Mechanism for sudden price appreciation and need for regulator

Author: Sachin Gupta | Find me on Twitter Follow @sach_gupta
 

To many this wouldn’t be a new thing, I am talking about the sudden increase in residential property prices in Indian metro cities between the periods 2003 to 2007. On a macroeconomic side, it is very well documented that prior to 2003, the property prices were significantly depressed and they shot up post 2003 on account of huge demand driven by increased jobs in sunshine sectors such as IT, Auto, and services. This coupled with relatively short supply gave further rise to real estate prices.

But how did prices go up so suddenly to the tune of almost 8 - 10 times. Well, I struggled a bit to understand that phenomenon and after years of being in real estate sector, here are my two cents.

Firstly, on account of increase in jobs as well as increase in income levels, the demand for housing was tangible. However, the supply was limited and new infrastructure has to be created to cater to that rising demand. That new infrastructure (if we talk about Delhi NCR) could only be developed in new locations such as Greater Noida, New Gurgaon, Golf course extension road, Greater Faridabad, Far away Ghaziabad, and so on.

Now, simple calculations will tell us that cost of construction is about rupees 1200 per square feet (I am talking about high quality construction at current prices). Add land prices to that number, and you would arrive at rupees 1300-1400 per square feet of developed land in the new locations mentioned above. So, how could builders of these new developments in those locations sell those properties for about Rs. 2500 – 3000 when you have properties being sold in primary (already developed) locations such as Faridabad, Noida, Gurgaon, Ghaziabad being sold for Rs. 1800 – 2000 per square feet. No guessing here, the prices have to move northwards in primary locations to justify the Rs. 2500 – 3000 in new locations.

But how do prices move northwards in primary locations? Well, tried hard and after spending some years in real estate sector came to realize that it needed vitamins, injections, or even better steroids. To illustrate it very simply, take a case of real estate sector in Noida where land rates in 2003 were hovering at around Rs. 800 – 1000 per square feet in most localities. All of a sudden builders ABC, XYZ, and few more enter the market and purchased the land plots for Rs. 3000 – 4000 per square feet and I am talking about the primary Noida locations here. What it meant for those builders was loss of money (maybe 50-100 crores) having bought the land at high prices when same was available at very low prices. What does it mean to Mr. Sharma, who believed that since Mr. Verma has sold his plot at Rs. 4000 per square feet, that he wouldn’t sell it for anything less than the Rs. 4000. And rest as they say, residential land price of Rs. 4000 per square feet became the market price in no time.

Now, the very same builders were developing the new locations and now that the price in primary location has already been put on steroid, they can charge Rs. 2500 – 3000 in new locations. So, for the loss of Rs. 50-100 crores, they can now easily make thousands of crores. No fault of theirs, in a capitalist world maximizing value is the key and they did it in open market. However, presence of real estate regulator could have avoided this steroid and maybe saved the common man with pains of going to new locations when most jobs are in primary locations. Given the income levels in major metros, can you justify the prices of real estate? No, and that’s where the real estate regulator could have been helpful.

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