Increase in real estate prices giving rise to property bubble

By: Santhosh Kumar, CEO – Operations, JLL India

Hyman Minsky, the noted American economist, linked an economy’s life cycle with speculative investment bubbles which are endogenous to it. He stated that during prosperous times when the economy booms, corporate cash flows rise higher than corporate debts, and this leads to speculative euphoria.

This euphoria continues to develop, allowing borrowers to borrow more until their income streams become inadequate to service their debts, creating a financial crisis. This speculative borrowing bubble then causes banks and financial institutions to reduce lending, which in turn causes a further contraction in the overall economy.

Our economy is currently facing such a contraction. Overall economic activity has slowed, with GDP growth estimated at 4.9% in 2013-2014. True, this is an improvement of 40 bps over the previous year and we have seen growth in the traditional agricultural and allied sectors; however, industrial output and manufacturing in India are currently in a stagnant mode in terms of growth.

What This Means For Real Estate

While infrastructure has been hit by rising input costs and delayed approvals, asset prices for residential real estate have recovered and grown over the past two years. The increasing residential asset prices have given rise to a potential bubble, causing stagnation over the past two quarters. From a pan-India perspective, new launches in the residential sector have dwindled over 2013, as developers have been looking at disposing of existing stocks to generate cash flow.

With project funding becoming expensive and buyers showing a lower propensity to purchase in view of unfavourable prices, developers have found it difficult to generate cash and service their debts. This state of affairs is also likely to create greater risks for lenders.

Commercial Real Estate

In Delhi NCR’s commercial office sector, we have seen moderate to healthy levels of net absorption over the past three years. Absorption in 2013 was the lowest in nine years, despite promising leasing activity. This was primarily because occupiers were focused on cost saving and portfolio rationalisation.

The IT/ITeS sector has been the dominant performer, contributing a major share of leasing volumes while the manufacturing and industrial sector has also shown good traction of late. While Gurgaon remains the most favoured destination of office occupiers, Noida has also performed well. However, while Gurgaon has seen a good mix of IT and corporate occupiers, Noida still remains primarily driven by IT.

Over a 1-3 year horizon, we are likely to see an improvement in demand and absorption as economic conditions in the US and Western Europe are showing signs of stabilising. This is likely to increase outsourcing business into India, which will result in improved performance of the office sector. Indian domestic corporates are also likely to continue contributing towards non-IT demand..

From an investment perspective, it makes more sense to opt only for leased assets in the current scenario. Larger investors should consider the domestic private equity funds being raised, which are looking at investing in commercial assets.

Residential Real Estate

The residential sector in Delhi NCR has been affected more by the domestic economy shocks such as high inflation, rising input costs and consistently increasing prices which have acted as a dampener to home sales. The festive season of 2013 was one of the most muted in the last 5-6 years, as sales remained sluggish despite the advertised discounts, festive offers and new projects.