Un­der­stand­ing the ef­fect in­fla­tion has on re­alty prices

Big de­vel­op­ers do not re­sort to cost re­duc­tion even when buy­ing seems to slow down be­cause of in­fla­tion

HT Estates - - HTESTATES - HT Es­tates Cor­re­spon­dent

There are sev­eral dif­fer­ent ways of un­der­stand­ing the con­cept of in­fla­tion. One way to ex­plain it in a way that most of us can re­late to is the be­hav­iour of spec­ta­tors of a cricket match in a sta­dium. On see­ing some in­ter­est­ing ac­tion on the field, the peo­ple in the front row rise to their feet to get a bet­ter view of the ground. As the view of the peo­ple in the rows be­hind is ob­structed, they rise to their feet as well. This be­hav­iour then trans­fers it­self to ev­ery­one present in the sta­dium and soon enough, ev­ery­one is stand­ing.

In sim­ple terms, this is how in­fla­tion works. The in­crease in price of one com­mod­ity leads to a price rise of a sup­ple­ment­ing prod­uct, and soon enough in­fla­tion spreads uni­formly through­out the econ­omy. Many be­lieve that this dy­namic is also ap­pli­ca­ble to the rise of prop­erty prices. How­ever, this is quite in­cor­rect. A proper anal­y­sis will re­veal that in­fla­tion does not quite im­pact real es­tate prices in this man­ner.

In­fla­tion, as put forth by econ­o­mists, is a global phe­nom­e­non that is largely gov­erned by the cost of credit. While the prices of es­sen­tial items like food­grains or fuel rise, the in­come of the com­mon man re­mains at the same level. In eco­nomic terms, the con­sumer’s dis­pos­able in­come or spend­ing power de­creases. Banks in turn, wit­ness­ing that the ba­sic cost of living has in­creased, work on re­cal­i­brat­ing their loan in­ter­est rates higher.

This brings us to how both con­sumers and de­vel­op­ers are de­pen­dent on the cost of bor­row­ing ( the in­ter­est rate on loans). Since in­ter­est rates have risen, the com­mon man is now more averse to any kind of debt, which in­cludes a home loan. Con­se­quently, some real es­tate de­vel­op­ers, fear­ing a se­vere busi­ness slow­down, are likely to re­sort to low­er­ing their prop­erty prices so as to re­vive buy­ing sen­ti­ment.

This dy­namic is of­ten seen among smaller de­vel­op­ers with a limited num­ber of projects, es­pe­cially play­ers op­er­at­ing in Tier 2 and Tier 3 cities where de­mand is not high at most given times. In such cities, the re­duc­tion in prop­erty prices as a re­ac­tion to in­fla­tion can be viewed as a method of sur­vival.

A jus­ti­fi­able ques­tion here would be how such de­vel­op­ers are able to re­duce their prop­erty rates when in­fla­tion­ary pres­sures push down de­mand. The an­swer is that land ac­qui­si­tion and prop­erty devel­op­ment costs in smaller cities re­main more or less con­stant and in­crease only a lit­tle bit over a long length of time. Price re­duc­tion is in­deed the last re­sort, but also the only op­tion left with th­ese de­vel­op­ers.

In case re­duc­tion in prop­erty prices fails to at­tract buy­ers, de­vel­op­ers will ul­ti­mately be forced to sur­ren­der their project (and other as­sets) to the bank and de­clare bank­ruptcy. In many cases, they are likely to sell their build­ings and land parcels to big­ger, more es­tab­lished de­vel­op­ers with bet­ter cap­i­tal­i­sa­tion. This is how con­sol­i­da­tion takes place, wherein the big­ger play­ers are al­ways win­ning.

For big­ger de­vel­op­ers the other hand, the sce­nario is quite dif­fer­ent. Since they have been in the busi­ness for quite a long pe­riod of time, they have been able to cre­ate a good sat­u­ra­tion of as­sets and achieve higher de­grees of cap­i­tal­i­sa­tion. This works in their favour in sit­u­a­tions of un­re­lent­ing in­fla­tion when debt fund­ing be­comes more ex­pen­sive. Their in­vest­ments are pri­mar­ily in larger projects and de­spite the ris­ing bor­row­ing rates, th­ese prop­erty prices re­main the same. What keeps them afloat is their cap­i­tal.This is why big­ger de­vel­op­ers do not re­sort to cost re­duc­tion even when buy­ing seems to slow down be­cause of in­fla­tion. How­ever, it is also true that they do not have the op­tion to raise their prop­erty prices ei­ther, since this would only help com­pet­ing de­vel­op­ers lure away buy­ers from them.

In other words, for re­alty projects by large de­vel­op­ers in qual­ity lo­ca­tions, in­fla­tion will only keep the prop­erty prices static be­fore they move up again, fol­low­ing the nat­u­ral course of econ­omy. For prospec­tive home­buy­ers, un­der­stand­ing th­ese ex­act ways of how in­fla­tion can af­fect prop­erty prices in dif­fer­ent lo­cal­i­ties can be an im­por­tant fi­nan­cial con­sid­er­a­tion.

THINKSTOCK

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