Indicators of a Real Estate Cycle - Implication for India

Dr V Chandrasekar, Professor, Executive Advisor, ICREI, ISB Gaurang Sanghvi, Research Associate, ISB
Indicators of real estate cycle: Implications for India

Disclaimer
This paper attempts to serve as the background note on the global real estate market and cycles. The paper provides an overview of the real estate cycle and market dynamics therein, and explores the imperative indicators which affect the real estate cycle. The paper also makes an effort to provide general information on dynamics of a real estate cycle. The paper tries to provide information on matters of interest to readers. The implications of indicators can vary widely from case to case, based upon the specific or unique characteristics of a particular macro-economy. Readers are encouraged to consult with professional advisors for advice concerning specific matters before implementing any investment or tax strategies. While due care has been taken during the compilation of this paper to ensure that the information is accurate to the best of the Authors and ISBs knowledge and belief, Author is not responsible for the accuracy or appropriateness of the information in this paper and disclaims responsibility for strategies implemented as a result of any information provided herein. The Author and ISB neither recommend nor endorse any specific products or services that may have been mentioned in this publication and nor do they assume any liability or responsibility for the outcome of decisions taken as a result of any reliance placed on this paper. Neither the Author nor ISB shall be liable for any direct or indirect damages that may arise due to any act or omission on the part of the user due to any reliance placed or guidance taken from any portion of this paper.

Indicators of real estate cycle: Implications for India Indu real estate research chair

Terms of reference
R Square and t Statistic: Given the scope of the paper, we can establish that there is a relationship between house price and income by the exercise of regression, and the respective values of R square and t statistic which comes in the output of the regression. R Square: The estimated value of R square (also known as coefficient of determination), signifies the extent to which the variation in the movement of price could be explained by the income. The value of R square ranges from 0 to 1. We generally express R square as percentage. If the value of R square is closer to 1 or 100%; we conclude that the variation in the price is explained by the movement in income. e.g.: if the value of R square is 0. 95 i.e. 95%, this means that 95% of the variations in the dependent variable can be explained by the independent variable in the regression model. t Statistic: t Statistic indicates that whether or not the given two variables can be related to each other. If the t statistic is higher than 2, than our hypotheses that the variables are related is taken as true.

Indicators of real estate cycle: Implications for India Indu real estate research chair

Approach

The term bubble implies a transient state where a rapidly growing boom is not supported by economic fundamentals but is based on false assumptions and expectations and would eventually prove to become short lived. Dehesh, Pugh (1996) Countries differ in their institutional, structural and economic fundamentals, and any economic phenomena associated with a particular economy would typically have different characteristic features, which can be attributed to geographical diversities and structural differences such as supply responsiveness, housing markets liquidity and mortgage market completeness. Similarly, features of real estate cycle across different economies are supposed to be exhibiting at best a spurious correlation only. However certain macroeconomic indicators such as household disposable income and market specific determinants such as interest rate, debt service ratio, rentals trends, tend to exhibit similar pattern in terms of their impact on the price movements in the real estate sector. Given this backdrop, the report is an attempt at outlining the impact of these indicators on the price trends in different real estate markets. Indian real estate market has been analyzed with the backdrop of the global trends, and a possible trajectory for the Indian market has been examined. Section 1 gives a brief overview of the theory of real estate cyles and the various indicators that affect the real estate cycle. Section 2 studies the real estate cycles in USA, Japan, and UK. The main criterian that have been considered while choosing these case studies have been a) The real estate cycles should have lasted atleast for five years b) The real estate market should have global significance c) Statistical data availability across markets. In this section we would separately analyse the pattern of real estate cycles in the respective economies, and would try to see similarities, if any, in the indicators responsible for the cycle and also in their respective magnitude. Section 3 analyses the Indian real estate cycle under the above select indicators. The opportunities and risks in Indian real estate market have also been analysed. The case of the Mumbai real estate market has been considered for the analysis, since it is believed to be the most burgeoning real estate market in India. Mumbai is also a mature, demand led market, where end users are higher as compared to other speculative markets in the country. We try to establish the presence or possibility of any similarity between the trends in the price movements in the real estate sector in India and the respective trends in the US, UK or Japan. The role of Government vis--vis policies, both fiscal and monetary, in the price movements of real estate sector has also been analysed in this section. An attempt has also been made to forecast the possible trajectory of the Indian real estate, in light of the present demand supply scenario. Section 4 analyses the key findings of the report and also attempts at highlighting the strengths and possible challenges faced by the Indian real estate sector.

Indicators of real estate cycle: Implications for India Indu real estate research chair

Table of contents
List of figures List of tables List of graph List of abbreviations 1. A brief background of Real Estate Global Cycle 1.1 Introduction 1.2 Real estate cycle 2. Real Estate Cycle : Case Studies 2.1 Indicators of the real estate cycle 2.2 United States of America - Real estate cycle 2.2.1 United States real estate cycle 2.2.2 Indicators of the real estate cycle 2.2.3 United States : Inference 2.3 Japan real estate cycle 2.3.1 Japanese real estate cycle 2.3.2 Indicators of the real estate cycle 2.3.3 Japan : Inference 2.4 UK 2.4.1 UK real estate cycle 2.4.2 Indicators of the real estate cycle 2.4.3 UK : Inference 3. Indian real estate cycle 3.1 Indian real estate cycle 3.2 Indicators of the real estate cyle 3.3 Demand supply scenario and policy perspective 3.4 Real estate cycles India v/s global market 4. India Road ahead Reference

Indicators of real estate cycle: Implications for India Indu real estate research chair

List of figures
Figure 1 Phases of a real estate cycle Figure 2 Indicators affecting a real estate cycle Figure 3 Selected indicators and the pattern of their movement during a real estate cycle Figure 4 Timeline of global real estate cycles and macroeconomic events Figure 5 House price changes for United States (1975 2006)

List of tables
Table 1 Timeline of real estate cycle United States Table 2 House price appreciation in United States Table 3 Indicators affecting global real estate cycles Table 4 India v/s global market

List of Graphs
Graph 1 United States real estate cycle (1980 2005) Graph 2 House price (1985 1989) Graph 3 Net rental yield (1985 1989) Graph 4 House price to income ratio (1985 1989) Graph 5 Interest rates (1985 1989) Graph 6 GDP vs disposable income (1985 1989) Graph 7 Demand supply scenario (1985 1989) Graph 8 House price (1995 1999) Graph 9 - Net rental yield (1995 1999) Graph 10 House price to income ratio (1995 1999) Graph 11 Interest rates (1995 1999) Graph 12 GDP vs disposable income (1995 1999) Graph 13 Demand supply scenario (1995 1999) Graph 14 - House price (2000 2005) Graph 15 - Net rental yield (2000 2005) Graph 16 House price to income ratio (2000 2005) Graph 17 Interest rates (2000 2005) Graph 18 GDP vs disposable income (2000 2005) Graph 19 Demand supply scenario (2000 2005)

Indicators of real estate cycle: Implications for India Indu real estate research chair

Graph 20 Japanese real estate cycle (1985 - 1999) Graph 21 House price (1985 1999) Graph 22 House price to rent index (1985 1999) Graph 23 Household debt service ratio (1985 1999) Graph 24 Interest rates (1985 1999) Graph 25 GDP vs disposable income (1985 1999) Graph 26 UK real estate cycle (1986 1991) Graph 27 House Price (1986 1991) Graph 28 Interest Rates (1986 1991) Graph 29 Disposable income vs GDP (1986 1991) Graph 30 Indian real estate cycle (1990 1999) Graph 31 House price (1990 1999) Graph 32 GDP vs disposable income (1990 1999) Graph 33 House price to income (1999 1990) Graph 34 Interest Rates (1999 1990) Graph 35 Housing shortfall in India Graph 36 Demand for new housing (2005 2030) List of Abbreviations CAGR Compound Annual Growth Rate FDI Foreign Direct Investment FII Foreign Institutional Investors GDP Gross Domestic Product INR Indian National Rupee IPO Initial Public Offerings NBO National Building Organization REIT Real Estate Investment Trust UK United Kingdom USA United States of America USD United States Dollar VC Venture Capital

Indicators of real estate cycle: Implications for India Indu real estate research chair

1. A Brief Background of the Real Estate Global Cycles:

1.1 Introduction:
Real estate cycles are described as cyclic movements of price in the real estate market which, over a period of time, causes fluctuations in the residential and commercial property market. This is a result of the economic, demographic and/or policy changes in the overall market environment.

1.2 Real estate cycles:

The real estate cycles involves periodic shifts of rapid growth of output (recovery and prosperity), alternating with relative stagnation or decline (contraction or recession) over time. Historically, in early 1980s and 1990s the price of new houses appreciated by 300 percent whereas prices of raw land appreciated by 1000 percent. Both subsequently depreciated, ushering in a recession that bottomed out in 1992. The trend post 1993 witnessed an even keel in the house price. (source to justify 300 and 1000 percent The four phases of a real estate cycle viz. Recession, Recovery, Expansion, Contraction. While phases 1 and 4 (recession and contraction) are characterized by rising vacancy rates, phases 2 and 3 (recovery and expansion) demonstrate falling vacancy rates as shown in figure 1. Figure:1 Phases of a real estate cycle

Expansion is accompanied by job and population growth along with high demand on the infrastructure. Equilibrium occurs when prices stabilize. Prices, having reached their maximum limits, less businesses move into, or expand in the area. Recession occurs due to declining job growth, relocation of businesses and depreciating housing demand. During this time, prices become stagnant or even decline as rents and occupancy depreciates. Absorption occurs as prices and occupancy depreciates and the area becomes attractive again to the market. In growing economy, the rising phase dominate the declining phase of the real estate cycle and on an average, there are more years of good times than bad times for investors.
Source Journal of real estate research, Volume 18, No 1, 1999

Indicators of real estate cycle: Implications for India Indu real estate research chair

2. Real estate cycle : Case Studies:

2.1 Indicators of Real estate cycle:
In attempting to identify real estate cycles across global markets, certain key indicators have been chosen. Analysis of these indicators across select markets signify whether a given real estate market is experiencing a boom or a bust phase. The various indicators which affect a real estate cycle are as follows: 1) 2) 3) 4) 5) Population growth Employment rate Gross Domestic Product (GDP) Household disposable income Stock Market values 6) Average House price movement 7) Price to Income ratio 8) Net rental yield 9) Household debt service ratio 10) Interest rate/mortgage rate 11) Demand- supply scenario Figure: 2 Indicators affecting real estate cycle

The above figure illustrates the various indicators affecting a real estate cycle, their corresponding impacts on the real estate cycle and their inter dependency on each other.

2 Indicators of real estate cycle: Implications for India Indu real estate research chair

2. Real estate cycle : Case Studies

The indicators chosen for the purpose of analysis are as follows 1) Average House price movement 2) Price to income index/ ratio 3) Price to rent ratio / net rental yield 4) Debt service ratio The figure 3 illustrates the indicators selected for the analysis of real estate cycle and the pattern of their movement during the boom and the bust phase of a real estate cycle. Figure: 3 Selected indicators and the pattern of their movement during real estate cycles 5) Interest rates / mortgage rates 6) Stock price values 7) Demand supply gap

The markets selected for analysing real estate cycle are United States of America, Japan and the UK. The various macro-economic events that have affected the above mentioned real estate cycle are as follows: 1985: Plaza agreement and Japanese asset boom - The Plaza Agreement was signed by five countries ie France, West Germany, Japan, United States and United Kingdom and it was agreed to depreciate the US dollar in relation to the Japanese Yen by intervening in the currency markets. 1986-1993: Increase in Japanese foreign investment This period was considered as the year of massive Japanese dominance over the world financial market, whereby Japans net long term capital outflow among the G 7 countries appreciated by 90% from 1982 to 1987.

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2. Real estate cycle : Case Studies

1987: Deregulation in real estate market and stock market crash in UK The stock market crash resulted in wealth losses on consumption. Thus the financial institutions eased credit which fuelled the on going real estate boom 19881992: Large inflow of capital in United States of America led to increase in gross national product Accelerated capital inflows started in 1989 which was affected by Japanese manufacturing investments leading to domestic structural reforms. The year 1993 was the peak in which the inflows were the highest. 1988-1993: Increase in cross-country real estate investment Cross country real estate investments were carried out by banks, pension funds and insurance companies for a better portfolio diversification and higher returns. 1991: Financial deregulation and capital market liberalization in United States of America and UK Major structural changes such as removal of restrictions on the establishment of foreign institutions, abolition of interest rate controls and removal of regulations segmenting the financial markets among others were introduced. The timeline of the global real estate cycle across global markets and the various macro economic incidents prevalent during the time is shown in figure 4. Figure: 4: Timeline of global real estate cycles and macroeconomic events

4 Indicators of real estate cycle: Implications for India Indu real estate research chair

2.2 United States of America : Real estate cycle

2.2.1 United States of America : Real estate cycle (1980-2005)

United States has witnessed three real estate cycles from the 1980s. The trend in house prices (i.e house prices adjusted for inflation) during real estate cycle has witnessed periods of appreciation and depreciation since 1975, although instances of nominal price declines have been rare. The three real estate cycles witnessed by United States are 1) 1986-1989, 2) 1995-1998, 3) 2001-2005. The trend of house price reveals that the prices have appreciated at a CAGR of 6.3 percent from 1975 to .2005. Graph 1 below indicates the increase in demand for housing and rapid appreciation in house prices as witnessed by the real estate cycle in the United States from the mid 1980s to 2007. Graph 1 United States real estate cycles (1980 2005)

Figure 5: House- Price change for United States (1975 2006)

Table:1: Timeline of real estate cycle United States Year 1985 - 1989 1986 - 1988 1988 - 1989 1995 - 1999 1995 - 1997 1997 - 1999 2000 - 2003 Timeline Real estate cycle - I Real estate boom phase of cycle - I Real estate bust phase of cycle - I Real estate cycle II Real estate boom phase of cycle - II Real estate bust phase of cycle - II Early 2000s recession Real estate cycle III Real estate boom phase of cycle III Real estate bust phase of cycle III

There has been considerable variation in house prices among different regions in the country as shown in figure 5. The West and the Northeast regions have had greater price appreciation than the national average. Within these two regions, the Pacific and Mountain states have had greater percentage increases in real house prices in recent years than they did in the previous episode of rising prices in the 1980s. States such as California, New York, and New Jersey have been identified as having higher price appreciation and more volatility as a result of limitations on new construction.

house prices are plotted on a logarithmic (log) scale. Schiller (2006)

2000- 2005 2001 - 2005 2005

Table:2: House Price Appreciation in the United States* First Quarter 1995 Second Quarter 2006 Metropolitan Area or Division United States New Jersey Pennsylvania
OFHEO House- price index deflated by CPI Schiller (2006)

% Increase 58.5 65 143.1 8.8 62.6

Indicators of real estate cycle: Implications for India Indu real estate research chair

United States of America : Real estate cycle

2.2.2 Indicators for real estate cycles: Real estate cycle I (1985 1989):
Graph 2: House price (1985-1989)
Gro wth Rate (%)

Graph 3: Net rental yield (1985-1989):

20.00 Growth Rate 15.00 10.00 5.00 0.00 -5.00
8 7.5 7 6.5 6 5.5 5 4.5 4

140 Average Price (USD) (per sq.feet) 120 100 80 60 40 20 0

Ho use P rice (USD) (per sq. feet)

1980

1981

1982

1983

1984

1985

1986

1987

Source: www.census.gov

1988

1989

1990

Source: www.census.gov

Graph 4: House price to income ratio (1985-1989):

Price to income ratio
3.4 3.2 3 2.8 2.6 2.4 2.2 2

Graph 5: Interest rate (1985-1989):

20 15
Rate (%)

3.3 3.25

10 5

Int erest Rate M ortgage Rat e

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989
1988

Source: www.census.gov

Source: www.census.gov

Graph 6: GDP vs disposable income (1985-1989):

8 6 4 2 0 1985 1987 -2 -4 1980 1981 1982 1983 1984 1986 1988 1989 1990 14 12 10 8 6 4 2 0

Graph 7: Demand and supply scenario (1985-1989):

New housing units completed (000)

2,000 1,500 1,000 500 0 1980

New houses sold (000)

Gro ss Do mestic P ro duct (GDP )

Dispo sable inco me (%)

1981

1982

1983

1984

Source: www.census.gov

Observed trends in different indicators between 1985 1989: The rise in house prices, as depicted in graph 2, for the same period reflect the negative relationship between the two indicators. {Ref sec 2.2.3} The house price shows a sudden growth of around 16 percent in 1986 from a low of around 2.5 percent in the previous year, only to sink to a negative growth in the year 1989, as indicated in graph 2. The house price to income ratio as shown in graph 4, for the same timeline though shows a depreciating trend, still the movement is not too sharp. The interest rates and mortgage rates as shown in graph 5, both exhibit a down turn starting with 1985, but they pick up by the end of 1989. For the period when price to income ratio shows a upward trend reaching 3.3 percent in the year 1988, major contribution to this trend comes from the rising prices, in light of decelerating growth rate of disposable income as depicted in graph 4 and graph 6 respectively. The decelerating pattern in the growth rate of disposable income, as indicated in graph 6, could be one of the reasons for the widening gap between demand for and supply of the housing units. The gap in the demand for and supply of new housing units for the period between 1985 and 1989, is more than 100%, with supply being greater than the demand. As the speculative pressure seem to settle down, the gap decreases, but the supply still being reasonably higher than the demand.

1985

Source: www.census.gov

1986

1987

1989

1990

Indicators of real estate cycle: Implications for India Indu real estate research chair

2.2 United States of America : Real estate cycle

Real Estate Cycle: II (1995-1999)
Graph 8: House price (1995-1999):
5 4 3 2 1 0 -1 1991 1992 1993 1994 1995 1996 1997 1998 1999 8 6 4 2 0

Graph 9: Net rental yield (1995-1999):

7.3 7.2 7.1 7 6.9 6.8 6.7 6.6

Gro ss Do mestic P ro duct (GDP )

Dispo sable inco me (%)

Source: www.census.gov

Source: www.census.gov

Graph 10: House price to income ratio (1995-1999):

Price to income ratio 3.35 3.3 3.25 3.2 3.15 3.1 3.05 3 1991 1992 1993 1994

Graph 11: Interest rate (1995-1999)

10 8 6 4 2 0 1991 1992 1993 1994 1995 1996 1997

3.1

3.1

Interest Rate M o rtgage Rate

1995

1996

1997

1998

1999

Source: www.census.gov

Source: www.census.gov

Graph 12: GDP vs disposable income (1995-1999):

5 4 3 2 1 0 1991 1992 1993 1994 1995 1996 1997 -1 1998 1999 8

Graph 13: Demand and supply scenario (1995-1999):

1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 1990 1991
New housing units completed (000) New houses sold (000)

4 2 0

Units (000)

1998

1999
1998

Gro ss Do mestic P ro duct (GDP )

Dispo sable inco me (%)

1992

1993

1994

Source: www.census.gov

Source: www.census.gov

Observed trends in different indicators between 1995-1999: The rise in the house price as shown in graph 8 has been a bit moderate relative to the rise experienced in the previous cycle as shown in graph 2. But the net rental yield as depicted in graph 9, has shown a steady decline through the period, from a stable 7.2 percent for a consecutive three to four years before the bubble set in. The price to income ratio as indicated in graph 10 has remained stable at 3.1 percent all through the period. The interest rates and mortgage rates as depicted in graph 11, both show a downward trend during the period, but unlike the observed trend in previous cycle, the interest rate actually picks up just before the cycle sets in, and then dips. The demand supply gap, as illustrated in graph 13, has narrowed down in this phase of the cycle, unlike the pattern in the previous cycle. The possible reason could be the moderate rising pattern of disposable income growth rate (graph 12) in this phase which was not the case in the previous cycle.

1995

1996

1997

1999

2000

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United States of America : Real estate cycle

Real Estate Cycle: III ( 2000 2005)
Graph 14: House price (2000-2005):
House Price (USD) (per sq.ft) 250 200 150 100 50 0 2000
Growth Rate (% ) House Price (USD) (per sq. feet)

Graph 15: Net rental yield (2000-2005):

15.00 10.00 5.00 0.00 -5.00 G row th Rate
7 6 5 4 3 2 1 0

2001

2002

2003

Source: www.census.gov

2004

2005

Source: www.census.gov

Graph 16: House price to income ratio (2000-2005):

5 4.5 4 3.5 3 2.5

Graph 17: Interest rate (2000-2005)

8 6 4 2 0
Interest Rat e M ortgage Rate

Source: www.census.gov

Source: www.census.gov

Graph 18: GDP vs disposable income (2000-2005):

5 4 3 2 1 0 2001 2000 2002 2003 2004 2005 8 6 4 2 0

Graph 19: Demand and supply scenario (2000-2005):

New housing units completed (000)
2,200 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0

New houses sold (000)

Gross Domestic Product (GDP)

Disposable income (% )

Source: www.census.gov

Units (000)

Source: www.census.gov

Observed trends in different indicators between 2000 2005: During this period of real estate cycle, almost all the indicators show steady trend. The bubble in this period has been identified primarily due to subprime mortgage crisis and the associated market correction. The remarkable feature of this cycle is the gap between the demand and supply for housing units as depicted in graph 19, which is the lowest among all the three cycles analysed so far. The main reason for this phenomena is the subprime lending in this sector. The subprime lending activity was in part demand driven and in part pushed by the State policies.

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United States of America : Real estate cycle

2.2.3 United States : Inferences

The analysis reveals that during the boom and bust phase of real estate cycles, the house prices have subsequently exhibited sharp appreciation up to 14 percent, followed by sharp depreciation. A shift can be witnessed from renting a house to owning a house from late 1990s. The factors that contributed to the shift were depreciation in interest rates, mortgage rates and appreciation in the disposable incomes. The price to income ratio reveals that housing looked relatively cheap when the ratio was 3.0, and expensive at 3.3 times which is a narrow range. It persisted for at least two decades from 1980- 2000. Interest rates now stands at 6.25 percent, compared with 10 percent in the late 1980s and a high of 11.5 percent in the early 1980s. The primary reason for the real estate bust was high interest rates. House purchase constitute a major chunk of the disposable income. This can be explained by the strong relation in the movement of the average house price and the disposable income, with R square at 93 percent and t statistic at around 10. The price movement in USA is more of a demand pull phenomena. This is explained by a relatively higher value of t statistic between demand for houses and the average house price than the t statistic for the supply of new house units and the house prices. One of the main features of the real estate cycles have been declining net rental yield. This could be explains the existence of a trend in the prices. The impact of interest rate is significant but the moderate level of R square suggests that on a one to one basis, not all the variation in the average movements only. Period ( 1980 2005 ) Regression of Prices on demand for house Regression of Prices on supply of house Regression of Price on interest rate t statistic 10.79351 03.095415 05.18395 R square 0.835125 0.29408 0.538831 price movements are explained by interest rate

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2.3 Japan - Real Estate Cycle

The Japanese real estate boom was a period of skyrocketing land prices and it lasted from 1985 to 1990. It is considered as the most famous of the economic booms. The land prices grew by around 28 percent over the 5 years preceding the peak and it witnessed an equally dramatic drop of approximately 22 percent over 5 years after the peak. Macro economic policies factors viz. an overvalued Yen and aggressive lending policies introduced by the financial institutions resulted in large amounts of capital introduced into the property sector. This led to speculation of land investments resulting in increasing prices. Residential land prices in 1990s in Japans six big city areas were 2.6 times those in 1985 and commercial land was 3.9 times as expensive. The time of the collpase hit the property market particularly hard. Investments were made from largely out of the country. When the prices crashed, commercial land value reduced to half, by 1995. Corporate Japan also lost money due to declining real estate holdings. Businesses cut back their plans to spend on plant and equipment, cut back on working hours and salaries of workers thus snapping economic growth. The average price of a 750 sft condominium in Tokyo rose to more than 70 million Yen (USD 625,000) in 1991 from about 25 million Yen (USD 223,000) in the early 1980s. After crashing in the early 1990s, the average house price hovered around 40 million Yen (USD 350,000).

2.3.1 The Japanese real estate cycle (1985 - 1999)

The Japanese real estate cycle lasted from 1985 until 1999, whereby the boom period lasted for around six years from 1985 to 1991 and the bust followed from 1991 until 1999 for a period of nine years as shown in graph 20. The land prices began to increase in around the year 1983 in the commercial districts of Tokyo which subsequently spread to the residential sector and regionally to the suburbs of Tokyo. This steady rise in land prices reached its peak in 1989. The land prices began to level off in 1988 and 1990 in Tokyo and Osaka respectively. The prices began to fall in 1991. In January 1992 the average land prices nationwide fell by 4.6 percent compared to the previous year. Graph 20 Japanese real estate cycle (1985 - 1999)

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Japan Real Estate Cycle

The real estate market followed uninterrupted growth until 1991 except for 1986-1987 due to an overvalued Yen. This was the period of increased investments in real estate due to speculation. For promoting the growth of real estate, large tax reductions were permitted such as real estate acquisition tax, registration tax and transfer tax. Housing loan deductions were extended from six years to fifteen years. The first period from 1992 to 1994 was affected by the economic slowdown with a real GDP growth of only 1.1 percent (from approximately 5 percent in 1990 to 1991). During the period from 1995 to 1997, the Japanese government introduced fiscal stimuli which improved the GDP growth rates to 2.7 percent. The unemployment rates began to increase over this period, (close to 3.5 percent from approximately 2.5 percent during 1992 to 1994). The office workers were the first to be hit due to the economic decline with cuts in the working hours and salaries. Over 1998 to 2000 Japan was at the peak of its crisis with the lowest ever GDP growth of -0.1 percent. This was the period of nation wide decline in disposable incomes and with unemployment rates at an all time high of almost 5 percent.

2.3.2 Indicators of the real estate cycle

House prices House prices reached its peak during 1990 and started steadily declining before bottoming out in 2000 as depicted in graph 21. The prices appreciated by about 28 percent over five years before its peak in 1990 and depreciated by about 22 percent over five years after the peak. The main reason for this was the easing of the monetary policies and the lowering of the interest rates. Graph 21: House price (1985 - 1999)
140 130 120 110 100 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
1999
1999

Index 1985 Q1 = 100

Y ear

Source UN and Japan stat

House price to rent index (reciprocal of net rental yield ) The price to rent curve, as shown in graph 22, matches the trend of the real estate cycle. Owner occupied residences have been stable at an average of 60 percent throughout the cycle. The rentals have witnessed a sharp decrease of 22 percent from 1993 to 1998. This must have been due to lack of policies that favored rental buildings. Focus was laid on measures to bring back the asset prices from the slump. House prices to income ratio The house price to disposable income followed the same curve as that of the real estate cycle, illustrated in graph 23. The peak of this cycle was between 1991 to 1992. Though income and house prices grew rapidly during identical time periods until 1990, house prices were eventually surpassed by the income. Interest rates were also lowered during the same time as that of rising incomes. This led to increasing land prices and this meant that the borrower could bid a higher price for a property.

Graph 22: House price to rent index (1985 - 1999)

140 130 120 110 100 90 80 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 2000
2000

Index 1985 = 100

Y ear

Source BOJ and Standard and Poors research

Graph 23: House price to income ratio (1985 - 1999)

115 110 105 100 95 90 85 80 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
Index 1985 = 100

Source Housing prices and monetary policy in Japan

2000

11

Indicators of real estate cycle: Implications for India Indu real estate research chair

Japan Real Estate Cycle

Interest rates The financial institutions increased their lending activity into the property sector from the late 1980s until the end of 1990. The bust in the economy resulted in large number of non performing loans. In order to remedy this situation the financial institutions were forced to lower the interest rates. The adjoining figure indicates the drop in interest rates on home loans from a high of 5.5 percent in 1990 to the lowest ever drop of 2 percent in 1998.

Graph 24: Interest rate (1985-1999)

9 8 7 6
Rate (in %) City Banks Housing Corporations

5 4 3 2 1 0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Year

Source Japan stat

GDP v/s disposable income Economic growth was triggered due to introduction of monetary policies by the government and due to an overvalued Yen. Real GDP witnessed a growth of 8.6 percent from the mid 1990s to the end of 2000. GDP growth has been negative since 1998 (graph 25). Steep rise in the value of the Yen during the late 1980s contributed to deteriorating employment situation. The unemployment rate rose from 2.1 percent in 1991 to 4.7 percent at the end of 2000 causing a negative growth in the household disposable incomes from 1990 to 1998.

Graph 25: GDP v/s disposable income (1985 - 1999)

8 6 4 2 0 -2 GDP growth rate 8 6 4 2 0 -2 Household disposable income (%)

Source Housing prices and monetary policy in Japan

2.3.3 Japan : Inferences

The rise in house price, as shown in graph 21, in Japan has been more steep than that experienced in the respective period of booms in USA. Though owner occupied residences remained stable at 60 percent, the rental trends are observed to have decreased by 22 percent. This was possibly due to lack of Government incentives for rental accommodation. The price to income ratio , in graph 23, reveals that eventually the house prices were surpassed by the income. This was coincidental with the lowering of interest rates by the Government as a deliberate move, to help the servicing of non performing loans. One of the remarkable feature of the price trends in the Japanese real estate was the rising interest rates during bubble phase. The possible reason could be the easy and massive loans made available for heavy investments. Declining employment rates and disposable income (graph 25) did not affect the household mortgage payment rates. This was primarily due to loosening of monetary policies by the Government and lowering of interest rates. Interest rates, as illustrated in graph 24, were slashed to 2 percent in 1998 from 5.5 percent in 1990 due to the high accumulation of non performing loans.

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United Kingdom Real estate cycle

2.4.1 UK real estate cycle (1986-1991):

UK has witnessed one real estate cycle from 1989 -1991.The late 1980s boom took place due to the appreciation of interest rates again in double-digits. House prices in the UK have appreciated by 169 percent since 1997, whereby appreciation and depriciation of house price booms was due to large quantities of mortgage debt in the system. Since 1970, the average house price for a first-time buyer has risen by approximately 3,100 percent but the average income of this group of borrowers has increased by only approximately 1,900 percent. For first-time buyers, house prices have appreciated the most in London where the increase was 3,432 percent followed by the South West with an increase of 3,427 percent. At the other end of the scale, Scotland has recorded house price growth of just 1,900 percent. In 1970, the average house price for a first time buyer in Scotland was 4,200, or 70 percent of the average price in London of 6,100. By 2005, the average price in Scotland had risen to 85,500, but this represents only 40 percent of the average 2005 London price of 216,000. (Source Research by Halifax Agents) Graph 26 UK real estate cycle (1986 to 1991)
2,500 H ou se Price (p er sq m eter) 2,000 1,500 1,000 500 0 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source www.statistics.gov.uk High interest rate Increasing no of non performing loan

The trend from 1980-2005 reveals that the UK witnessed an extraordinary appreciation in the demand for housing followed by a subsequent increase in the house prices. Smaller cities, have an average population of less than 250,000 recorded the largest appreciation in average price per square meter. House prices have appreciated by triple fold in 15 cities and at least doubled in all 62 cities since 1996. The majority of the cities recording the biggest increases are in Southern England, but Salford and Newcastle also feature in the top 10. Brighton (260 percent), Salford (255 percent), London (252 percent) and Bath (236 percent) follow Truro in the top five. (Source Research by Halifax Agents) Scottish cities dominate the list of cities experiencing the smallest increases in house prices on a per square meter basis during the past decade. Three of the bottom five cities are north of the border: Aberdeen (104 percent), Stirling (122 percent) and Glasgow (126 percent). Southampton (132 percent) and Preston (133 percent) are the other cities in the bottom five. (Source Research by Halifax Agents)

13 Indicators of real estate cycle: Implications for India Indu real estate research chair

United Kingdom Real estate cycle

2.4.2 Indicators for Real Estate boom and bust cycle UK

House Price: UK average house prices have witnessed a phenomenal appreciation of 768 percent from 1980 to 2006. House price of homes have appreciated at a CAGR of 8.34 percent from 1980 to 2006. The trend in cycle I (1989-1996) as shown in graph 27, reveals that during boom phase (1989-1991) the prices have appreciated 42 percent from 349 /sq.mt to 602 /sq.mt. and depreciating to almost 3 percent during the bust phase. Graph 27: House Price (1986-1991)
2,500 20

House Price (per sq meter)

2,000

15 Growth Rate (%)

1,500

10

1,000

500

0 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

-5

Grow th Rate (%)

House Price

Source www.statistics.gov.uk

Interest Rates : The average or effective mortgage rate that UK households pay has steadily declined over the past 20 years. It now stands at 4.65 percent, compared to the 10 percent during the late 1980s and a high of 16.6 percent in the early 1980s. As the graph 28 shows, the effective interest rates have steadily depreciated over a period of time from 1980 to 2005. at a CAGR of 4.69 percent. The trend reveals that interest rates during the cycle-I (1986- 1991) as shown in graph 28 have appreciated and depreciated for the UK i.e. in 1987 the rate was lowest 9.62 percent and then appreciating during the bust phase to 14 percent in 1990. Disposable Income vs Gross Domestic Product (GDP) : The disposable personal income from 1980 to 2005 has appreciated at a CAGR of 6.7 percent. If we observe cycle - I (1986- 1991), the disposable personal income has decreased for the UK i.e. in 1986 the disposable income appreciated to 7.5 percent and subsequently depreciated to 5.1 percent during the bust phase in 1991. On the contrary the GDP during cycle-I (1986-1991) was 4 percent during boom phase, depreciating to .1.4 during bust phase in 1991 as depicted in graph 29.

Graph 28: Interest Rate (1986-1991)

18 16 14 12 10 8 6 4 2 0

Rate (%)

Graph 29: Disposable Income to GDP (1986-1991):

20.0 15.0 10.0 5.0 0.0 -5.0 Disposable income GDP

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source www.statistics.gov.uk Source www.statistics.gov.uk

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Indicators of real estate cycle: Implications for India Indu real estate research chair

2.4.2 United Kingdom : Inferences

The analysis reveals that during the boom and bust phase of real estate cycle the house prices have subsequently appreciated by 42 percent and depreciated to 3 percent during the bust phase. Interest rates now stands at 4.65 percent, compared to the 10 percent during the late 1980s and a high of 16.6 percent in the early 1980s. Disposable personal income has decreased for the UK i.e. in 1986 the disposable income appreciated to 7.5 percent and subsequently depreciated to 5.1 percent during the bust phase in 1991.

15 Indicators of real estate cycle: Implications for India Indu real estate research chair

3. Indian real estate cycle

The Indian real estate market, during the early 1990s, was highly unorganized and fragmented with issues which ranged from lack of institutional funding support to developers, absence of world class developers to limited consumer demand due to unavailability of easy financing options and lack of transparency in the market. In this section we shall discuss the Indian real estate cycle, and the trend in the different indicators, then we shall compare the trend in the price movements in Indian real estate market and that of USA, Japan, and UK and would try to look for similarity if any. We shall then attempt to analyse the demand and supply scenario of Indian real estate market, and analyse the future trend. The role of the government would also be analysed in this respect.

3.1 Indian real estate cycle

The Indian real estate cycle lasted from 1990 until 1999 whereby the boom period lasted for a period of six years from 1990 to 1996 followed by the bust from 1996 until 1999. The prices began to level off from 1999 onwards. The residential property prices in some markets have recorded a growth of approximately 15 to 20 per cent in the last two years and have witnessed substantial activity in the year 2004 -05. Graph 30: Indian real estate cycle (1990-1999)

The last decade witnessed a frenzied boom in the residential property prices. This boom was artificially created where it was backed primarily by the boom in the stock market that was kicked off in 1991. The prices appreciated sharply during 1994 to 1995 whereby it witnessed a phenomenal growth of almost 420 percent from 1990 to 1996. The stock market and real estate markets crashed in quick succession just a little after 1995. This was followed by a prolonged period of about 8 years of little or no appreciation in real estate. A reversal in trend has been witnessed over the past 2 to 3 years with real estate prices inching up backed by strong demand. This demand in turn is primarily being driven by strong demographic trends and the emergence of a favorable environment for real estate investment.

16 Indicators of real estate cycle: Implications for India Indu real estate research chair

3.2 Indicators of the real estate cycle

House prices Average house prices in Mumbai hit its peak during 1994 to 1995 as indicated in graph 31. The prices increased at a CAGR of 3 percent from 1990 to 1996. This boom lasted only for 4 years from 1992 till 1996 before bottoming out in 1999. The bust period lasted for 3 years from 1996 until 1999 where the prices dropped by 60 percent. This boom and bust was created due to the stock market rise and crash respectively. GDP v/s disposable income Economic growth in India was triggered by the economic liberalization of 1991. One of the consequences of this was the approval of FDI into many sectors. The economy had grown at a constant excepting a few major setbacks. As shown in graph 32, the rise in disposable incomes was steady until 1998. Employment opportunities brought in by the IT/ITeS sectors resulted in a sharp rise in disposable incomes during the period from 1998 to 2001. The disposable incomes have been growing at a steady pace since then. House price to disposable income The house price to income follows the same curve as that of the real estate cycle (graph 33). A large amount of investment in real estate was witnesses during the peak period. This trend was mainly backed by speculation. After a sluggish period from 1998 to 2004, this trend has picked up primarily due to sharp rise in property prices backed by rising income levels and an investment friendly. This allows the borrower to bid a higher price for a property. Interest rates Financing option for real estate, during the 1980s and early 1990s, was fairly unorganized and bureaucratic in nature. Financial institutions increased their lending rates and it reached an all time high at 17 percent (graph 34) during 1995 to 1996 which hampered the inflow of capital into the property sector. As a remedy to this situation significant transformations have taken place on the financing side whereby interest rates have been reduced drastically along with lenient lending policies. Lending rates recorded an all time high of 17 percent in 1995 to 1996 and reached an all time low of 7.5 percent during 2005. Graph 31: House price (1990-1999)
70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 -20.0 -10.0 9000 8000 7000 6000 5000 4000 3000 2000 1000 0

Graph 32: GDP vs disposable income (1990-1999)

9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Disposable income growth rate (left axis) GDP growth rate (right axis)

19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07
Average house price grow th rate (left axis) Average house price (INR/sft) (right axis)

Source Industry sources

10 9 8 7 6 5 4 3 2 1 0

G ro w th rate (in % )

Source UN stat and Mckinsey research

Graph 33: House price to disposable income (1990-1999)

80 70 60 50 40 30 20 10 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Price to income

Source UN stat, industry sources

Graph 34: Interest rate(1990-1999)

19 17 15 In % 13 11 9 7 5 1 990 1 991 1 992 1 993 1 994 1 995 1 996 1 997 1 998 1 999 2 000 2 001 2 002 2 003 2 004 2 005 2 006 2 007 Interest rates

Source UN stat, industry sources

G ro w th rate (in % )

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Indicators of real estate cycle: Implications for India Indu real estate research chair

India: Demand - Supply scenario & Policy Perspective

Growth Drivers The Indian real estate market is growing at an annual growth rate of 30% (Source NorthBridge Capital Research, June 2007). Factors such as the high GDP growth, strong demographics, positive urbanization trend and increasing disposable income are causing a demand pull in the real estate market. On the other end, factors such as favorable policy/ regulatory changes, positive investment climate and unlocking of land parcels are the supply factors changing the dynamics of real estate market in India. Graph 35: Housing shortfall in India
Housing Shortfall in India Shortfall (mn) 25 20 15 10 5 0 1961 1971 1981 1991 2001

T o tal

R ura l

Urba n

According to the National Building Organisation (NBO), the total demand for housing is estimated at 2 million units per year and the total housing shortfall is estimated to be 19.4 million units, of which 12.76 million units is from rural areas and 6.64 million units from urban areas. According to 2001 national statistics as depicted in graph 35, there was a total of about 187,162,172 residential dwelling units nationwide and the gap between supply and demand in residential market is 41 billion sq.ft. The persistent gap between demand for and supply of housing units as pointed out by the NBO study can be explained by the fact that major contribution to the shortfall of housing units comes from rural area. With more emphasis on the supply creation in urban centers, the gap is only going to widen, and thus putting further pressure on the prices. Future demand As per Detusch Bank research approximately 4.7 million housing units would have to be completed up to 2030. This estimated figure is based on additional demand of roughly 2.7 million housing units and annual replacement demand of roughly 2 million dwellings as indicated in graph 36. The housing markets have appreciated considerably from 2003 - 2004. Strong demand stimuli have caused shortages in housing in cities, pushing up residential property prices. The Government on its part is also giving policy incentives (discussed in the next section), towards the movement of capital in the real estate sector. Enabling Policy and Regulatory Environment Government incentives such as favorable reforms ensuring easy project financing, increased fiscal incentives and simplification of government procedures assisted the real estate developers to expand their horizons and improved their risk appetite for large scale projects. Incentives on project financing Policy to permit FDI up to 100% in housing, townships, built-up infrastructure and construction development projects. This paved the way for a significant capital infusion to the capital intensive sector through Foreign Institutional Investors (FIIs), Venture Capital (VCs) funds etc. The Government has also lowered the floor on minimum land area for FDI investment to 25 acres from an earlier 100 acres. This move has triggered a spurt in construction activity especially in urban areas as developers are now able to source foreign funds for developments on smaller parcels of land in congested metros. The Government allowed FIIs to take part in Initial Public Offerings (IPO) and pre-IPO placement of real estate companies. The Government is also evaluating proposal to introduce Real Estate Investments Trusts (REITs). REITs will give international investors a familiar means of investing in real estate, which would provide an impetus to the existing real estate market.
Deutsche Bank Research

Graph 36: Demand for new housing (2005 2030)

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Indicators of real estate cycle: Implications for India Indu real estate research chair

Fiscal Incentives for supply creation Tax holiday of 100% for profits derived by an undertaking engaged in developing and building housing projects in the country. The new SEZ Act, 2006 has also provided for 100 per cent tax holiday for profits derived by an undertaking engaged in development of a SEZ, exemption from levy of MAT etc. Focus on Urban Infrastructure Development The increased focus of Indian government on urban infrastructure development has led to emergence of newer locations and has significantly induced the real estate activity. Public authorities like housing boards and development authorities are now taking special initiatives for provision of housing, which creates strong competition to the private developers and also provide a wide range of options to the urban consumers.

3.4 Real Estate Cycles: India v/s the global market

The above table signifies that the indicators have similar impacts on the property prices during the real estate cycles across global property markets. One remarkable result which comes out of the econometric exercise is the similarity in the magnitude of impact of interest rate movements on the real estate price trends, observed between India and USA.
Table 4 - India v/s global market United States Indicators House Price Net Rental Yield Price to Income ratio Interest Rate / Mortgage Rate Disposable Income and Gross Domestic Product Supply and Demand Scenario
Not available Not available Not available Not available

Japan Boom phase Bust phase Boom phase

UK Bust phase

India Boom phase Bust phase

Boom phase

Bust phase

The R square estimate and t statistic between interest rate and price trend, in the case of both the country, is almost the same for the period between 1994 and 2006. In case of the impact of disposable income on the trend in the price of housing units, though there seems to be a valid one to one relationship between the two in the case of both India and USA, but disposable income seems to be having more strong effect on the prices in the case of USA, than in India. Which also holds true, as the trend in the case of India happened more because of the stock market bubble. It is evident that the Indian real estate cycle was an unnatural occurrence whereby property prices were artificially corrected due to a boom in the stock market. After a brief period of stabilization in these prices, a significant boom can be seen over the past few years. There is no significant rise in the prices of residential property over the past six months and these prices are expected to stabilize in the next few years.

19 Indicators of real estate cycle: Implications for India Indu real estate research chair

References
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Indicators of real estate cycle: Implications for India Indu real estate research chair