1.00 Honourable Prime Minister Shri. Narendra Modi declared demonetisation of 500 & 1000 Rupees Notes on 8-11-2016. This caused havoc in Banking Sector , Gold Market, Stock Market, Money Market & Real Estate Market. Everyone connected with these markets started thinking what would be effect of demonetisation !
1.10 Senior Vice President in Charge of Mortgage Credit Policy of a Private Bank at Mumbai invited a Senior Valuer on 11-11-2016 to find out his opinion on the effect of demonetisation on Real Estate Market.
1.20 A valuer from Udaipur also wanted to find out what will be effect in his city where Black Money transaction in real estate was as high as 70 % to 80%.
1.30 A valuer from Surat wanted to find out whether valuer could with hold valuation reports for Bank mortgage due to volatility and uncertainty in Real Estate Market.
1.40 Answers to all these question is very simple. Go to the Market. It will never disappoint you. MARKET IS SUPREME. It takes into account each and every market force including demonetisation. If you ignore market forces , you are bound to be in trouble.
2.00 Let us examine important Market Forces that are subsisting in Indian Real Estate Market.
2.10
• Demand & Supply
- Black Money
- Mafia Power
- Political Power
- Paying Capacity of Residents in Locality
- Location & Technical Aspects
- Legal Aspects – RERA Act, Capital Gain Tax, Stamp Duty Act ,
Development Control Regulations.
- Latest being : Demonetisation
Each and every factor affects value of the property in R.E. Market.
2.20 As valuers want to know short term effect they must first know what type of short term. Let us see some instances of short term effects on Real Estate.
( i ) Due to Earthquake of Bhuj in 2001, some of the buildings in Amdavad were damaged. This created panic ( stigma ) in buyers. There were no buyers for Top floor pent house flats in high rise buildings in city. Prices of pent houses were 30% below preearth quake rates. Prices of flats on lower floors increased & were sold at premium. This situation remained for about a year. After that short term effect was over , market was back to normal.
( ii ) A bungalow fully painted in dirty red colour was known as Red house and was suspected as Ghost House. It was on corner plot having Prime location on important road in prestigious suburb of Mumbai. It was not being sold for 3 years as it was known to be a Ghost House. Finally Standard Chartered Bank purchased & built excellent Bank cum office complex.
( iii ) Well known actress Perwin Babi owned an excellent flat in posh locality of JVPD Scheme of Mumbai. After her death due to litigation court receiver advertised for letting of flat. There were no takers and Nil bid for rental. Even brokers could not get prospective tenants because said flat was considered inauspicious. Perwin Babi died in said flat due to starvation & lack of care. Only after 2 years Court Receiver got bid for rental that too at lower rental than that was prevalent in the Locality.
2.30 Demonetisation also will have short term effect on Real Estate Market. Immediate effect will be no demand but plenty of supply. This will result in reduction in rate as compared to rates prevalent during predemonetisation period. It was reported in press that there were major cancellation of booked flats in certain towns. However after one year Real Estate Market will become stable and normal.
3.00 SHORT TERM EFFECT
Immediate effect due to demonetisation clubbed with high price and low paying capacity will be reduced salability.
3.10 Due to reduced demand in market and reduced paying capacity as well as due to volatility in RE Market, Flats/Land lying as security with Bank will not sell at least for 1 OR 2 years period. Valuers must discount value of these assets for reduced salability. At 8% yield rate, for 1 years delay in sale, discount in value could be 8%. For 2 years period delay and non salability, discount rate should be 15% , considering 8% interest rate. Valuers must allow appropriate discount as per their judgement.
3.20 Some Valuers are of view that due to Volatility in RE Market & Uncertainty of effect of demonetization, valuers must withhold report to be submitted to bank. Some other valuers are of view that report must be based on predemonetisation market data with a caveat that it is too premature to make a judgement of market behavior or trend due to lack of reliable instances.
3.30 Both views are incorrect. Valuers are supposed to know market and also all forces affecting market including demonetisation. It is utter commonsense to understand that demand in market will reduce due to demonetisation & flats will not sell easily. Obviously discount for no demand & lack of salability has to be considered by the valuer as stated in earlier para. Withholding valuation report is not the correct solution.
3.40 Similarly valuing asset based on predemonetisation market data is absurd. Valuer has to report on the basis of current trend in the market. Writing caveat in report that it is premature to make a judgement is also ridiculous. Valuer is bound to interpret & judge market forces and its effect on value. Writing caveat means acceptance of fact that you are not an expert valuer.
3.50 Short Term effect on Primary Market and Secondary Market of Real Estate will be quite different. Builders and developers who constitute primary market will sell their flats at 15% to 20% reduced rate. They will also sell flats with reduced cash component. If predemonetisation payment proportion was 70 : 30, now builders may sell flats in 80 : 20 OR 90 : 10 proportion. We as valuers must understand that Black Money is likely to stay in Real Estate Market in India, even after demonetisation . Mafia factor, Bureaucrats & Political forces will continue demanding cash ( Black Money ) in Real Estate Market. This will force builders to claim some black money from flat purchaser.
3.60 Flat Owners and Investors who constitute secondary market will also sell their premises at reduced rate and with more white component. It was common for sellers in secondary market to demand more cash component say 40% ( 60 : 40 prop ) to save on Capital Gain Tax. Purchasers willingly paid 40% cash because they had two benefits. They saved on stamp duty and their black money got invested in real estate. After demonetisation immediate effect will be that 60 : 40 OR 50 : 50 Proportion may get changed to 80 : 20 because purchasers will not have enough cash money for payment. They will require some time to generate adequate cash money.
3.70 Cash money component in all land transaction will also drastically reduce after demonetisation.
3.80 One unbelievable immediate effect was noticed in certain quarters of Real Estate Market during 8-11-16 TO 30-12-16 period. In some metropolitan towns some builders offered to sell their ready to use flats at 15% to 20% premium rates by accepting demonetised old notes. Before demonetisation if flat worth Rs. 200 Lacs was being sold at 140 Lacs plus Rs. 60 Lacs cash , after demonetisation similar flat was sold by builders at the rate of Rs. 230 Lacs. (Rs. 140 Lacs plus Rs. 90 Lacs cash in old notes). Purchaser willingly paid extra money as they could not deposit such big amount in Bank. However Central Government did raid some builders where such illegal transfer of money were suspected.
3.90 Rental premises in city will not have much effect so far as commercial properties are concerned. However in residential rental sector it will have some effect particularly in town areas where investor/land lord were charging some cash money in rental also. It was customary to charge some portion of rental in cash in advance for rental period to save on Income Tax and Municipal property tax. Such land lords will be forced to charge lesser cash component in rental after demonetisation.
4.00 LONG TERM EFFECT
Real Estate Market will have substantial long term affect in all cities and towns of India. However long term effect in R.E. Market in different cities are bound to be quite different. Basis of long term effect on rates will be prevalent market trend of cash payment in each city before demonetization. Cities such as Surat, Rajkot, Udaipur, Jaipur which are known for high cash component ( say 60% to 80% cash ) will have about 50% drop in such high cash percentage. It may go down to even 30% to 40% cash component. However in cities such as Mumbai, Bangalore where cash component is low ( say 20% to 30% cash ) drop in cash component will also be low. It may get reduced to only 10% to 20% cash component in long run. Principle could be : “Higher the cash component in pre demonetisation period, higher will be drop in value post demonetisation. Lower the cash component in sale rate, lower will be drop in value ”.
4.10 Long term effect in R.E. Market throughout India will be that cash part in sale transaction will reduce. Not only because of demonetisation but also due to fear of MODI FACTOR.
4.20 To understand long term effect of rate, we must take help of BEFORE & AFTER THEORY of Valuation. Let us take example of 2 different cities. One with low cash component & another with high cash component.
CITY – A Intrinsic Agreement Cash Proportion
( FLAT ) Value Value Payment _________
BEFORE : 200 Lacs 120 Lacs 80 Lacs 60 : 40
AFTER : 160 Lacs 128 Lacs 32 Lacs 80 : 20
( Note : Intrinsic value reduced by 20 % but Agreement value increased by only 6 % )
CITY – B Intrinsic Agreement Cash Proportion
( LAND ) Value Value Payment _________
BEFORE : 30,000/SY 9000/SY 21000/SY 30 : 70
AFTER : 21000/SY 12600/SY 8400/SY 60 : 40
( Note : Land rate reduced by 30% but agreement value increased by 40% )
We can summarise from these examples that ultimate result of Long Term Effet will be that
“ INTRINSIC VALUE WILL FALL AND AGREEMENT PRICE WILL RISE. ”
4.30 Well known developer of Mumbai Shri. Niranjan Hiranandani stated after demonetisation that “ Cash Payment will be thing of past in Real Estate Sector ” He is wrong. Black money will remain in all sectors of economy due to Cash Payment to Bureaucrats, Mafias and Politicians. However it is possible that everyone will be paid less cash money than that was paid before 8-11-2016.
4.40 Some of the other long term effect on R.E. market are listed below.
- Land owners will lose. Open land prices will fall by 30% or even more.
- Shops & Office purchasers will have to pay more white component.
- Flat purchasers will benefit due to reduction in flat price in primary as well as secondary
market. He will have to shell out less cash money from his pocket.
- Investors will run away from Real Estate Sector. Genuine end users will benefit. If
Investor – Builder tie up continues, investors will demand much higher yield rate on their
investment.
- Builder’s profitability will reduce substantially after demonetisation. Even in the medium
term project , Profit after tax could be as low as 8% to 12%.
- State government will lose initially due to reduced transactions but in long run state will
benefit due to higher agreement value. Next year Ready reckoner rates will be higher
instead of being lower.
- Central Government will benefit as Capital Gain Tax income will be more. Even Income
Tax yield rate will be much higher than previous year.
4.50 Bankers will have to face unusual situations. There will be a great PARADOX. Prices in the market will fall but Worth of Security ( Flat/Land ) mortgaged with Bank will rise in Real Estate Market. There will be reduced risk for the security lying with Bank. In case of borrower becoming defaulter in payment ( NPA ), his security will fetch higher sale price in Public Auction. Bankers will thus benefit substantially.
5.00 Valuation is not a perfect science rather it is an economic concept. Economic Theories are seldom precise and neither final nor exact like laws of physical and natural sciences. Applicability of economic theories can be supported or challenged based on observations of the real world ( Market ). If predictions are refuted, theory is rejected but if predictions are found true and supported , new theory is formulated.
5.10 Values in Real Estate Market henceforth shall be affected by several factors.
( i ) Demonetisation w.e.f. 8-11-2016.
( ii ) Enforcement of Real Estate ( Regulations and Development ) Act 2016,
RERA Act w.e.f. 30-4-2017.
( iii ) Prohibition of Benami Property Transactions Amendment Act 2016.
PBPT Act w.e.f. 1-11-2016.
( iv ) The right to Fair Compensation and Transparency in Land Acquisition,
Rehabilitation and Resettlement Act 2013
known as LARAR Act 2013 w.e.f. 1-1-2017
( v ) Introduction of Goods and Services Tax ( GST ) w.e.f. 1-4-2017.
5.20 It is impossible to predict combined effect of above factors. However, some of these have already started affecting transactions in Real Estate Market. Due to unenforceable LARAR Act, entrepreneurs have started purchasing land directly from farmers rather than taking help of LARAR Act. Due to demonetization demand for premises have fallen down. GST when implemented will reduce COST to developers & ultimately to purchasers. Benami Act 2016 has yet to cast its effect on market but it will certainly reduce rates in market.
5.30 RERA Act is worst Act like Rent Control Act and Urban Land ceiling Act. Developers say that there will be more transparency but it is not true. It is going to increase corruption and increase project cost. It is going to cause great damage to the overall economy of the nation. Various provisions of Act in present from are unenforceable. It will perhaps bring building industry into a grinding halt if some of stupid provision are not removed or amended. One such provision is 70% to 75% of sale money to be deposited in Escrow account of Bank. Money can be withdrawn only after NOC clearance from R.E. Regulatory Authority appointed under RERA Act. Draft rules of RERA has some Modified Provisions. Under Rule 5 of Maharashtra Government RERA , it will be necessary for the developer to Produce 3 certificates ( Architect, Engineer and Chartered Accountant ) to the Bank at the time of each withdrawal from Escrow Account. This unenforceable RERA Act needs suitable amendment like LARAR Act which also requires material change. In the present form of RERA, cost of construction will increase atleast by 15 % because of delay in release of funds from escrow account. Prices of flat will also increase to a certain extent instead of reducing.
RERA ACT WILL HAVE GREATER EFFECT ON R.E. MARKET AS COMPARED TO EFFECTS DUE TO DEMONETISATION.
6.00 Some of the important points that valuers must always remember are as under.
- Valuer must be in constant touch of R.E. Market. Market is supreme and it takes into account all types of factors including Black Money and demonetisation.
- Valuer must know when it is BOOM period and when it is SLUMP period in Market.
- There is a range of prices of a property in the market. Valuer must estimate value by
Judging effect of all market forces including bargaining power of transacting parties.
- Valuation methods are tools of valuer. Most appropriate method should be selected.
- What is valued is not Physical Land and Building but RIGHTS of a person in Land and
Building. “ IF THERE ARE NO RIGHTS, THERE IS NO VALUE ”.
- Never value a property without visiting site.
- Valuer must never forget golden rule of valuation :
“ PROPERTY MUST SELL AT REPORTED VALUE .”
7.00 We have heard about Smart Mobile, Smart and Intelligent Buildings and even Smart City. When are we going to have SMART VALUER ?
7.10 It is difficult to understand why valuers are asking about effect of demonetisation on Real Estate ! If you apply commonsense, you will immediately come to know that effect will be drastic reduction in demand and hence fall in real estate prices.
10-12-2016
Articles on Valuation of Real Estate 