Realty: Greater Fool Theory in Slow Motion

Ever wondered why rates of homes are spiralling each month, despite large tracts of buildings remaining unoccupied? Several like Keki Mistry, MD of HDFC, say prices in India are 3 times more affordable than in the US and around the world.

Basically, has Mr. Mistry lost his nuts?

I have friends who earn more than Rs 25-50 lakh a year, and yet cringe at paying an EMI of Rs 1 lakh a month. And as someone said, try getting a 800-square feet home in Andheri and Goregaon (suburbs of Mumbai) for less than Rs 60 lakh (Rs 6 million).

Everytime, the markets go up, Mistry and others talk of these ubiquitous genuine buyers driving up prices. This is definitely not true, because these so-called genuine buyers have themselves become speculators.

The second reason they give is that the arrival of cheap home loans have made housing more accessible. This is indeed true, yet, not completely responsible for this manic rise of 300%.

Contrast this to 1995. There were no home loans then, yet prices were driven up to what they are at current levels in India. Then came the huge fall where a correction went to almost 50-60%, and during this time, home loans were amply available; yet they did not take the market up. So somewhere we are missing out an important fact.

Fact is, real estate is not being driven up by availability of cheap home loans or genuine buyers, but by the same bunch of speculators/investors who buy "call options" on homes - i .e. they book 100 flats by paying the price of one flat at booking time. A month or two later, the building is advertised to retail buyers. When these buyers approach the builder, they are told that the project is already full, but a flat is available only on resale.

However, retail buyers, either driven by desperation for a home, or by sheer desire to make capital gains on a perpetually rising-in-value asset, are forced in to a purchase. It's the greater fool theory, in slow motion. This cycle was excellent as long as speculators could access easy money from the profits of stock markets and pump it in to real estate.

However, this cycle now has faced a massive discontinuity -- the effect of which will become evident in April 2008. Huge losses in the stock markets and the subsequent broker payment crises of January 2008 will rear their ugly heads on these housing industry speculators at the end of March 2008.

In May 2008, professionals will see their salaries cut, as is evident in the IT industry, which will turn in to less demand for new rentals and home purchases, since professionals buy homes in the May-June timeframe, after looking at their raises and perks in March.

The next year, we will bear witness to a painful downturn in real estate prices, as current projects will experience a massive slowdown.

An interestin phenomenon in the US is the emergence of "ghost towns", where large swathes of row houses and condiminiums have been abandoned by buyers who cannot afford the EMIs any more, as they see the cost of their homes fall to half of what they were when they purchased them. I will not be surprised to see this phenomenon here in India too. In the 1995 boom, we did not have massive projects like townships, cities etc. Today in 2008, real estate companies, flush with funds, are developing entire cities and towns.

The main indicator is the advertisement of BL Properties of the UAE, which was advertising its Lakeview project in Mumbai newspapers. These chaps are selling "Ajman" a desolate emirate in UAE as a potential suburb of Mumbai. Now, I have heard of good salesmen selling snow to the Eskimo and sand to the Arab. However, this is the first instance of me seeing an Arab selling sand to an Indian. As I see it -- either Indians are super rich, super fools, or the real estate market has truly hit the peak.