India’s Residential Property Market : After One Year high appreciation is predicted..!

By Mr. Himadri Mayank, JLL India

Mr. Himadri Mayank, JLL India

In the year 1959, Mr. Charles E Lindblom, the American political scientist, published a paper in the Public Administration Review entitled The Science of ‘Muddling Through’. In this, he contrasted what he called the ‘root method’ of decision-making with the ‘branch approach’.
 

The root method involves comprehensive evaluation of options in the light of defined objectives, whereas the branch method involves building up, step-by-step & by small degrees, from the current situation. Prof. Lindblom claimed that the root method was, in fact, not usable for complex policy questions. His verdict was that the practical individual must follow the branch approach – applying the science of muddling through.

Residential Property Market..!

The residential property market in India, particularly in the Tier I cities, has remained sluggish for the last one year, with significantly lower sale volumes when compared to the high absorption rates of  2010. Home loan interest rates now seem to be at their cyclical highs, But should soon decline & unforeseen tax levies have come at a time when the industry is facing its moment of reckoning.
 

In these uncertain times, the question arises whether strategic decision making for residential property developers to improve sales should follow the root method – a comprehensive evaluation of options, or the branch approach – a process of muddling through. In a multiple stakeholder environment with several large uncertainty input parameters, the branch approach seems to be the instrument of choice.
In adverse market conditions, developers want to ascertain facts on some key issues. 

They consider whether they should:
# Lower prices in on-going projects
# Proceed with construction
# Launch new projects at lower prices
# Sell non-performing assets such as land
# The ‘Logic’ Of Residential Property Pricing

While others require comprehensive evaluation, determining residential property prices usually entails a trial & error approach. During good times, prices are invented. When the going gets tough, prices are discovered (hence the term ‘price discovery’).
 

Developers continually assess the market with trial price levels to increase sales in on-going projects. To avoid adversely signalling the market (which could lead to a downward spiral) prices in on-going projects are kept ‘sticky-upward’.
 

In the first phase, negotiations are held behind closed doors to test the market’s appetite. If sales do not recover, discounts are offered up-front on the table. If there is still no perceived recovery, discounts are advertised to increase visitors to the sales office. At this stage, the market is said to have witnessed a correction. This is fundamentally a process of ‘muddling through’, in which residential prices offered by developers in on-going projects rise like rockets but fall like feathers.
 

However, during a slowdown, developers try to register sales by launching new projects which are different from on going projects  and priced much lower than the market average (the price levels being decided by the root method of decision making). Since new projects have a high construction risk, the lower price is somewhat justified and avoids the signalling effect to the market.

Trouble Ahead....?

Is the Indian residential property market headed for a hard landing? During the slowdown in the year 2009, prices in some on going projects witnessed corrections while a large number of projects maintained stable prices. New launches were made at highly discounted prices; subsequently, a significant rise in absorption was observed as prices were termed ‘affordable’. Prices then increased rapidly by as much as 30 to 40% (mostly in newly launched projects) across Indian Tier I cities until end the year 2010, followed by slower growth in 2011.

However, all predictions of a hard landing for the residential property market in 2011 have failed to come true. Despite slow sales, highly leveraged balance sheets, expensive finance in a high interest rate environment &  rising input costs, developers have been able to avoid a market-wide crash. They have been able to generate sufficient cash flow through the gradual process of price discovery, and several factors are in their favour in the near term.
Top seven Cties..!
Over 60% of residential launches in the top 7 cities (mostly in cities other than NCR- National Capital Region and Mumbai) are priced from  Rs. 2,000 to 4,000 per square feet, which meets the demand of middle income group buyers
The RBI (Reserve Bank Of India) has given sufficient indications of probable cuts in key rates during second  half of 2011- 12, which will improve affordability for house buyers & provide lower interest costs for developers
Prevailing absorption rates at about 10 to 12% translate into an average absorption period of 8 to 10 quarters for a residential project. This implies that at average prices, any average residential project should be sold out before construction is completed
 

New project launches, slow in Mumbai and NCR during first of half of 2010-11 due to approval and land acquisition issues, have started to pick up and should improve cash flows for developers with land banks during 2012

Rising Input Costs..!

With rising input costs, developers do not want to sell below a threshold which does not justify their minimum replacement returns . 

This leaves house buyers with a small window of opportunity – the next 6 months, when house prices should witness marginal appreciation. After 6 months, a second wave of high appreciation is predicted. Are you geared for it?
 

About the author..!
Mr. Himadri Mayank is  Senior Manager – Research & REIS in Jones Lang LaSalle India