Friday, 12 June, 2009

Two questions we need to ask before buying a home

Real estate prices had shot up in the last few years, by as much as 100% a year in some places. Developers were getting any price they quoted. Ask anyone and he’d say it was a simple matter of demand and supply. But when we saw a single room going for Rs 500,000, I instinctively knew it couldn’t be so simple.

There had to be something fundamentally wrong.

Prices have come down since the global crash, but developers’ ads insist that they will not go down any more.

I’m not so sure. Anyways, I’d like to ask two questions.

Why must one own a home? ‘Land to the tiller’ is a wonderful political slogan; it’s economic merits are debatable – ask any Bengali farmer who got land during the Barga ‘reforms’.

(It can be easily argued that a lot of other things have gone wrong for them since, but surely quite a few of them can be traced to the miniscule size of their holdings.)

Perhaps the blessings of ‘my own home’ are mixed too. Huge amounts are involved and at least two powerful industries, the banks and the builders. Such forces can mould minds of millions.

Let’s go a little deeper. Tell anyone you find prices too high and you get a stock reply: ‘If you’re going to live in it, don’t think about the price.”

By that logic you shouldn’t think of the price of the food that you will eat. But you do. And if you think it’s too high, you do buy cheaper alternatives.

And renting can be a cheaper alternative than paying EMIs. Because rents can go down, while the EMIs won’t – at least not the principle involved. So, you need to think through the time cost of money before spending it, even if it’s for your home.

I suppose the unsaid part of the justification (of not looking the price of your home) is the hope that the property will certainly appreciate substantially by the time you sell it, several decades later.

This brings me to my second question.

What’s the guarantee that property prices won’t come down? In The Wall Street Waltz, Ken Fisher shows how home prices came down in the US during the Depression. In Irrational Exuberance, Robert J Shiller records several instances of crashes in real estate markets, including the Indian market.

But let’s say those crashes never happened. Fact remains real estate prices have crept up till quite recently.

(Real estate gave the appearance of being a great investment because there was, usually, an enormous time gap between buying and selling, in which compounding interest showed its power. Moreover, the investor would be daddy and beneficiary sonny. One sowed, the other reaped, for free.) 

In the last few years, it has galloped. That may have changed the very nature of this investment.

(Think of a parallel. ‘What goes up, comes down.’ True, but that was as long we didn’t know about escape velocity. Since we blasted off, all that goes up hasn’t come down.)

For starters, it may fall. Second, even if it doesn’t, it may solidify.

That is, it can suffer an enormous and crippling loss in liquidity, because too few people would be able to buy homes, or would want to. Convertibles and yachts may not deprecate, but you can’t sell them as easily as you can sell, say, old newspapers.

In other words, homes may become a luxury, with a economics very different from what it had half a decade ago.

The home market is a case of sour grapes with me. Yet, these questions will need answers.

On the face of it, Indian banks may not have made subprime loans. But in a recession, one cannot be so sure.

Also, those who bought solely to sell and pocket the difference may behave very differently from those who wanted to move in: It doesn’t take too many sellers for bears to rampage. Let’s not forget that the majority of subprime debtors are still repaying their loans.

Third, do we know what will happen if there is a sudden drop in the number of applicants for home loans? Will banks rethink the security afforded by the properties mortgaged by existing debtors? Will home loan laws change? What fraction of homes are bought with loans anyways? What will home owners, who need not be landlords (i.e., they may be living in the property themselves) do if they see rents going down?

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