Sunday, August 1, 2010

Is a housing bubble brewing in South Delhi?

After looking at several residential flats (apartments/condos) in the posh South Delhi area, I am tempted to conclude yes.

First some observations: A new 300 yard (2200 square feet) 4 bed 3 bath flat bought directly from a builder in South Delhi's Greater Kailash (GK) neighborhood is currently quoted at $850,000 (Rs. 4 crore) for a price per square foot of $386. This place will rent for $1500 to $2000 per month. An older flat in the same neighborhood is going for about $691,000 (Rs. 3.25 crore) and rents for $1100 to $1600 per month.

Here's why I think there's trouble brewing:

1. Rent vs. Buy: The price to rent ratio for the new apartment in GK is over 35! At these prices, the rental yield is less than half the 7 to 8% you can currently get on a one year fixed deposit (CD) so the only reason to buy is if you believe that prices will continue to escalate i.e. The Greater Fool Theory. As we have seen with the Tech and Real Estate bubbles in the U.S., when prices are divorced from economic fundamentals i.e. the cash flows of the underlying asset, they eventually return back to earth.

2. Incomes: There's no getting around the fact that real estate prices are absurdly high compared to household income. Household income statistics in Delhi are very difficult to come by (please contact me if you have access to this data), but even today, a $50,000 annual salary is considered very good and a $150,000 to $200,000 annual salary is a king's ransom in Delhi. According to this slightly dated presentation (page 41) from the respected Times Group, only 5085 households in Delhi made over $200,000! Even at that salary the house I described above would be difficult to afford for two reasons. One, at the prevailing home loan rate of 8%+, this income would not qualify someone for a $700,000 loan. Second, the buyer may need to fork over 50% of the purchase price up front in cash (see the next bullet for details) which is a prohibitive amount. Indeed, I'd estimate that less than 2% of Delhiites can afford to buy a $850,000 flat in South Delhi.

Note: Furthermore, the price per square foot is high when you consider the fact that these prices are similiar to prices in Chicago or Los Angeles but the per capita income in Delhi at approximately $2000 per year (yes you read that right) is a tiny fraction of the per capita income of the afore-mentioned cities.

3. The 2010 Common Wealth Games: This is my favorite theory. The 2010 Common Wealth Games will be held in Delhi in October 2010. The total expenditure on the games by the Government of India is $17.5 billion. Assuming that 75% of that amount is spent in Delhi and assuming 30% "leakage" i.e. bribes (which many people assure me is a conservative estimate) we get a ton of money hitting the local economy through both legit and illegitimate channels. Sadly, $4 billion in "black" money will be transferred from tax payers to corrupt developers, engineers, and all the way down the food chain. Real Estate is a very popular (but not the only) channel for laundering this kind of money because a house that sells for $850,000 will probably be recorded on the books at $300,000 to $400,000 with the remaining amount paid in cash. If my theory is correct, we should see the rate of price appreciation slow down after the games end.

Note: The circle rate is the minimum government-set rate for valuation of land for residential use. These rates are typically much lower than the actual transaction rates in the housing market but properties are usually officially recorded at close to the circle rate in India to minimize taxes and registration fees, and to launder money.

4. Rapid Price Appreciation: According to the IQ property index, prices in the Delhi area are up 41.7% year-on-year. I could not find a South Delhi property index, but it's safe to assume that prices rose by at least that percentage in this area as well. For obvious reasons, this rate of annual growth is unusual and not sustainable, especially when prices in South Delhi dipped by less than 15% in 2008-09, if at all. If you believe this rate of appreciation is sustainable, please contact me because I have some properties to sell you.

5. What you actually get for that money: Finally, as nice as South Delhi is, it's no Beverly Hills.There is massive traffic congestion, inadequate parking, almost no sidewalks for pedestrians, as well as an erratic water and electricity supply. Furthermore, the recent monsoon rains have led to street flooding all over the place! Sure, these new direct-from-the-builder apartments have excellent fixtures and quality finishing, but not enough in my mind to be worth anywhere close to the current asking price.

In a future post: Why the $%#% are prices so high?