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The Real Estate Ponzi Scheme

Oct 4, 2014 | Dr C K Narayan | Fundamental Twist, Interesting Read | 1 Comment

The Real Estate Ponzi Scheme
Or, how we are getting ripped off, legally!            Oct 3, 2014

The weekend reading threw up some really interesting data that seemed to me like that there is a legal Ponzi scheme is going on right under our noses!

RBI data recently made the following revelations. Bank lending over the last one year has dropped from 17% to around 10% (period Aug 2013 to Aug 2014).  This means that banks are lending less (I doubt if business is borrowing less). This may be owing to the fact that the NPA has increased, during this period, from around 3.5% to around 4.7% (soure ICRA). Although the banks are saying that it is probably higher interest rates currently prevailing that could be the reason, it does not wash, because the same interest rates were prevalent a year ago too!

During the same period of Aug 2013-Aug 22014, the lending to the real estate sector remained more or less same, at around 17% (around 1.5 lac crores). Now banks like to lend to good borrowers, those that do not default on their loans. The fact that the lending to the sector did not reduce would imply that real estate loans were good ones! Clearly the rise in NPAs were occurring from non- real estate loans.  How is this possible? We keep reading in the papers about how inventory is building up. We know from our interactions with people in the real estate business of how everything is stuck. Despite low sales and growing inventory, however, the real estate prices are not falling. This defies business and economic logic! The only explanation that can be offered is that developers are somehow managing not to sell their inventory to raise money.

The only way they can do this is to borrow fresh loans and repay the old ones! This ensures that the borrower remains “good” in the books of the banks and thus become eligible for continued funding. This prevents them from selling their inventory to clear maturing debts and thus the prices remain firm! Buying a house now in Mumbai is out of reach for most people. For a reality check, here is some data from Forbes. They estimate that the average income of a Mumbaikar is about 3.5 lacs while an average flat in Mumbai is priced around 1 cr plus. This equates to a 30x multiple of the average annual income! For comparison, such a multiple in the US is around 2.6x while in London it is 4.5x!! Can you then imagine how expensive reality prices are in Mumbai! I recall buying my first house for about 2.40 lacs in 1984. At that time my annual income was about 1.20 lacs. So that was a multiple of 2x. I bought and sold three more houses since then and the last one probably had a multiple of around 3x in 2003. I am sure it would be more or less similar for most other people. Even assuming a current middle class annual salary of 12 lacs, a decent 2 BHK in the city suburbs would be around 2cr, giving you a multiple of 18x!

Where does this become a Ponzi scheme though? Consider this. The Banks are lending to the real estate developers, using our money that we keep as deposits. They earn interest from these “good” borrowers who thru the use of our money, manage to keep their property rates high. Then we go to these very developers to buy flats and get fleeced by the rates. We then turn to the same banks that oblige us by giving us loans on which they charge us interest. In the end, both banks and developers are happy while the individual depositor cum borrower is taken to the cleaners by them!! What a racket! And it’s all legal and proper and happening right under our noses! Ponzi!

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