A friend, who has been flat hunting in Delhi, found real estate prices extremely exorbitant, to the extent that he could not afford to buy something in the areas he would like to stay in.
Declaimer: This article written was originally in October 2006, and some of the data points may be outdated.
A couple of months ago, before he started on this quest, he was quite content with the rapid gains made in the stock market. His question was, “Am I richer or poorer, since I cannot afford what I like, despite having made money from the stock market? With the property prices reaching bubble proportions, should I buy a place now or wait for a crash?”
His pointed query makes us re-think our collective joy of becoming ‘rich’. Absolute salaries in the corporate job markets have quadrupled –my friend’s salary jumped from Rs.14 lacs to Rs.65 lacs in 3 years. Even private and business incomes have zoomed in similar proportions.
A quick check on property prices in Delhi and nearby areas indicates that real estate prices too have quadrupled in the past four years. A flat in Janakpuri, for instance, has gone up from Rs.22 lakhs to Rs.80 lakhs.
Undeniably, our absolute wages and paper wealth have increased. But the reality is that we can buy only the same piece of land that we were able to buy four years ago. We are on a treadmill – however hard we run, we end up being in the same place where we started. If his income is measured in terms of “sq. ft of space in Janakpuri”, my friend is in the same place, without being richer or poorer than he was three years ago.
This answer, however, left my friend unconvinced and he insisted that he was able to buy less today compared to what he could buy earlier. This was puzzling, and after some more questioning, we concurred that he was using a period before 2000 as his mental reference point, so I re-phrased his question to “Has buying power increased or decreased over time?” Are we able to buy more ‘real’ assets today relative to the past?”
If you hear the earlier generation’s reminiscence about their days, they would fondly mention that in their ‘old’ times things were cheap, gold was inexpensive, and housing was affordable. In short, money had good ‘buying power’. Our common sense also tells us that while absolute incomes have risen rapidly, money has ‘become cheap’ over the years.
A person, for example, working as a general manager for a private company in 1974 could buy a 500-yard plot in Panchsheel Park, New Delhi for Rs.72, 000, when his annual income was Rs.36,000. The cost of the house was twice his annual income. Today, the same manager, who has an income of Rs.22 lacs, will require 60 years of income to buy the same piece of land, which costs Rs.13 crores.
It seems that the real buying power has decreased by 30 times in 30 years. But there is a flaw in this comparison. When Panchsheel Park was initiated 30 years ago, it was 12 kilometers from Connaught Place — the heart of the city at that time — having little connectivity, infrastructure, development, or transport. Today 30 years later, with the expansion of the city, it has now become an integral part of the inner city. To make a fair comparison, we should take an example from the current property market.
Let us take DLF Phase 2, which is seemingly emerging as the equivalent of CP of the seventies, and look for a remote, poorly inaccessible place 12 kilometers from there. Plots on the Gurgoan-Sohna Road, for instance, fit the bill perfectly. With a price of Rs.17,000 per square yard, a 500-yard plot will cost Rs.85 lacs. So for the general manager, with an annual income of Rs.22 lakhs, the plot costs about four years’ income.
Hence, while the general manager’s income has increased by 60 times in 30 years, using the yardstick – an under-developed plot 12 km. from the center of the city –, which cost two years’ income earlier, today costs four years of income, indicating a 100% jump. This is a crude, but effective way of measuring purchasing power of money over different time frames, often termed “Purchasing Power Parity” by economists.
Despite incomes having risen by 13% in absolute terms, real estate prices have increased by 16.3% per year over this period. So our paper money has decreased in its real ‘buying power’ at a rate of about 3.3% per year. This has left us ‘poorer’ since our money’s real-estate buying power has decreased at a rate of 3.3% per year.
So what does the future hold for my friend? The bad news is that it will now take him 22 years’ income to buy the Panchsheel Park plot. If he were to invest with his retirement or the next generation in mind, it would be preferable to buy a 500-yard fully built-up plot on Sohna Road, worth around two years of his annual income.
A second option for my friend is to wait for his income to rise faster than property prices in the future. The expected returns from the property are still expected to be the same as in the past, i.e. 16.3% per year (real interest rate 4%+ real estate inflation 3.3%+ general inflation 6%+ rent yield 3%). He should enhance his skills and accelerate his value-add to increase his income by 18% per year compounded, slightly more than the returns from property. In other words, he should aim for doubling his salary every 4 years.
To delve briefly into the above statement that returns from land are expected to continue at 16.3% in the future years to come, we need to look at the demand-supply scenario. There is already a pent-up demand in India for 20 million housing units. The increasing availability and variety of new jobs in our industrial, manufacturing, and services sectors will be filled up by a youthful population in the 21-28 age group in the next 15 years.
This generation will need housing, adding to the demand for land in cities. We can also assume that our complicated legal and political system will not favor major changes in the urban land ceiling act and outdated tenancy protection laws. These are factors that lead to poor availability and liquidity, and consequently keep prices high.
The real estate boom that started in the large cities of India 30 years ago is alive, going strong, and is likely to continue in the future. The current property prices seem to be high and reaching stratospheric heights, but that is when you look at them in the rear-view mirror. The long-term trend is that property demand will keep rising, and this is likely to continue providing returns of 16.3% in the future.
So what should you do? The action to take is to empty your bank fixed deposits locked at 7-8%, seek a large loan from a housing loan company and look for a piece of land in a suburb that is well-connected to a city using a rule-of-thumb of two years’ total income. Move your money out of the stock market, which is likely to yield only a 14.5% return (GDP growth of 6.5%+ real interest of 4%+equity risk rate of 3%+ dividend yield 1%), and go and buy land wherever you can afford it within a drivable distance of your place of work.
For all you know, you will end up shifting there after 10 years and enjoying life in a well-developed, good locality with enough surplus wealth to pass on to your grandchildren who will remember you for your ‘foresight’ while they count the riches of their goldmine.