Question from a reader:
My housing loan is being disbursed in stages as my house is getting complete. My bank charges me only the interest until I get possession. Can I pay the Full EMI instead?
Of course you can. Banks don't want you to, largely because it increases the total interest you have to pay.
With the real estate situation in India getting too hot, it seems our folks have found better opportunities elsewhere.
Rohit Prakash, based in Austin, Texas , has for long been doing brisk business helping Americans and foreigners buy and sell property in the capital of one of America's biggest states.
Recently, he set up American Full House to cater to Indians looking to buy homes in locations that have seen a huge price drop. An Indian buyer who contacted him sometime ago is close to doing two deals in a suburb of Los Angeles at $82,000 and $85,000 each for a three-bedroom condominium. At the peak of the housing boom, these properties were selling at close to $250,000.
A 3 bed flat at $82,000 near Los Angeles? That's about Rs. 35 lakhs. In comparison the apartment I live in (I rent) is at the outer edge of Gurgaon and sells for 1.2 crores, for a 3 bedroom.
I couldn't find anything of that sort on Craigslist for California, but I saw this house - a 1400 sq. ft, 3 bedroom house on a 7,500 ft lot at El Monte for $289K. That, in comparison with the 2 cr.+ ticket size for that kind of land (house or no house) in NCR (and the same for most of developed India), is cheap.
Expect more of this as US prices come down; that Indians will consider buying. Of course, the rental yields don't make sense for India, but we are very big on capital appreciation. It would make a lot of sense though to set up a fund that will buy and hold such properties, perhaps next year. Gives me ideas!
An incredible video by the Australian SBS DateLine on China. 64 million apartments are empty!
The empty malls and overconstruction seems just like Gurgaon's Sohna Road or indeed much of the out-of-city developments in most metros. Sohna Road has like 10 malls, nearly all of them bare empty. Developers are holding on to price points like nobody's business, and "investors" are waiting for the upmove.
If China drops, then India drops too. We will eventually blame it on an external event, because everyone inside is invested. What isn't really accurately known is how levered our economy is on real estate.
I got a couple of emails that asked me about the new phase of real estate offers that go something like this:
(Yes, it's real. Actual screen shot of this page)
Other variations of such plans are like this:
What's this all about? A guarantee of a return?
It's like this: The real estate developer can't finish the project, and needs money. No bank is going to lend him any more money because honestly banks are up to *here* with their real estate exposure to developers and soon, unless the RBI extends the mark-to-make-believe that they started two years ago, all the banks are going to have seriously soiled diapers.
So, they can't get money from banks. But they can borrow from you. At 12% the loan is ridiculously cheap, compared to even bank rates of 15%+. In the above image example, they expect you to pay the full money in 90 days, except the apartment will not even exist then. So you're paying for, literally, thin air. And someone's giving you 12% return for that. Sure, there's an agreement and all, but when was the last time you enforced an agreement in India, huh?
You'll bite, and hopefully, the builder will finish the apartment and give it to you. Or, you might be able to palm it off before that to another buyer who's even more kicked about this project. You'll end up making some money and feeling darn good about it, even if now, most of your gains are "black" and need to be put into another ...hold your breath....property. This gets bigger and bigger and at some point it all goes *pop*. And that's if it doesn't go *pop* before you make any money. But don't take my word for it, how would I know.
Second, notice the term "lease rent". It seems there is some sort of scam going on in Noida where property is not given to you freehold, but is leased out for 99 years. With the propensity of people to believe they actually own what they buy (what's the world coming to, nowadays) this kind of deal should be carefully examined through multiple lawyers.
The "Take a loan, and builder will pay your EMI! Till possession" scam is a variant. Builders can't get a loan. But *you* can. Meaning, *you* take the loan from the bank, and give the money to the builder . The bank has no problem funding you because you, sir, are a nice clean individual with other assets such as cars and perhaps children that banks can take hostage in case you show jitters in paying back. (I'm only kidding. They don't necessarily take cars.)
(By the way, the real estate fellows only pay interest. They don't pay back the principal. Fine print.)
The apartment is the collateral, but it is not yet built. Remember, the collateral, in India, is just one piece of the pie - should you default, and they can't recover the entire money by selling the collateral, you will have to find the money elsewhere. Some people think that they can run away and the banks can't find them. In a few years, after UID and all that, the banks *can*.
Sometimes banks are happy to loan you money, because they probably own the non existent apartment as collateral ANYWAY. Your taking the loan allows them to recover what they lent to the builder, plus it will cover a little more to actually build the place, hopefully, with the risk transferred to you, an individual. In RBI's terms you, as an individual borrower, are a lower risk asset.
Your biggest problem is what happens if the builder doesn't complete the project. UID or not, you won't be able to get him to do anything, not unless you're too rich to be reading this blog.
There are altogether too many builders using these schemes. One project in Bangalore offered a fancy car if you booked a project (you HAD to take a loan, of approximately 3.6 crores. The car was a gimmick :) ). A friend tells me of a famous builder offering returns of greater than 24% a year, officially. Official web pages of properties state the return guarantee or EMI subvention gladly. There is way too much demand for money, and desperate folks make dangerous mistakes. If you're considering buying now, and the "guaranteed return" seems attractive, consider yourself warned.
My article at Yahoo: Cutting Real Estate Down To Size on their Budget Site.
In an economy that is seeing ridiculous levels of increase in real estate prices, it is strange that we continue to give it sops, sometimes to an extreme. Let me list the ways real estate is "preferred" as a mode of investment.
First, you are allowed an income tax deduction of Rs. 150,000 on the interest paid for the home you live in. This, you think, is justified; you are also allowed a deduction (without limit) on any education loan. But it doesn't apply to any other loan you ever take - car loans, personal loans, a loan to buy that fridge that ensures your food doesn't rot and so on. I would recommend that either all interest paid on a loan for ANY durable - like cars or fridges - be tax free. After all, the government charges the bank income tax on that money.
Or, they must remove the special exemption for housing loan interest completely. Education loan exemptions are far less kind; they should stay, for the only reason that education is far more useful. A house is only as useful as a car nowadays.
Second, if you buy a second house, you're allowed to deduct an unlimited amount of interest paid on the loan. Again, just because no other item on your personal balance sheet is allowed that kind of deduction, I say remove it for housing, or let everything else in. How can you incentivize SECOND houses, for goodness sake!
Third, lower housing loan rates. Have you ever wondered why you get cheaper housing loans, but no other type of loan is cheap? It's not the fact that the "collateral" - the house itself - is easily sellable, and housing prices don't go down. No, if that was the case, I should be able to get a cheap loan if I give my house as collateral against, say, a personal loan. And I can't - those rates still stay beyond the 18% range, while home loans are at 10%.
The answer is in the "risk weight" of housing loans. Banks are allowed to borrow (deposits) and lend (loans), but they have to have their own skin in the game. The amount of such skin is determined by the the kind of loan - a housing loan (for acquiring a house) gets a lower capital requirement than, say, a car loan or a personal loan. A bank has only that much capital, they can lend out more money where they have a lower risk weight and not quite as much to others, so housing gets a better interest rate. RBI has been trying to fix this recently by providing for a much higher risk weight when the loan crosses 75 lakh rupees, a good sign. Read the rest of this entry »
(Thanks to @Work_ant for mentioning this)
HDFC increased its Retail Prime Lending Rate (RPLR) to 15% yesterday – see pic below - , up 75 basis points (0.75%) from December 1. This follows an increase in RPL increase of 0.5% on September 1.
(Excuse the horrific graphic skills)
They’ve also stopped their teaser home loans – offered at 8.5% until March 2011, and 9.5% till March 2012, with a floating rate thereafter. Typical “thereafter” rates were RPLR minus 5% (4.75% to 4.5% advertised, but many have negotiated to 5%)
That means if interest rates stay where they are, home loan buyers will end up paying 10% on their home loans post 2012, and further increases till then will hurt them more.
To give you an idea, imagine a Rs. 50 lakh loan taken in October 2010.
The 8.5% teaser rate would involve an EMI of Rs. 43,400 till March 2011.
If you took the loan in October, you’d have paid 6 EMIs till March 2011. That leaves a balance of 49.5 lakhs, which takes the EMI up to Rs. 46,500 in 2011.
In 2012, the rate resets to, say, 10%. That takes the EMI up to 48,100 – with another 18.5 years remaining. That means EMIs go up 1.1x from current. Manageable, one might think – a 10% hike is less than inflation, currently.
But if the rate went up to 12% effective (RPLR went to 17%, say) – the EMI will be 54,500, which is 125% of the current payment. Given that there is no restriction on RPLR – HDFC can set what it wants – there is no reason to assume that rates will remain in sane boundaries. As RBI raises rates, money gets scarce, and the cost of borrowing of an NBFC like HDFC goes up, and they will raise rates accordingly.
You want to know how expensive money is? RBI conducted an auction today for T-Bills – the safest form of debt, since it’s government guaranteed. The 91 day T-Bill sold for 6.94% and the 364 day for 7.27% (all annualized, btw). That’s what the government will pay to borrow, for less than a year. And the 10 year T-Bond rate is 8.11%, and the 30 year, 8.43%. With the spread that small, we’re speaking of a very flat yield curve, and the rule of thumb is that financial institutions make loads of money on a steep yield curve (they borrow short term and lend long term) but not so much when the curve is flat.
It seems 27% of HDFC’s loans are in the teaser rate scheme. That’s more than 25,000 cr. - which means if interest rates stay high, the reset rates will hit these consumers hard.
Since they’ve stopped teaser loans, all new floaters will likely be at 10% or more. How much that will help offtake is something time will tell – but it is likely to hurt sales. Even then, I think the stopping of teaser loans is good – there is some level of systemic risk such loans introduce.
Disclosure: No holding in HDFC.
The CBI yesterday busted a scam where executives in banks and fin-organizations took bribes (surprise!) to give real estate developers large loans. Among the arrested were a director of Central Bank, and senior executives of LIC Housing Finance, Punjab National Bank, Bank of India and an intermediary called Money Matters Financial Services (MMFS). MMFS was the go-between; they would organize loans by bribing these officials, and take a cut of around 5% from the RE company (one such was DB Realty).
Nearly all the people interviewed on TV seemed to think this wasn’t a big deal – it happens, it is reality. Implying perhaps that we shouldn’t be angry? Perhaps relatively true, in a situation where there is so much to be angry about – the 2G scam, Yediyurappa, Reddy Brothers, Adarsh in Mumbai, The CWG scam, Kalmadi’s arrogance, Lalit Modi and the IPL, and I must stop here. The amounts too – sub 1 crore worth bribes – are not even worth the CBI’s time, honestly, so this was done to either deflect public anger from the bigger scams, or to just arrest someone who didn’t hold the political system to ransom.
Either ways, the consequences are weird – the stocks of LICHF, Central Bank, PNB etc. fell like crazy – more than 5%, and some upto 20%, on the news. They have recovered somewhat, but I expect more news flow to damage the stocks – the news channels don’t give up this easy, and they do sway sentiment in a thin market. Now, what does this otherwise mean?
Think about it. Banks will now be even more careful of lending to real estate. After RBI’s recent RE loan tightening, real estate developers are probably finding it tough to get money to complete their projects. Since they were (indirectly) bribing bank officials, they probably had shady stuff as collateral – otherwise why wouldn’t banks be trying to lend more to them anyhow? And now, with the scam out there, not only will bankers refuse the bribes, they might not even want to lend to legit projects for fear of a probe. Simply put, RE developers have a liquidity problem – no money, and further sources are drying up. Plus, the new norms have made the loans tough for borrowers.
Over the last few years, with real estate going up, (anecdotally) developers have levered up on their own projects. Instead of selling all the apartments early, and then watching as prices doubled as the project neared completion, many developers have taken to keeping inventory with themselves, holding out for a better price. This comes to bite them now – if they had sold their properties upfront, they could delay the project until cash was easier to get. Sure, that’s havoc on the poor investor or home buyer, but that’s not really the developer’s problem in a crisis. But with their own money stuck, they have to raise the money to finish the projects. My feeling is: they’ll sell properties at lower rates.
This can only mean a fall in real estate prices. This theory that will take time to play out, but in a crisis, time intervals become distressingly short. All RE stocks seems to be down today – from 3% in DLF to 6% in HDIL.
But there are ways out – RBI can’t handle another systemic crisis so they may relax these restrictions, or make loans available temporarily. Banks still do quasi-lending to developers, with offers such as – you take the loan, the builder pays the EMI. I’ll write about that later, but it is a functioning source of debt today, and much less expensive than the 13% they seem to have snagged in the bribery tainted loans. It’s not game over yet.
Disclosure: No RE positions. I recently got out of all banks as well. This is an opinion piece, and if there is data to refute or support this please let me know.
At Yahoo, I write: Seven myths of buying pre-construction apartments
Buying a house that will be constructed in the next few years is perhaps the only way a few of us will be able to afford to buy, but the process isn't entirely without roadblocks. Here are seven points you hear in favour, and my take on them.
Disclosure: I may be biased - my father booked an apartment in 1980, and was only given possession in 1991.
1. Prices are ridiculous but they will get more ridiculous.
Real estate prices never fall, they say, and if you can't buy now you'll never be able to get on that train. But when a train's going way faster than sane speed limits, do you really want to get on? Sure, prices in India have gone only one way in the last 20 years - bar a few years in the 80s and 90s, and perhaps one year in 2008. When Japanese house prices crashed in the 90s (they still remain depressed), people in the U.S. thought that could never happen to America; 10 years later we see a U.S. housing bust of Japanese magnitude. Just because we haven't seen enough doesn't mean we're immune. Of course, if you choose to live in the apartment it doesn't really matter. Read the rest of this entry »
Copyright (C) Deepak Shenoy 2005-2012
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