Real estate investment in Mumbai- it’s simple economics my friend!

For last few years I have been arguing with many people over the real estate rates in Mumbai. People from my age group come to me seeking an advice on real estate investment and I keep telling them “please hold on”. Now, when I say no they ask for the reasons. It is a common belief that real estate investment is the safest investment and gives you supernormal returns, especially in the city like Mumbai where people have seen around 500-600% rise in property rates since 2003. How hard I try to explain that though the prices have gone up in last 12 years, it won’t be the situation in the future. People don’t understand why I say so. Many of my friends have even humiliated me by saying your bookish economics doesn’t work in real life so it’s better to keep that aside and accept the reality. Finally, let me put my thoughts on a piece of paper. Why it’s always about the economics.

It’s very simple that the market works on the demand and supply, even the people those who are not educated can tell you this simple fact. Though this simple fact is simple but it is not that simple that everyone will make sense out of it. One needs to understand that though everything works on the demand-supply factors but the demand and supply can be manipulated and so do the equilibrium. Of course, the real estate market also works on this simple demand-supply rule but you need to understand how these demand and supply factors are playing role in determining the prices of houses in the city.

Let’s look at demand and supply factors through a layman’s eye. There are three categories of people who create the demand for the houses in the city. First is the newly married couple or a person who is about to get married. Generally, they are at the initial stage of their career where the buying capacity is low and the purpose of buying a house is to use it. Second, the people who are in the middle age group and have a stable career. They focus on saving for their future generation and own retirements. These people have relatively more buying power and the purpose of buying flat is not for using it but for an investment. Third are the people those who have huge money and they invest in the real estate market with the speculative motive to earn money.

Supply of real estate depends on the investments made in the real estate projects. Real estate is one of the most favored gateways to convert unofficial money into the official one. When there is a lack of governance people generate piles of black money. That is the case with India where we had 10 years of low governance since 2004 and with Maharashtra where we had 15 years low governance since 1999. In the case of Mumbai, BMC also adds into it. One needs to understand that when you invest the money which you have got for free you have a greater holding capacity and you do not look for quick returns.

So when you look at the above demand-supply factors together you can see that demand from the second and third group is for the investment and speculative purpose and they have the capacity to invest. If you look at the supply side, here people have the capacity to hold. The demand side pressure and suppliers’ control over the prices due to their greater holding capacity pushed the prices up by 500-600 percents.

Now you will ask me if this was working for last 10 to 12 years then why it can’t work now. The answer is, prices got fueled by demand-side pressure till 2007 to 2009 when IT sector was at boom and people had the money to invest in the houses. After the 2007 US subprime crisis when IT sector got hit and 2009 European debt crisis when the whole Indian economy got hit, the average income went down by 30 to 40%. After 2009 it was the supply side holding capacity which held the prices high until the last year. In 2014, the change in the power at center and state has changed many equations of investments in the real estate. Now people are eager to get their money out and keep it in a safe place. Due to this, the holding capacity of suppliers has come down.

So what’s the current situation and what we can expect?

Now the demand is down because the people with the investment and speculative motive are reluctant in putting their money in flats and the people those who have a genuine need cannot afford it. On the other hand, due to more transparency, new laws related to black money, vigilance on corruption, high governance and investigations on various scams, people are looking for liquidating their money to keep it at a safe place. This has made the builders and investors vulnerable which may lead to the fall of the cartel in the real estate industry.

What simple economics says, when the market doesn’t work naturally you may see inflated prices and the bubbles but as soon as the external force which was holding the prices fades out, the market comebacks to its natural equilibrium. By far many of you must have observed that the real estate market has already started showing corrections. Though I personally hate predictions (because that is what an economist must not do) this is for my friends those who are eagerly searching for it, that you may see a correction of 40 to 50 percent within a year or two. So again my advice to all genuine buyers like me is to hold on because after all, it’s all about economics my friend!