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Real estate in Bangalore – cost/benefit analysis

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I decided to dedicate an entire article to this topic due to its increasing significance. 

Please also read one more post on a similar topic: https://ecofin.wordpress.com/2007/05/27/a-note-on-the-top-developers-at-bangalore/

Bangalore is still reeling under a real estate bubble. The real estate in Bangalore can be categorized under two broad heads:

1. Land

2. Apartment complexes

A few years ago, while the boom was still peaking, banks were falling all over themselves to lend us money.

Today, the scenario is slightly different. There are quite a few reasons for this shift in the stance banks have.

1. The RBI has issued guidelines to all banks to tighten their loan policies so as to not risk the possibility of increased default. While the loan seekers increase, the risk of default also increases proportionally. Banks need to maintain sufficient liquidity for them to be able to write-off such loans as bad debt.

2. The RBI has hiked the CRR and the Repo. The CRR hike impacts the loan market since banks tend to raise interest rates on almost all of their financial instruments – fixed deposit schemes, home loans etc. FD’s are now running at close to 9.5% pa pre-tax so this would work out to be a modest 6.5-7% after-tax (not great). Home loans are running at an average of 12.75% FRR (floating reference rate) and 13% for their Fixed interest rate since the last few months. Although there is talk of the interest rates cooling, I doubt it because the bubble is still quite inflated and there is a liquidity squeeze for banks – which explains why they are attracting new customers to invest in savings as opposed to borrowings.

What is causing the real estate bubble in India and especially places such as Gurgaon/Bangalore etc.?

Many reasons:

1. Bangalore is home to the IT revolution that has swept India over the last decade since the early 1990’s. This means more and more housing has to be provided for people seeking employement. IT companies are also flocking to Bangalore setting up shops either on lease (majority of the cases) or if they have long-term plans, simply buying land and building their own buildings. This leads to an increase in both residential as also commercial real estate land value.

2. The Devanahalli International airport project (please see one of my earlier post on this – https://ecofin.wordpress.com/2007/04/28/a-visit-to-the-devanhalli-international-airport/) has caused a major appreciation in land prices in/around the Bangalore North district that leads upto the Devanahalli International airport.

3. The plans of the Bangalore peripheral ring roads have made commute times lesser thereby leading to a spurt in value of land in/around Mysore road (where the BMIC corridor is supposed to pass through (please see one of my earlier post on this – https://ecofin.wordpress.com/2007/02/04/nandi-infrastructure-corridor-the-bmic-project/).

4. The Whitefield, Koramangala and the Hosur road areas around Bangalore have witnessed a phenomenal growth in terms of IT companies sprouting up leading to a lot of apartment complexes coming up in that vicinity.

So, where will this lead to?

Correction in interest rates have already seen a drop in demand. This demand is going to subside more and more as more home loan borrowers get discouraged from the home loan market due to the high interest rates.

For the uninitiated, a 7.5% fixed rate interest on a Rs. 20 lac property corresponds to the home loan borrower paying Rs. 2 lacs pa to the bank as Interest+principal. This when cumulated over a 20-year period translates to Rs. 18 lacs as the Interest (roughly) and another Rs. 20 lacs as the principal repayment (what was originally borrowed). The concept of EMI’s (equated monthly instalments) are usually that the interest payments are very high in the initial 5 years of the loan (Assuming a 20-year loan period) and the interest payments reduce as the repayment tenure approaches completion). Also, EMI’s are built on a concept of “Reducing balance” with a small portion of the principal being repaid in the initial stages and this principal component that is being repaid increases as the borrower is into the middle stages of the loan.

A rise in interest rates by about 6% from the 7.5% to 13.5% will rocket the EMI’s substantially or the banks will simply increase the repayment tenure from 20 years to say, 20 + <X> years where X is a period in years that are additional to the original tenure of the loan availed.

Almost all banks have a Force Majeure clause (or what is popularly called the MMC – money market clause) that allows them to offset this interest rate even if it is “Fixed”.

Coming back to the point of the impact the rise in interest rates would have on the same example where a Rs. 20 lac loan was availed by the bank at the new rate of interest, say, 13.5%, this means the home loan borrower would now have to cough up almost double the EMI (if the loan tenure does not change) or the loan duration would go up substantially. Its tough to quantify what would be the duration since banks are usually averse to giving out loans for periods as high as 20-years etc.

Assuming the EMI payments almost double, the impact on the entire repayment scheme for the borrower would be that the borrower ends up paying almost double or triple of the interest (excluding the principal component which is anyway fixed).

Residential real estate prices in Bangalore vary across various locations – but, by and large, the average price of an apartment complex from a builder of medium reputation is about Rs. 40 lacs for a 2 BHK (including registration, stamp duties etc.) and from a well-known builder is in the region of Rs. 70 lacs – Rs. 1 crore for a 2 BHK. The average price per sq. ft. charged by most builders is about Rs. 2000 – Rs. 4000 sq. ft – depending on the area.

For commercial real estate, the equation falls roughly in the same zone but since space used up in commercial real estate is much larger, the final values are much larger.

Land prices are a different ball game. First of all, buying land right now in Bangalore is like a game of poker. You have a 50-50 chance of ensuring that the land you purchase has not been already sold to someone else or you are not getting duped and you have not been sold a lemon. This practice of illegal sale of land is nothing special and happens all over India with the same corruption.

My take on this would be that if you are a serious real estate investor and wish to invest in Bangalore, this may not be the best of times for myriad reasons – some of which are highlighted above indicating the general scenario.

https://ecofin.wordpress.com/2007/05/27/a-note-on-the-top-developers-at-bangalore/

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Written by Naveen Athresh

May 3, 2007 at 12:30 pm

5 Responses

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  1. Nice Article

    http://kickink.blogspot.com/ Know Bangalore More

    kickink

    May 3, 2007 at 8:43 pm

  2. […] Flats/land in Bangalore Bangalore’s real estate boom and subsequent bubble has already been mentioned on one of my earlier post – https://ecofin.wordpress.com/2007/05/03/real-estate-in-bangalore-costbenefit-analysis/ […]

  3. Very interesting article. Really learned a lot.

    FredS

    February 21, 2008 at 10:50 pm

  4. Поставте антиспам

    bbizbor

    February 18, 2009 at 12:48 am

  5. Современные игры – опаснее старых или нет?

    gamer_r

    April 11, 2009 at 9:33 pm


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