by Anil Pharande, Chairman - Pharande Spaces & President - CREDAI Pune-Metro
What comes to mind when we speak of inflation and its impact on real estate? Real estate is not a commodity like rice or petrol, which immediately reacts to inflationary trends. Yet, it is an accepted fact that inflation negatively impacts property prices.
Most people imagine inflation and its effect on the prices of everything in graphic terms. For instance, we imagine it as the ripple effect of the behaviour of spectators in a cricket stadium. When spectators in the front rows stand up, those in the rows behind them also get up so that they don't miss anything.
Soon, the entire stadium is on its feet and will only sit down once the excitement diminishes, and those in the front rows begin to sit down again. This is a simplistic and not entirely inaccurate way of looking at inflation - but this is not how it works in real estate.
Inflation & real estate
An important fact to consider is that inflation, while fairly predictable, does not behave in such a uniform manner. Real estate prices do not simply rise because everything else has become costlier. In fact, property prices will usually remain flat - and, in some cases, even decrease - when inflation hits everything else.
Inflation is influenced by the cost of credit. When the prices of essential goods like rice, wheat, and fuel increase, most people's salaries do not go up in tandem. It means they can now afford less with the same amount of money. When the baseline cost of living goes up, banks will increase their lending rates. This is what the RBI recently did during its surprise monetary policy review.
The increased cost of borrowing has an almost immediate effect. People whose incomes have not increased along with living costs will become more careful about borrowing from banks - especially when it comes to expensive borrowing such as availing of home loans. To counter this negative impact on demand, some developers in smaller cities where land is cheaper will sometimes reduce their prices.
This was true in the past, but not any longer. Developers can only reduce prices if their overall development cost has not increased. Unfortunately, prices of construction raw materials had shot up by as much as 35% even before the Ukraine war caused inflation everywhere else.
Developers have now announced that to remain in business, they have no option but to increase their prices. This is how the current inflationary cycle has impacted real estate prices.
Will costlier home loans impact housing demand?
Costlier home loans and higher property prices will inevitably impact housing demand to some extent. But will this contraction be uniform across all housing segments? Let us examine this more closely.
Affordable Housing - Logically, the customer group that will be most affected is affordable housing buyers, with budgets below Rs. 30 lakh. The affordability of this buyer segment is already under strain because of the inflated cost of living.
However, first-time affordable housing buyers enjoy several benefits from the government and banks. An essential aspect of the Pradhan Mantri Awaas Yojna (PMAY) is the interest subsidy on home loans. In Maharashtra, about 13.82 lakh homes under the PMAY-Urban scheme have been sanctioned since 2014. Of this, over 43% have been completed, and another 8.35 lakh have been grounded for construction.
Mid-income Housing - The higher salaried middle-class, which has been buying larger homes in the last 2.5 years, does not enjoy such benefits. However, most homebuyers today are buying homes for their own personal use, and they are not motivated by a speculative 'buy low, sell high' mentality.
These buyers are compelled by genuine need and intend to use these homes for several years, and know that housing prices will definitely go up in this period. If most of the demand came from investors, the increased cost of borrowing would certainly impact demand for mid-income housing.
Luxury Housing - The luxury housing segment is now in a peculiar position. Luxury home buyers are not driven by actual need - their demand is mainly discretionary. Contrary to popular opinion, these buyers do care about costs and will not buy homes regardless of price. Decent discounts by developers and very low cost of borrowing played a significant role in the revival of luxury housing over the last 2.5 years.
The cost of borrowing impacts this buyer group less, but the luxury housing sector will bear the full brunt of increased home loan interest rates and higher property prices. However, even if we see a temporary demand contraction in the luxury housing segment, it will not last very long.
Since there is sufficient demand and new supply is lowest in this segment, luxury housing prices will not soften. The value proposition of luxury housing is not so much a function of cost arbitrage but an aspiration for a superior lifestyle.
Despite all the arguments and counterarguments, there is no doubt that the next 6-12 months will bring their challenges. Reflective of the old Japanese curse 'may you live in interesting times', the Indian housing sector - notoriously averse to change - faces some 'interesting times' ahead. Nevertheless, the fundamentals driving the Indian housing story remain powerful.
Kaushik Desai from Walton Street Blacksoil Fund recently shared an insightful perspective on the recent hike in home loan rates by India's leading banks - “RBI’s move to increase the repo rate to 4.40% to curb the rising inflation has led to an increase in home loan rates by several financial institutions and banks."
"This incline is less likely to have a significant impact on the home buyer’s sentiment, as the home loan rates post increase will be in the range nearing 7%, which is still attractive for the home buyers, especially against the backdrop of price increase on account of rising input costs,” he concludes.
As long as genuine end-users guide housing demand and speculative investors' activities remain curtailed by India's highly conservative banking system, the sector will shake off the current shocks and retain an even keel despite such headwinds. Both pent-up and fresh housing demand will bulwark the Indian housing market, and developers are making sure that supply remains aligned with demand.