Why a Real Estate Bust is in Offing

Stock market crashes almost always precede a real estate bust, and there is no reason why it should be different this time.

Several analysts are waxing glory about the Indian real estate market, creating a belief that it can never collapse. However, history has proven that there is a direct correlation between the stock markets and real estate markets, with a time lag of usually 6 months to 1 year.

If the Nifty and Sensex do not make new highs by June 2008, India’s real estate market will start accelerating downward. By this yardstick, we have another 3 months before the property dream becomes really sour.

However, this doesn’t mean that all will be hunky-dory for those who have invested in property. Until then, prices will not rise; at best they will stagnate or remain in a state of limbo – both sellers and buyers won’t budge.

Whenever the stock markets have passed through boom times, demand for – and consequently prices – of property have gone high. Likewise, in depressed stock markets, property prices tend to soften.

The reason for this relation between the two markets is that, in rising markets, investors find real estate as the ideal place to park the huge gains made in the stock markets, leading to escalation in prices; conversely, in a falling market disposal of property is the quickest way to cover losses, leading to a fall in property prices.

History is replete with examples to confirm this nexus. The most glaring is Japan. It has never recovered since its real estate boom and subsequent bust of 1985–90. India incidentally is exhibiting the same pattern as the Japanese cycle.

• Japan’s real estate market crashed in 1990 following the stock market crash. It is almost 18 years since, but the real estate market is still stagnant in Japan.
• In 1991, post the Harshad Mehta-led market crash in India, the real estate markets also crashed and prices remained stagnant for next 6-7 years. They bottomed out in 2002.
• In 2001, the tech-led Nasdaq crash caused the real estate market to fall around 20-30 percent.
• The 2007-08 downturn in US real estate markets is staring at us right in the face.

The reasons for the crashes may be different, but the pattern is almost always the same. People who have lost heavily in stock markets are keen to dispose off their investments in the real estate market. Distress selling always depresses prices. Small builders facing financial shortage have to sell some of their property to meet financial requirements.

Many other individual investors, who have purchased multiple properties with their own funds or loans for speculative purposes now have to sell some of their property before prices go down further.

The question many ask is why did the fall of May 2006 not trigger a real estate crash, in fact real estate reached even higher heights since then. The answer is again in the stock markets. After May 2006, the stock market recovered within 6-8 weeks and even touched a new high, thus buoying real estate prices with it.

However, when the massive sudden fall in the Indian stock markets was seen, there were reports from Mumbai, Delhi, Bangalore, Ahmedabad and Coimbatore that clearly indicated that property prices (specifically residential property) dropped 10 to 15 percent off their highs. Fresh buying had come to a screeching halt in all major cities.

The current scenario in 2008 paints a picture of almost every retail investor waiting for the market to rally up to new highs and this is a huge gamble to take. If the stock markets do not make new highs, and in all probability they will not, it will be no surprise for real estate prices to drop by up to 30 -40 percent in the near future.

However, it is not just the stock market that is responsible for downturn in the property market. Other factors that escalate a crash are:

• Rising interest rates on housing loans; these have increased from 8 to 10.5 percent in last two years, thus increasing the number of EMIs.
• RBI tightening liquidity. RBI has tightened lending norms by raising risk weightage for real estate loans to 150 percent. A lot of speculation in real estate was because of excess liquidity in the market.
  
• Rise in petrol prices and other commodities puts pressure on monthly budgets of the middle class, forcing it to postpone the purchase of homes.
  
• Lack of government regulation in the market.

The above are reasons why we are primed for a real hard knock in real estate. If you do a check of the above factors, you will see that the current situation complies with each and every point. Yet, almost every person is in denial that an imminent correction awaits the Indian real estate market.

A stock market crash is just a trigger. Usually, property prices reach unsustainable levels on account of huge speculative demand, and the real estate market collapses under its own weight.

The current article has been developed upon an idea from another website. You can read the original 2006 article here