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The economics of housing

S Sivakumar

The Asian Development Bank, International Monetary Fund and analysts have slashed India's economic growth rate for this financial year.

There seems to be no clear signal from the policy makers in Delhi as to how they will deal with this increasingly pessimistic growth outlook.

This article explores the importance of housing sector by taking a holistic view, a quick review of the developments in other Asian countries and specific policy actions to prime this sector.

The housing sector accounts for a significant share of economy in developed economies. In the United States, housing consumption and housing related expenditure together account for one-fifth of the gross domestic product.

Two-thirds of US households are home owners and home equity is by far the single most important asset.

Home equity is more evenly distributed than either income or stock market holdings. The growth of publicly listed real estate investment trusts (REITs), publicly listed property companies, mortgage backed securities have also helped in dispersing the investment risk associated with this sector.

The surge in mortgage refinancing, which has helped homeowners in the US extract equity and pay down costly consumer debt.

The driving force behind this is the reduction in transaction costs associated with refinancing (referred to as "points") due to computerisation. Given the importance of this sector, India is yet to realise its potential.

India's macroeconomic stability provides a favourable environment for the sustainable growth of the housing sector.

The level and volatility of inflation has been low. Interest rates have been coming down in recent years. But surprisingly, macro stability has not led to a rapid growth of the housing sector, until recently.

Also government initiative was mainly directed at providing low cost housing without adequate attention to the overall development of the sector.

Banks with excess liquidity are making the paradigm shift from wholesale banking to retail banking. Banks have also been inspired by the fact that the Housing Development and Finance Company which has been giving home loans for the last twenty years has a non-performing loans level of only 0.91 per cent.

The underlying source of demand is robust. India's population growth, its rapid urbanisation and growth in per capita income are solid drivers of demand.

Interestingly in cities like Mumbai, as offices shift from the downtown area there is already a boom in residential property development in sub urban areas.

Three Indian cities Mumbai, Calcutta and Delhi are urban agglomerates with a population exceeding ten million.

Over the next fifteen years, the population in these cities is expected to grow at the rate of 2.26 per cent, 1.66 per cent and 3.45 per cent respectively above the national average of 1.3 per cent for the same period.

In 1970-71 household savings accounted for 70 per cent of gross domestic savings and by 1999-00, that ratio has reached a level of 89 per cent. Given that the moderate private savings and public dissavings are expected to continue in future, households' savings will continue to form a significant portion of gross domestic savings.

Data shows that household saving has been increasing as a per cent of disposable income over the last thirty year. Financial assets in the form of bank deposits, Unit Trust of India investments, et cetera too have grown over the years. Household savings in physical assets have declined in the last thirty years.

However, given the decline in interest rates, UTI debacle, household savings in physical assets are expected to increase significantly in future.

The decline in property prices in major metros by over 40 per cent over the last five years has brought down the median income to property price ratio from 1:13 to 1:6. This is close to the level in China of 1:6 and much lesser than Hong Kong of 1:10.

The increase in affordability and availability of finance are the key long-term sustainable drivers for the growth of the residential market.

Banks have started financing houses and competition has been driving down rates and forcing them to offer value added services to clients.

Banks can also emphasise on branding to change the disorganised state of property development and strictly enforce standards for building materials.

The outstanding mortgage debt as a percentage of GDP for India is less than 1 per cent and for the US it is 53 per cent.

In emerging markets such as Brazil, Korea and Thailand the ratio is between 10-20 per cent. All this indicates the catch up potential for India even if it manages to get to the level of other emerging markets.

The supply side initiatives are equally important. There is an urgent need to develop suburban areas so that the urban agglomeration can be effectively managed.

The provision of infrastructure such as road/rail transport, water, sewage, power, telecom are necessary preconditions for growth of sub urban areas.

In Mumbai, this is already happening. Policy attention has to be focussed on simplifying the procedures for purchase and transfer of property, financing property purchases and using it as collateral. At present the procedures for tracing property title are cumbersome.

The transaction costs are excessive. The property registrar office is actually a 'den of thieves.'

Unless standardisation and computerisation is enforced at least in major cities, the growth of the housing sector will be stymied.

Given the importance of this sector, there should be a regulator at the federal level with coordination units at state level.

India does not have a single property development company or REITs listed on its stock exchange. A quick look at rest of Asia illustrates that in most countries the property development industry is well organised.

However potential for future growth will be mainly from India and China.

Hong Kong, the largest market, suffers from unfavourable demographic trends reflected by the slowing of population growth and poor economic conditions, which has kept housing prices depressed.

The city of Shanghai offers a vivid illustration of the potential for growth in housing. Shanghai's local GDP has been growing at the rate of 11 per cent over the last 5 years against China's 7.1 per cent.

In 1996, approximately 117 million square feet was developed. Last year, the area developed was 150 million square feet.

A quick comparison reveals that the price per square foot in Shanghai is $62.5 and in the suburbs of Mumbai it is $36, which is almost close to the ratio of per capita incomes of India and China.

The core demand is the mass residential market. The city of Shanghai is implementing the vision 'one city and nine towns.'

Delhi and Mumbai can replicate this success to a great extent provided they get the details right.

Given the propitious alignment of surging demand, availability of financing and developers who are acting on the massive opportunity, it is time that the government acts promptly to eliminate the inefficiencies that have constrained the sector.

The main areas to concentrate on are reduction of transaction costs to facilitate exchange of land and property, encourage development of REITs, mortgage financing, public listing of property development companies and foreign investment so that risk is well dispersed throughout the financial system.

Rationalising the property tax regime will ensure better compliance and fund infrastructure development.

Hopefully the government will realise the tremendous potential of the housing sector and act expeditiously to evolve a comprehensive policy and implement it.

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