate buyers.
Current State of Surat Residential Real Estate:
Surat is a thriving mercantile city in one of India’s most dynamic states (Gujarat). It is the hub for cutting and polishing of 80% of the world’s small diamonds. It is also India’s textile hub with many job and business opportunities, and has a large and thriving middle-class and rich class. It has exhibited similar capital gains dynamics as other Indian cities and from 2000-2018 has provided capital gains of 500%+/-, in Indian Rupees. Like most Indian cities, the yields there too tend to be in the range of 2%-3%. The big advantage for Surat is the affordability factor and lower relative prices. It would take an average professional 2-5 years of income to purchase an average property. It has not suffered from the downturn currently affecting Mumbai and the real estate prices are up about 50% from 2013-2018.
Indian Real Estate a Key Asset Class:
Among the Most Popular Investment Option for Indians: Historically, Indians invest their savings in real estate, gold or bank deposits. The stock market is getting more attention among domestic investors but still makes up only a small investment option for a majority of Indians (variety of reasons). Real estate is the largest investment allocation for most Indian middle class and richer families. Further, use of leverage, though growing, is not as prodigious as it is in the west. Indian real estate purchases typically have 50%+ equity component and this creates a “holding capacity” for real estate investments, even in tough times.
The India Story has Legs: India has been clocking 6%-9% annual GDP growth rates consistently for the past 15+ years. Foreign investment is increasing in all sectors including real estate. Most global funds and corporates have significant investments in Indian real estate, equities and economy. It is currently Asia’s 3rd largest economy and among the top 10 globally. On a PPP basis, the IMF estimates Indian GDP to top $11T in 2019 (3rd largest worldwide). The large Indian middle-class is growing fast and many Indian companies are competing globally creating employment and wealth domestically. There are many write-ups about the attractiveness of the “India Story” in the public realm, so being brief, HNIs should definitely and seriously consider allocating some investment dollars to India.
There are headwinds which could cap Mumbai real estate prices or act as an impetus to drive down prices over the next 1-2 years. However, long-term, India is too attractive a market to ignore. Further, once the pressure points are resolved, this cyclical downturn will pass and the bull-run in Mumbai real estate will happen again. Long-term, this pressure is beneficial to Indian real estate because it will streamline the market and make it more transparent. A healthier market, in an attractive and dynamic economy, could be a recipe for success. Currently, being watchful (1-2 years+/-) is warranted and focus on a purchase at the RIGHT PRICE. In my opinion, long-term, Mumbai real estate is a great investment and additionally a hedge to US real estate and is a MUST HAVE in HNI real estate portfolios.