Sucheta Dalal :The realty bubble
Sucheta Dalal

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The realty bubble  

Dec 4, 2006

George Santayana famously warned that "those who do not learn from the past are doomed to repeat it"—a maxim that is invariably quoted when it is actually time to deal with the aftermath of events rather than prevent them. The history of stock bubbles seems destined for a repeat in the realty sector as investors insist on ignoring obvious warning signals.

Fortunately, retail investors who are the most vulnerable segment appear to be more circumspect about subscribing to realty IPOs (Initial Public Offerings). But mutual funds, institutional investors and high networth individuals are more than making up for retail reticence when they ought to be alarmed at the similarity with the primary market mania of 1993-95 and the dotcom bubble later on.

Some analysts insist that IPOs are not overpriced and tracking their secondary market performance is unfair. These views are not at all surprising in a monster bull run. But when a bubble bursts it is bound to hurt the entire capital market. After investors lost heavily in the mid-1990s, it killed the primary market for almost a decade (barring the dotcom blip) and drove out of business scores of merchant banks, registrars, printers, financial advertising agencies and other support services. At a time when India has emerged as one of the fastest growing economies in the world, it will be a pity if history is repeated because of excesses in a single sector.

The dotcom bubble at the turn of the century, which itself was in line with a saga that includes the Tulip mania and the South Sea bubble of past centuries, has lessons that are destined to be ignored. These were times that experts had set aside reason. When eyeballs decided dotcom valuations, sceptics were dismissed with the assertion that they were out of tune with a paradigm changing transformation.

They are saying it again, this time for realty companies. Insiders call most realty valuations a ‘fraud’ and laugh at the ease with which companies pick up public money. Developers are being valued at three times their ‘landbank’, which is a stable-sounding but meaningless coinage like the ‘eyeballs’ of the dotcom era. Claims about landbanks are either grossly exaggerated or totally false. Thanks to the joint family system, finding a large piece of land with a clean title is rare. Developers usually pay a premium to obtain such land from people who often use dubious means to paper over inconveniences such as acquiring statutory clearances, removing encroachments and settling legal disputes, all to project the title as clear. But the landbanks claimed by developers today have not even bothered with the cumbersome process of acquisition. Anecdotal reports say that many developers have included simple MoUs to purchase land or ‘Option to buy land’ letters (a new gimmick) as part of their landbanks. Since these are often spread across the country, title deeds and documents are in regional languages and subject to so many different state regulations that it is impossible for most investors to assess and authenticate valuations.

The relevance of owning large landbanks is rather doubtful in itself. For decades, we have blamed the nexus between politicians and land sharks for stunting the development of Mumbai. Fabulously rich, politically connected builders owned large tracts of land (mostly under benami titles) and extracted value from them by preventing the development of Mumbai’s hinterland. That is also why the Urban Land Ceiling Act and archaic rent control rules have remained in place in Maharashtra and the trans-harbour link has not been cleared for over 30 years. Choking the supply of housing and office space ensured a steady rise in property prices for decades; it was only disrupted in the 1990s when easy corporate money that was raised from the capital market flooded the realty sector, causing a property bubble that burst in 1994.

Do we want to reward such vested interests? Haven’t newer builders done equally well by the immediate development of acquired property? We need such developers to pressure the government to scrap anti-people legislation and focus on infrastructure development.

Will our regulators prevent a repeat of bad history? Recollect the plantation companies of the 1990s that walked away with a whopping Rs 15,000 crore of investors’ money making fanciful profitability claims? Nobody stopped them until investor complaints began to pile up and the government ordered the Securities and Exchange Board of India (SEBI) to take charge of the sector. It was already too late then, and nothing meaningful can come from the flurry of litigation that has since been filed by the regulator. This time too, there is no attempt to check reckless price manipulation or verify landbank claims.

The Reserve Bank of India (RBI) appears more proactive in curbing the irrational exuberance of foreigners about realty investment, but they have discovered back doors to the domestic market. These include acquisition of non-banking finance companies, which in turn invest in realty companies, or pre-IPO investments in the property sector.

All this has led to 100-fold over-subscriptions of recent realty company IPOs, mainly from institutional investors and high networth individuals. Since there is already a wide consensus that we are in the middle of a realty bubble, a repeat of another bit of history seems inevitable. When the bubble bursts, big chunks of this over-valued equity will be dumped on government owned insurance companies, or pension funds (if they are allowed to invest in the market) by bringing political pressure to bear. All of us will pay for the excesses, directly or indirectly.

-- Sucheta Dalal