Indicators of a Real Estate Cycle - Implication for India - Dr V Chandrasekar, Professor, Executive Advisor, ICREI, ISB Gaurang Sanghvi, Research ...
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Indicators of a Real Estate Cycle - Implication for India Dr V Chandrasekar, Professor, Executive Advisor, ICREI, ISB Gaurang Sanghvi, Research Associate, ISB Indicators of real estate cycle: Implications for India
Disclaimer
This paper attempts to serve as the background note on the global real estate market and cycles. The
paper provides an overview of the real estate cycle and market dynamics therein, and explores the
imperative indicators which affect the real estate cycle.
The paper also makes an effort to provide general information on dynamics of a real estate cycle. The
paper tries to provide information on matters of interest to readers. The implications of indicators can vary
widely from case to case, based upon the specific or unique characteristics of a particular macro-economy.
Readers are encouraged to consult with professional advisors for advice concerning specific matters
before implementing any investment or tax strategies.
While due care has been taken during the compilation of this paper to ensure that the information is
accurate to the best of the Author’s and ISB’s knowledge and belief, Author is not responsible for the
accuracy or appropriateness of the information in this paper and disclaims responsibility for strategies
implemented as a result of any information provided herein.
The Author and ISB neither recommend nor endorse any specific products or services that may have been
mentioned in this publication and nor do they assume any liability or responsibility for the outcome of
decisions taken as a result of any reliance placed on this paper.
Neither the Author nor ISB shall be liable for any direct or indirect damages that may arise due to any act
or omission on the part of the user due to any reliance placed or guidance taken from any portion of this
paper.
Indicators of real estate cycle: Implications for India
Indu real estate research chairTerms of reference
R Square and t Statistic:
Given the scope of the paper, we can establish that there is a relationship between house price and
income by the exercise of regression, and the respective values of R square and t statistic which
comes in the output of the regression.
R Square:
The estimated value of R square (also known as coefficient of determination), signifies the extent to
which the variation in the movement of price could be explained by the income.
The value of R square ranges from 0 to 1.
We generally express R square as percentage.
If the value of R square is closer to 1 or 100%; we conclude that the variation in the price is explained
by the movement in income.
e.g.: if the value of R square is 0. 95 i.e. 95%, this means that 95% of the variations in the dependent
variable can be explained by the independent variable in the regression model.
t Statistic:
t Statistic indicates that whether or not the given two variables can be related to each other.
If the t statistic is higher than 2, than our hypotheses that the variables are related is taken as true.
Indicators of real estate cycle: Implications for India
Indu real estate research chairApproach
“The term ‘bubble’ implies a transient state where a rapidly growing boom is not supported by economic
fundamentals but is based on false assumptions and expectations and would eventually prove to become
short lived. “
Dehesh, Pugh (1996)
Countries differ in their institutional, structural and economic fundamentals, and any economic phenomena
associated with a particular economy would typically have different characteristic features, which can be
attributed to geographical diversities and structural differences such as supply responsiveness, housing
markets liquidity and mortgage market completeness. Similarly, features of real estate cycle across
different economies are supposed to be exhibiting at best a spurious correlation only.
However certain macroeconomic indicators such as household disposable income and market specific
determinants such as interest rate, debt service ratio, rentals trends, tend to exhibit similar pattern in terms
of their impact on the price movements in the real estate sector. Given this backdrop, the report is an
attempt at outlining the impact of these indicators on the price trends in different real estate markets.
Indian real estate market has been analyzed with the backdrop of the global trends, and a possible
trajectory for the Indian market has been examined.
Section 1 gives a brief overview of the theory of real estate cyles and the various indicators that affect the
real estate cycle.
Section 2 studies the real estate cycles in USA, Japan, and UK. The main criterian that have been
considered while choosing these case studies have been a) The real estate cycles should have lasted
atleast for five years b) The real estate market should have global significance c) Statistical data
availability across markets. In this section we would separately analyse the pattern of real estate cycles in
the respective economies, and would try to see similarities, if any, in the indicators responsible for the
cycle and also in their respective magnitude.
Section 3 analyses the Indian real estate cycle under the above select indicators. The opportunities and
risks in Indian real estate market have also been analysed. The case of the Mumbai real estate market has
been considered for the analysis, since it is believed to be the most burgeoning real estate market in India.
Mumbai is also a mature, demand led market, where end users are higher as compared to other
speculative markets in the country.
We try to establish the presence or possibility of any similarity between the trends in the price movements
in the real estate sector in India and the respective trends in the US, UK or Japan. The role of Government
vis-à-vis policies, both fiscal and monetary, in the price movements of real estate sector has also been
analysed in this section. An attempt has also been made to forecast the possible trajectory of the Indian
real estate, in light of the present demand supply scenario.
Section 4 analyses the key findings of the report and also attempts at highlighting the strengths and
possible challenges faced by the Indian real estate sector.
Indicators of real estate cycle: Implications for India
Indu real estate research chairTable of contents
List of figures
List of tables
List of graph
List of abbreviations
1. A brief background of Real Estate Global Cycle
1.1 Introduction
1.2 Real estate cycle
2. Real Estate Cycle : Case Studies
2.1 Indicators of the real estate cycle
2.2 United States of America - Real estate cycle
2.2.1 United States real estate cycle
2.2.2 Indicators of the real estate cycle
2.2.3 United States : Inference
2.3 Japan real estate cycle
2.3.1 Japanese real estate cycle
2.3.2 Indicators of the real estate cycle
2.3.3 Japan : Inference
2.4 UK
2.4.1 UK real estate cycle
2.4.2 Indicators of the real estate cycle
2.4.3 UK : Inference
3. Indian real estate cycle
3.1 Indian real estate cycle
3.2 Indicators of the real estate cyle
3.3 Demand supply scenario and policy perspective
3.4 Real estate cycles – India v/s global market
4. India – Road ahead
Reference
Indicators of real estate cycle: Implications for India
Indu real estate research chairList of figures
Figure 1 – Phases of a real estate cycle
Figure 2 – Indicators affecting a real estate cycle
Figure 3 – Selected indicators and the pattern of their movement during a real estate cycle
Figure 4 – Timeline of global real estate cycles and macroeconomic events
Figure 5 – House price changes for United States (1975 – 2006)
List of tables
Table 1 – Timeline of real estate cycle – United States
Table 2 – House price appreciation in United States
Table 3 – Indicators affecting global real estate cycles
Table 4 – India v/s global market
List of Graphs
Graph 1 – United States real estate cycle (1980 – 2005)
Graph 2 – House price (1985 – 1989)
Graph 3 – Net rental yield (1985 – 1989)
Graph 4 – House price to income ratio (1985 – 1989)
Graph 5 – Interest rates (1985 – 1989)
Graph 6 – GDP vs disposable income (1985 – 1989)
Graph 7 – Demand supply scenario (1985 – 1989)
Graph 8 – House price (1995 – 1999)
Graph 9 - Net rental yield (1995 – 1999)
Graph 10 – House price to income ratio (1995 – 1999)
Graph 11 – Interest rates (1995 – 1999)
Graph 12 – GDP vs disposable income (1995 – 1999)
Graph 13 – Demand supply scenario (1995 – 1999)
Graph 14 - House price (2000 – 2005)
Graph 15 - Net rental yield (2000 – 2005)
Graph 16 – House price to income ratio (2000 – 2005)
Graph 17 – Interest rates (2000 – 2005)
Graph 18 – GDP vs disposable income (2000 – 2005)
Graph 19 – Demand supply scenario (2000 – 2005)
Indicators of real estate cycle: Implications for India
Indu real estate research chairGraph 20 – Japanese real estate cycle (1985 - 1999)
Graph 21 – House price (1985 – 1999)
Graph 22 – House price to rent index (1985 – 1999)
Graph 23 – Household debt service ratio (1985 – 1999)
Graph 24 – Interest rates (1985 – 1999)
Graph 25 – GDP vs disposable income (1985 – 1999)
Graph 26 – UK real estate cycle (1986 – 1991)
Graph 27 – House Price (1986 – 1991)
Graph 28 – Interest Rates (1986 – 1991)
Graph 29 – Disposable income vs GDP (1986 – 1991)
Graph 30 – Indian real estate cycle (1990 – 1999)
Graph 31 – House price (1990 – 1999)
Graph 32 – GDP vs disposable income (1990 – 1999)
Graph 33 – House price to income (1999 – 1990)
Graph 34 – Interest Rates (1999 – 1990)
Graph 35 – Housing shortfall in India
Graph 36 – Demand for new housing (2005 – 2030)
List of Abbreviations
CAGR – Compound Annual Growth Rate
FDI – Foreign Direct Investment
FII – Foreign Institutional Investors
GDP – Gross Domestic Product
INR – Indian National Rupee
IPO – Initial Public Offerings
NBO – National Building Organization
REIT – Real Estate Investment Trust
UK – United Kingdom
USA – United States of America
USD – United States Dollar
VC – Venture Capital
Indicators of real estate cycle: Implications for India
Indu real estate research chair1. A Brief Background of the Real Estate Global Cycles:
1.1 Introduction:
Real estate cycles are described as cyclic movements of price in the real estate market which, over a
period of time, causes fluctuations in the residential and commercial property market. This is a result of
the economic, demographic and/or policy changes in the overall market environment.
1.2 Real estate cycles:
The real estate cycles involves periodic shifts of rapid growth of output (recovery and prosperity),
alternating with relative stagnation or decline (contraction or recession) over time.
Historically, in early 1980s and 1990s the price of new houses appreciated by 300 percent whereas prices
of raw land appreciated by 1000 percent. Both subsequently depreciated, ushering in a recession that
bottomed out in 1992. The trend post 1993 witnessed an even keel in the house price. (source to justify
300 and 1000 percent
The four phases of a real estate cycle viz. Recession, Recovery, Expansion, Contraction. While phases
1 and 4 (recession and contraction) are characterized by rising vacancy rates, phases 2 and 3 (recovery
and expansion) demonstrate falling vacancy rates as shown in figure 1.
Figure:1 Phases of a real estate cycle
Expansion is accompanied by job and population growth along with high demand on the infrastructure.
Equilibrium occurs when prices stabilize. Prices, having reached their maximum limits, less businesses
move into, or expand in the area. Recession occurs due to declining job growth, relocation of businesses
and depreciating housing demand. During this time, prices become stagnant or even decline as rents and
occupancy depreciates. Absorption occurs as prices and occupancy depreciates and the area becomes
attractive again to the market.
‘In growing economy, the rising phase dominate the declining phase of the real estate cycle and on
an average, there are more years of “good times” than “bad times” for investors.’
Source – Journal of real estate research, Volume 18, No 1, 1999
1
Indicators of real estate cycle: Implications for India
Indu real estate research chair2. Real estate cycle : Case Studies:
2.1 Indicators of Real estate cycle:
In attempting to identify real estate cycles across global markets, certain key indicators have been
chosen. Analysis of these indicators across select markets signify whether a given real estate market is
experiencing a “boom” or a “bust” phase. The various indicators which affect a real estate cycle are as
follows:
1) Population growth 6) Average House price movement
2) Employment rate 7) Price to Income ratio
3) Gross Domestic Product (GDP) 8) Net rental yield
4) Household disposable income 9) Household debt service ratio
5) Stock Market values 10) Interest rate/mortgage rate
11) Demand- supply scenario
Figure: 2 Indicators affecting real estate cycle
The above figure illustrates the various indicators affecting a real estate cycle, their corresponding impacts
on the real estate cycle and their inter dependency on each other.
2
Indicators of real estate cycle: Implications for India
Indu real estate research chair2. Real estate cycle : Case Studies
The indicators chosen for the purpose of analysis are as follows
1) Average House price movement 5) Interest rates / mortgage rates
2) Price to income index/ ratio 6) Stock price values
3) Price to rent ratio / net rental yield 7) Demand supply gap
4) Debt service ratio
The figure 3 illustrates the indicators selected for the analysis of real estate cycle and the pattern of their
movement during the “boom” and the “bust” phase of a real estate cycle.
Figure: 3 Selected indicators and the pattern of their movement during real
estate cycles
The markets selected for analysing real estate cycle are United States of America, Japan and the UK. The
various macro-economic events that have affected the above mentioned real estate cycle are as follows:
1985: Plaza agreement and Japanese asset boom - The Plaza Agreement was signed by five countries
ie France, West Germany, Japan, United States and United Kingdom and it was agreed to depreciate the
US dollar in relation to the Japanese Yen by intervening in the currency markets.
1986-1993: Increase in Japanese foreign investment – This period was considered as the year of
massive Japanese dominance over the world financial market, whereby Japan’s net long term capital
outflow among the G 7 countries appreciated by 90% from 1982 to 1987.
3
Indicators of real estate cycle: Implications for India
Indu real estate research chair2. Real estate cycle : Case Studies
1987: Deregulation in real estate market and stock market crash in UK – The stock market crash
resulted in wealth losses on consumption. Thus the financial institutions eased credit which fuelled the on
going real estate boom
1988–1992: Large inflow of capital in United States of America led to increase in gross national
product – Accelerated capital inflows started in 1989 which was affected by Japanese manufacturing
investments leading to domestic structural reforms. The year 1993 was the peak in which the inflows were
the highest.
1988-1993: Increase in cross-country real estate investment – Cross country real estate investments
were carried out by banks, pension funds and insurance companies for a better portfolio diversification and
higher returns.
1991: Financial deregulation and capital market liberalization in United States of America and UK –
Major structural changes such as removal of restrictions on the establishment of foreign institutions,
abolition of interest rate controls and removal of regulations segmenting the financial markets among
others were introduced.
The timeline of the global real estate cycle across global markets and the various macro economic
incidents prevalent during the time is shown in figure 4.
Figure: 4: Timeline of global real estate cycles and macroeconomic events
4
Indicators of real estate cycle: Implications for India
Indu real estate research chair2.2 United States of America : Real estate cycle
2.2.1 United States of America : Real estate cycle (1980-2005)
United States has witnessed three real estate cycles from the 1980s. The trend in house prices (i.e house
prices adjusted for inflation) during real estate cycle has witnessed periods of appreciation and depreciation
since 1975, although instances of nominal price declines have been rare. The three real estate cycles
witnessed by United States are 1) 1986-1989, 2) 1995-1998, 3) 2001-2005.
The trend of house price reveals that the prices have appreciated at a CAGR of 6.3 percent from 1975 to
.2005. Graph 1 below indicates the increase in demand for housing and rapid appreciation in house prices
as witnessed by the real estate cycle in the United States from the mid 1980s to 2007.
Graph 1 – United States real estate cycles (1980 – 2005)
Figure 5: House- Price change for United States
Table:1: Timeline of real estate cycle – United States
(1975 – 2006)
Year Timeline
1985 - 1989 Real estate cycle - I
1986 - 1988 Real estate “boom phase” of cycle - I
1988 - 1989 Real estate “bust phase” of cycle - I
1995 - 1999 Real estate cycle – II
1995 - 1997 Real estate “boom phase” of cycle - II
1997 - 1999 Real estate “bust phase” of cycle - II
2000 - 2003 Early 2000s recession
house prices are plotted on a logarithmic (log) scale.
Schiller (2006) 2000- 2005 Real estate cycle – III
There has been considerable variation in house 2001 - 2005 Real estate “boom phase” of cycle – III
prices among different regions in the country as
shown in figure 5. The West and the Northeast 2005 Real estate “bust phase” of cycle – III
regions have had greater price appreciation than
the national average. Within these two regions, the Table:2: House Price Appreciation in the United States*
Pacific and Mountain states have had greater First Quarter 1995 – Second Quarter 2006
percentage increases in real house prices in recent Metropolitan Area or Division % Increase
years than they did in the previous episode of rising
United States 58.5
prices in the 1980s.
New Jersey 65 – 143.1
States such as California, New York, and New
Pennsylvania 8.8 – 62.6
Jersey have been identified as having higher price
appreciation and more volatility as a result of OFHEO House- price index deflated by CPI
limitations on new construction.
Schiller (2006)
5
Indicators of real estate cycle: Implications for India
Indu real estate research chairUnited States of America : Real estate cycle
2.2.2 Indicators for real estate cycles:
Real estate cycle I (1985 – 1989):
Graph 2: House price (1985-1989) Graph 3: Net rental yield (1985-1989):
Gro wth Rate (%)
140 Ho use P rice (USD) (per sq. feet) 20.00 8
7.5
Average Price (USD)
120
15.00 7
Growth Rate
100
(per sq.feet)
10.00 6.5
80
6
60 5.00 5.5
40 5
0.00
20 4.5
0 -5.00 4
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
Source: www.census.gov Source: www.census.gov
Graph 4: House price to income ratio (1985-1989): Graph 5: Interest rate (1985-1989):
20
3.4 3.3 3.25
Price to income ratio
3.2
15
3
Rate (%)
2.8
10
2.6
2.4
2.2 5
Int erest Rate
M ortgage Rat e
2
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
Source: www.census.gov Source: www.census.gov
Graph 6: GDP vs disposable income (1985-1989): Graph 7: Demand and supply scenario (1985-1989):
New housing units completed (000)
8 14
New houses sold (000)
2,000
6 12
10 1,500
4
8
2 1,000
6
0 500
4
1985
1987
1980
1981
1982
1983
1984
1986
1988
1989
1990
-2 2 0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
-4 0
Gro ss Do mestic P ro duct (GDP ) Dispo sable inco me (%)
Source: www.census.gov Source: www.census.gov
Observed trends in different indicators between 1985 – 1989:
The rise in house prices, as depicted in graph 2, for the same period reflect the negative relationship
between the two indicators. {Ref sec 2.2.3}
The house price shows a sudden growth of around 16 percent in 1986 from a low of around 2.5
percent in the previous year, only to sink to a negative growth in the year 1989, as indicated in graph
2.
The house “price to income ratio” as shown in graph 4, for the same timeline though shows a
depreciating trend, still the movement is not too sharp.
The interest rates and mortgage rates as shown in graph 5, both exhibit a down turn starting with
1985, but they pick up by the end of 1989.
For the period when “price to income ratio” shows a upward trend reaching 3.3 percent in the year
1988, major contribution to this trend comes from the rising prices, in light of decelerating growth rate
of disposable income as depicted in graph 4 and graph 6 respectively.
The decelerating pattern in the growth rate of disposable income, as indicated in graph 6, could be
one of the reasons for the widening gap between demand for and supply of the housing units.
The gap in the demand for and supply of new housing units for the period between 1985 and 1989, is
more than 100%, with supply being greater than the demand. As the speculative pressure seem to
settle down, the gap decreases, but the supply still being reasonably higher than the demand. 6
Indicators of real estate cycle: Implications for India
Indu real estate research chair2.2 United States of America : Real estate cycle
Real Estate Cycle: II (1995-1999)
Graph 8: House price (1995-1999): Graph 9: Net rental yield (1995-1999):
5 8 7.3
4 7.2
6
3 7.1
7
2 4
6.9
1
2 6.8
0
6.7
1999
1991
1992
1993
1994
1995
1996
1997
1998
-1 0 6.6
Gro ss Do mestic P ro duct (GDP ) Dispo sable inco me (%)
Source: www.census.gov Source: www.census.gov
Graph 10: House price to income ratio (1995-1999): Graph 11: Interest rate (1995-1999)
3.35 10
Price to income ratio
3.3
3.25 8
3.2 6
3.15 3.1 3.1 4 Interest Rate
3.1
3.05 2 M o rtgage Rate
3 0
1991
1992
1993
1994
1995
1996
1997
1998
1999
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Source: www.census.gov Source: www.census.gov
Graph 12: GDP vs disposable income (1995-1999): Graph 13: Demand and supply scenario (1995-1999):
1,800 New housing units completed (000)
5 8 New houses sold (000)
1,600
4 1,400
6 1,200
Units (000)
3 1,000
2 4 800
600
1 400
2
0 200
0
1999
1991
1992
1993
1994
1995
1996
1997
1998
-1 0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
Gro ss Do mestic P ro duct (GDP ) Dispo sable inco me (%)
Source: www.census.gov Source: www.census.gov
Observed trends in different indicators between 1995-1999:
The rise in the house price as shown in graph 8 has been a bit moderate relative to the rise experienced
in the previous cycle as shown in graph 2.
But the net rental yield as depicted in graph 9, has shown a steady decline through the period, from a
stable 7.2 percent for a consecutive three to four years before the bubble set in.
The “price to income” ratio as indicated in graph 10 has remained stable at 3.1 percent all through the
period.
The interest rates and mortgage rates as depicted in graph 11, both show a downward trend during the
period, but unlike the observed trend in previous cycle, the interest rate actually picks up just before the
cycle sets in, and then dips.
The demand supply gap, as illustrated in graph 13, has narrowed down in this phase of the cycle, unlike
the pattern in the previous cycle. The possible reason could be the moderate rising pattern of
disposable income growth rate (graph 12) in this phase which was not the case in the previous cycle.
7
Indicators of real estate cycle: Implications for India
Indu real estate research chairUnited States of America : Real estate cycle
Real Estate Cycle: III ( 2000 – 2005)
Graph 14: House price (2000-2005): Graph 15: Net rental yield (2000-2005):
250 15.00 7
House Price (USD)
6
G row th Rate
200 10.00
(per sq.ft)
5
150 4
5.00
100 3
50 Growth Rate (%) 0.00 2
House Price (USD) (per sq. feet) 1
0 -5.00
0
2000
2001
2002
2003
2004
2005
Source: www.census.gov Source: www.census.gov
Graph 16: House price to income ratio (2000-2005): Graph 17: Interest rate (2000-2005)
5
8
4.5 6
4
3.5
4
3 2 Interest Rat e
2.5 M ortgage Rate
0
Source: www.census.gov Source: www.census.gov
Graph 18: GDP vs disposable income (2000-2005): Graph 19: Demand and supply scenario (2000-2005):
New housing units completed (000)
5 8 New houses sold (000)
2,200
4 6 2,000
1,800
3
Units (000)
1,600
4 1,400
2 1,200
1 2 1,000
800
0 0 600
400
2001
2003
2004
2005
200
2000
2002
0
Gross Domestic Product (GDP) Disposable income (%)
Source: www.census.gov Source: www.census.gov
Observed trends in different indicators between 2000– 2005:
During this period of real estate cycle, almost all the indicators show steady trend.
The bubble in this period has been identified primarily due to subprime mortgage crisis and the
associated market correction.
The remarkable feature of this cycle is the gap between the demand and supply for housing units as
depicted in graph 19, which is the lowest among all the three cycles analysed so far. The main
reason for this phenomena is the subprime lending in this sector.
The subprime lending activity was in part demand driven and in part pushed by the State policies.
8
Indicators of real estate cycle: Implications for India
Indu real estate research chairUnited States of America : Real estate cycle
2.2.3 United States : Inferences
The analysis reveals that during the boom and bust phase of real estate cycles, the house prices have
subsequently exhibited sharp appreciation up to 14 percent, followed by sharp depreciation.
A shift can be witnessed from renting a house to owning a house from late 1990s. The factors that
contributed to the shift were depreciation in interest rates, mortgage rates and appreciation in the
disposable incomes.
The “price to income ratio” reveals that housing looked relatively “cheap” when the ratio was 3.0, and
“expensive” at 3.3 times which is a narrow range. It persisted for at least two decades from 1980- 2000.
Interest rates now stands at 6.25 percent, compared with 10 percent in the late 1980s and a high of
11.5 percent in the early 1980s. The primary reason for the real estate bust was high interest rates.
House purchase constitute a major chunk of the disposable income. This can be explained by the
strong relation in the movement of the average house price and the disposable income, with R square
at 93 percent and t statistic at around 10.
The price movement in USA is more of a demand pull phenomena. This is explained by a relatively
higher value of t statistic between demand for houses and the average house price than the t statistic
for the supply of new house units and the house prices.
One of the main features of the real estate cycles have been declining net rental yield. This could be
explains the existence of a trend in the prices.
The impact of interest rate is significant but the moderate level of R square suggests that on a “one to
one basis”, not all the variation in the average price movements are explained by interest rate
movements only.
Period ( 1980 – 2005 ) t statistic R square
Regression of Prices on demand for house 10.79351 0.835125
Regression of Prices on supply of house 03.095415 0.29408
Regression of Price on interest rate 05.18395 0.538831
9
Indicators of real estate cycle: Implications for India
Indu real estate research chair2.3 Japan - Real Estate Cycle
The Japanese real estate boom was a period of skyrocketing land prices and it lasted from 1985 to 1990. It
is considered as the most famous of the economic booms. The land prices grew by around 28 percent
over the 5 years preceding the peak and it witnessed an equally dramatic drop of approximately 22 percent
over 5 years after the peak. Macro economic policies factors viz. an overvalued Yen and aggressive
lending policies introduced by the financial institutions resulted in large amounts of capital introduced into
the property sector. This led to speculation of land investments resulting in increasing prices. Residential
land prices in 1990’s in Japan’s six big city areas were 2.6 times those in 1985 and commercial land was
3.9 times as expensive.
The time of the collpase hit the property market particularly hard. Investments were made from largely out
of the country. When the prices crashed, commercial land value reduced to half, by 1995. Corporate Japan
also lost money due to declining real estate holdings. Businesses cut back their plans to spend on plant
and equipment, cut back on working hours and salaries of workers thus snapping economic growth. The
average price of a 750 sft condominium in Tokyo rose to more than 70 million Yen (USD 625,000) in 1991
from about 25 million Yen (USD 223,000) in the early 1980s. After crashing in the early 1990s, the average
house price hovered around 40 million Yen (USD 350,000).
2.3.1 The Japanese real estate cycle (1985 - 1999)
The Japanese real estate cycle lasted from 1985 until 1999, whereby the boom period lasted for around six
years from 1985 to 1991 and the bust followed from 1991 until 1999 for a period of nine years as shown in
graph 20. The land prices began to increase in around the year 1983 in the commercial districts of Tokyo
which subsequently spread to the residential sector and regionally to the suburbs of Tokyo. This steady
rise in land prices reached its peak in 1989. The land prices began to level off in 1988 and 1990 in Tokyo
and Osaka respectively. The prices began to fall in 1991. In January 1992 the average land prices
nationwide fell by 4.6 percent compared to the previous year.
Graph 20 – Japanese real estate cycle (1985 - 1999)
10
Indicators of real estate cycle: Implications for India
Indu real estate research chairJapan Real Estate Cycle
The real estate market followed uninterrupted growth until 1991 except for 1986-1987 due to an
overvalued Yen. This was the period of increased investments in real estate due to speculation. For
promoting the growth of real estate, large tax reductions were permitted such as real estate acquisition
tax, registration tax and transfer tax. Housing loan deductions were extended from six years to fifteen
years.
The first period from 1992 to 1994 was affected by the economic slowdown with a real GDP growth of
only 1.1 percent (from approximately 5 percent in 1990 to 1991). During the period from 1995 to 1997,
the Japanese government introduced fiscal stimuli which improved the GDP growth rates to 2.7 percent.
The unemployment rates began to increase over this period, (close to 3.5 percent from approximately 2.5
percent during 1992 to 1994). The office workers were the first to be hit due to the economic decline with
cuts in the working hours and salaries. Over 1998 to 2000 Japan was at the peak of its crisis with the
lowest ever GDP growth of -0.1 percent. This was the period of nation wide decline in disposable
incomes and with unemployment rates at an all time high of almost 5 percent.
2.3.2 Indicators of the real estate cycle
House prices
Graph 21: House price (1985 - 1999)
House prices reached its peak during 1990 and 140
started steadily declining before bottoming out in
130
2000 as depicted in graph 21. The prices
appreciated by about 28 percent over five years 120
before its peak in 1990 and depreciated by about 22 110
percent over five years after the peak. The main
reason for this was the easing of the monetary 100
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
policies and the lowering of the interest rates.
Index 1985 Q1 = 100 Y ear
Source – UN and Japan stat
House price to rent index (reciprocal of net rental yield ) Graph 22: House price to rent index (1985 - 1999)
The “price to rent” curve, as shown in graph 22, 140
Index 1985 = 100
matches the trend of the real estate cycle. Owner 130
120
occupied residences have been stable at an 110
average of 60 percent throughout the cycle. The 100
rentals have witnessed a sharp decrease of 22 90
percent from 1993 to 1998. This must have been 80
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
due to lack of policies that favored rental buildings. Y ear
Focus was laid on measures to bring back the asset
prices from the slump. Source – BOJ and Standard and Poor’s research
House prices to income ratio Graph 23: House price to income ratio (1985 - 1999)
The “house price to disposable income“ followed the 115
same curve as that of the real estate cycle,
Index 1985 = 100
110
illustrated in graph 23. The peak of this cycle was 105
100
between 1991 to 1992. Though income and house 95
prices grew rapidly during identical time periods until 90
1990, house prices were eventually surpassed by 85
80
the income. Interest rates were also lowered during
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
the same time as that of rising incomes. This led to
increasing land prices and this meant that the Source – Housing prices and monetary policy in Japan
borrower could bid a higher price for a property. 11
Indicators of real estate cycle: Implications for India
Indu real estate research chairJapan Real Estate Cycle
Interest rates
Graph 24: Interest rate (1985-1999)
The financial institutions increased their lending 9
City Banks Housing Corporations
activity into the property sector from the late 1980’s 8
until the end of 1990. The bust in the economy 7
6
resulted in large number of non performing loans. In
Rate (in %)
5
order to remedy this situation the financial 4
3
institutions were forced to lower the interest rates. 2
The adjoining figure indicates the drop in interest 1
rates on home loans from a high of 5.5 percent in 0
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
1990 to the lowest ever drop of 2 percent in 1998. Year
Source – Japan stat
GDP v/s disposable income Graph 25: GDP v/s disposable income (1985 - 1999)
Economic growth was triggered due to introduction 8 8
of monetary policies by the government and due to
an overvalued Yen. Real GDP witnessed a growth 6 6
of 8.6 percent from the mid 1990’s to the end of 4 4
2000. GDP growth has been negative since 1998
(graph 25). 2 2
Steep rise in the value of the Yen during the late 0 0
1980’s contributed to deteriorating employment -2 -2
situation. The unemployment rate rose from 2.1
percent in 1991 to 4.7 percent at the end of 2000 GDP growth rate Household disposable income (%)
causing a negative growth in the household Source – Housing prices and monetary policy in Japan
disposable incomes from 1990 to 1998.
2.3.3 Japan : Inferences
The rise in house price, as shown in graph 21, in Japan has been more steep than that experienced
in the respective period of booms in USA.
Though owner occupied residences remained stable at 60 percent, the rental trends are observed to
have decreased by 22 percent. This was possibly due to lack of Government incentives for rental
accommodation.
The “price to income ratio” , in graph 23, reveals that eventually the house prices were surpassed by
the income.
This was coincidental with the lowering of interest rates by the Government as a deliberate move, to
help the servicing of non performing loans.
One of the remarkable feature of the price trends in the Japanese real estate was the rising interest
rates during bubble phase. The possible reason could be the easy and massive loans made
available for heavy investments.
Declining employment rates and disposable income (graph 25) did not affect the household
mortgage payment rates. This was primarily due to loosening of monetary policies by the
Government and lowering of interest rates.
Interest rates, as illustrated in graph 24, were slashed to 2 percent in 1998 from 5.5 percent in 1990
due to the high accumulation of non performing loans.
12
Indicators of real estate cycle: Implications for India
Indu real estate research chairUnited Kingdom – Real estate cycle
2.4.1 UK real estate cycle (1986-1991):
UK has witnessed one real estate cycle from 1989 -1991.The late 1980’s boom took place due to the
appreciation of interest rates again in double-digits. House prices in the UK have appreciated by 169
percent since 1997, whereby appreciation and depriciation of house price booms was due to large
quantities of mortgage debt in the system.
Since 1970, the average house price for a first-time buyer has risen by approximately 3,100 percent but
the average income of this group of borrowers has increased by only approximately 1,900 percent. For
first-time buyers, house prices have appreciated the most in London where the increase was 3,432
percent followed by the South West with an increase of 3,427 percent. At the other end of the scale,
Scotland has recorded house price growth of just 1,900 percent. In 1970, the average house price for a
first time buyer in Scotland was £4,200, or 70 percent of the average price in London of £6,100. By 2005,
the average price in Scotland had risen to £85,500, but this represents only 40 percent of the average
2005 London price of £216,000. (Source – Research by Halifax Agents)
Graph 26 – UK real estate cycle (1986 to 1991)
Increasing no of non
2,500 performing loan
H ou se Price (p er sq m eter)
2,000
High interest rate
1,500
1,000
500
0
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Source – www.statistics.gov.uk
The trend from 1980-2005 reveals that the UK witnessed an extraordinary appreciation in the demand for
housing followed by a subsequent increase in the house prices. Smaller cities, have an average population
of less than 250,000 recorded the largest appreciation in average price per square meter. House prices
have appreciated by triple fold in 15 cities and at least doubled in all 62 cities since 1996. The majority of
the cities recording the biggest increases are in Southern England, but Salford and Newcastle also feature
in the top 10. Brighton (260 percent), Salford (255 percent), London (252 percent) and Bath (236 percent)
follow Truro in the top five. (Source – Research by Halifax Agents)
Scottish cities dominate the list of cities experiencing the smallest increases in house prices on a per
square meter basis during the past decade. Three of the bottom five cities are north of the border:
Aberdeen (104 percent), Stirling (122 percent) and Glasgow (126 percent). Southampton (132 percent) and
Preston (133 percent) are the other cities in the bottom five. (Source – Research by Halifax Agents)
13
Indicators of real estate cycle: Implications for India
Indu real estate research chairUnited Kingdom – Real estate cycle
2.4.2 Indicators for Real Estate boom and bust cycle – UK
House Price: Graph 27: House Price (1986-1991)
UK average house prices have witnessed a 2,500 20
phenomenal appreciation of 768 percent from
2,000 15
1980 to 2006. House price of homes have
House Price (per sq meter)
Growth Rate (%)
appreciated at a CAGR of 8.34 percent from 1,500 10
1980 to 2006.
1,000 5
The trend in cycle I (1989-1996) as shown in 500 0
graph 27, reveals that during boom phase
(1989-1991) the prices have appreciated 42 0 -5
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
percent from 349 £/sq.mt to 602 £/sq.mt. and
depreciating to almost 3 percent during the Grow th Rate (%) House Price
bust phase. Source – www.statistics.gov.uk
Interest Rates : Graph 28: Interest Rate (1986-1991)
The average or effective mortgage rate that
UK households pay has steadily declined over
the past 20 years. It now stands at 4.65 18
16
percent, compared to the 10 percent during the
14
late 1980s and a high of 16.6 percent in the 12
Rate (%)
early 1980s. As the graph 28 shows, the 10
8
effective interest rates have steadily
6
depreciated over a period of time from 1980 to 4
2005. at a CAGR of – 4.69 percent. 2
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
The trend reveals that interest rates during the
cycle-I (1986- 1991) as shown in graph 28 Source – www.statistics.gov.uk
have appreciated and depreciated for the UK
i.e. in 1987 the rate was lowest 9.62 percent
and then appreciating during the bust phase to
14 percent in 1990.
Disposable Income vs Gross Domestic Graph 29: Disposable Income to GDP (1986-1991):
Product (GDP) :
20.0
The disposable personal income from 1980 to
2005 has appreciated at a CAGR of 6.7 15.0
percent. If we observe cycle - I (1986- 1991),
the disposable personal income has 10.0
decreased for the UK i.e. in 1986 the 5.0
disposable income appreciated to 7.5 percent
and subsequently depreciated to 5.1 percent 0.0
during the bust phase in 1991. On the contrary
-5.0
the GDP during cycle-I (1986-1991) was 4 Disposable income GDP
percent during boom phase, depreciating to -
.1.4 during bust phase in 1991 as depicted in Source – www.statistics.gov.uk
graph 29. 14
Indicators of real estate cycle: Implications for India
Indu real estate research chair2.4.2 United Kingdom : Inferences
The analysis reveals that during the boom and bust phase of real estate cycle the house prices have
subsequently appreciated by 42 percent and depreciated to 3 percent during the bust phase.
Interest rates now stands at 4.65 percent, compared to the 10 percent during the late 1980s and a
high of 16.6 percent in the early 1980s.
Disposable personal income has decreased for the UK i.e. in 1986 the disposable income appreciated
to 7.5 percent and subsequently depreciated to 5.1 percent during the bust phase in 1991.
15
Indicators of real estate cycle: Implications for India
Indu real estate research chair3. Indian real estate cycle
The Indian real estate market, during the early 1990’s, was highly unorganized and fragmented with
issues which ranged from lack of institutional funding support to developers, absence of world class
developers to limited consumer demand due to unavailability of easy financing options and lack of
transparency in the market.
In this section we shall discuss the Indian real estate cycle, and the trend in the different indicators, then
we shall compare the trend in the price movements in Indian real estate market and that of USA, Japan,
and UK and would try to look for similarity if any.
We shall then attempt to analyse the demand and supply scenario of Indian real estate market, and
analyse the future trend. The role of the government would also be analysed in this respect.
3.1 Indian real estate cycle
The Indian real estate cycle lasted from 1990 until 1999 whereby the boom period lasted for a period of
six years from 1990 to 1996 followed by the bust from 1996 until 1999. The prices began to level off
from 1999 onwards. The residential property prices in some markets have recorded a growth of
approximately 15 to 20 per cent in the last two years and have witnessed substantial activity in the year
2004 -05.
Graph 30: Indian real estate cycle (1990-1999)
The last decade witnessed a frenzied boom in the residential property prices. This boom was artificially
created where it was backed primarily by the boom in the stock market that was kicked off in 1991. The
prices appreciated sharply during 1994 to 1995 whereby it witnessed a phenomenal growth of almost 420
percent from 1990 to 1996. The stock market and real estate markets crashed in quick succession just a
little after 1995. This was followed by a prolonged period of about 8 years of little or no appreciation in
real estate.
A reversal in trend has been witnessed over the past 2 to 3 years with real estate prices inching up
backed by strong demand. This demand in turn is primarily being driven by strong demographic trends
and the emergence of a favorable environment for real estate investment.
16
Indicators of real estate cycle: Implications for India
Indu real estate research chair3.2 Indicators of the real estate cycle
House prices Graph 31: House price (1990-1999)
Average house prices in Mumbai hit its peak during 70.0 9000
1994 to 1995 as indicated in graph 31. The prices 60.0
50.0
8000
7000
increased at a CAGR of 3 percent from 1990 to 40.0 6000
1996. This boom lasted only for 4 years from 1992 30.0
20.0
5000
4000
till 1996 before bottoming out in 1999. The bust 10.0 3000
0.0 2000
period lasted for 3 years from 1996 until 1999 where -10.0 1000
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
the prices dropped by 60 percent. This boom and
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
20
20
20
-20.0 0
bust was created due to the stock market rise and Average house price grow th rate (left axis)
crash respectively. Average house price (INR/sft) (right axis)
Source – Industry sources
GDP v/s disposable income Graph 32: GDP vs disposable income (1990-1999)
Economic growth in India was triggered by the 9.0 10
economic liberalization of 1991. One of the 8.0 9
G ro w th rate (in % )
G ro w th rate (in % )
8
consequences of this was the approval of FDI into 7.0
6.0 7
many sectors. The economy had grown at a 5.0
6
5
constant excepting a few major setbacks. 4.0
3.0
4
3
2.0
As shown in graph 32, the rise in disposable 1.0
2
1
incomes was steady until 1998. Employment 0.0 0
opportunities brought in by the IT/ITeS sectors
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
resulted in a sharp rise in disposable incomes Disposable income growth rate (left axis) GDP growth rate (right axis)
during the period from 1998 to 2001. The
disposable incomes have been growing at a steady Source – UN stat and Mckinsey research
pace since then.
House price to disposable income Graph 33: House price to disposable income
(1990-1999)
The house price to income follows the same curve 80
as that of the real estate cycle (graph 33). A large 70
amount of investment in real estate was witnesses 60
during the peak period. This trend was mainly 50
backed by speculation. After a sluggish period from 40
1998 to 2004, this trend has picked up primarily due 30
20
to sharp rise in property prices backed by rising Price to income
10
income levels and an investment friendly. This
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
allows the borrower to bid a higher price for a
property. Source – UN stat, industry sources
Interest rates Graph 34: Interest rate(1990-1999)
Financing option for real estate, during the 1980’s 19
and early 1990’s, was fairly unorganized and 17
bureaucratic in nature. Financial institutions 15
increased their lending rates and it reached an all 13
In %
11
time high at 17 percent (graph 34) during 1995 to 9
1996 which hampered the inflow of capital into the 7 Interest rates
property sector. As a remedy to this situation 5
significant transformations have taken place on the
1 990
1 991
1 992
1 993
1 994
1 995
1 996
1 997
1 998
1 999
2 000
2 001
2 002
2 003
2 004
2 005
2 006
2 007
financing side whereby interest rates have been
Source – UN stat, industry sources
reduced drastically along with lenient lending
policies. Lending rates recorded an all time high of
17 percent in 1995 to 1996 and reached an all time
low of 7.5 percent during 2005.
17
Indicators of real estate cycle: Implications for India
Indu real estate research chairIndia: Demand - Supply scenario & Policy Perspective
Growth Drivers Graph 35: Housing shortfall in India
Housing Shortfall in India
25
The Indian real estate market is growing at an annual
Shortfall (mn)
20
growth rate of 30% (Source – NorthBridge Capital Research,
15
June 2007). Factors such as the high GDP growth, strong
10
demographics, positive urbanization trend and
5
increasing disposable income are causing a demand
0
pull in the real estate market. On the other end, factors
1961
1971
1981
1991
2001
such as favorable policy/ regulatory changes, positive
investment climate and unlocking of land parcels are T o tal R ura l Urba n
the supply factors changing the dynamics of real estate
market in India.
According to the National Building Organisation (NBO), the total demand for housing is estimated at 2
million units per year and the total housing shortfall is estimated to be 19.4 million units, of which 12.76
million units is from rural areas and 6.64 million units from urban areas. According to 2001 national
statistics as depicted in graph 35, there was a total of about 187,162,172 residential dwelling units
nationwide and the gap between supply and demand in residential market is 41 billion sq.ft.
The persistent gap between demand for and supply of housing units as pointed out by the NBO study can
be explained by the fact that major contribution to the shortfall of housing units comes from rural area. With
more emphasis on the supply creation in urban centers, the gap is only going to widen, and thus putting
further pressure on the prices.
Future demand Graph 36: Demand for new housing (2005 – 2030)
As per Detusch Bank research approximately 4.7
million housing units would have to be completed up to
2030. This estimated figure is based on additional
demand of roughly 2.7 million housing units and annual
replacement demand of roughly 2 million dwellings as
indicated in graph 36. The housing markets have
appreciated considerably from 2003 - 2004.
Deutsche Bank Research
Strong demand stimuli have caused shortages in housing in cities, pushing up residential property prices.
The Government on its part is also giving policy incentives (discussed in the next section), towards the
movement of capital in the real estate sector.
Enabling Policy and Regulatory Environment
Government incentives such as favorable reforms ensuring easy project financing, increased fiscal
incentives and simplification of government procedures assisted the real estate developers to expand their
horizons and improved their risk appetite for large scale projects.
Incentives on project financing
Policy to permit FDI up to 100% in housing, townships, built-up infrastructure and construction
development projects. This paved the way for a significant capital infusion to the capital intensive sector
through Foreign Institutional Investors (FIIs), Venture Capital (VCs) funds etc.
The Government has also lowered the floor on minimum land area for FDI investment to 25 acres from
an earlier 100 acres. This move has triggered a spurt in construction activity especially in urban areas as
developers are now able to source foreign funds for developments on smaller parcels of land in congested
metros.
The Government allowed FIIs to take part in Initial Public Offerings (IPO) and pre-IPO placement of real
estate companies.
The Government is also evaluating proposal to introduce Real Estate Investments Trusts (REITs). REITs
will give international investors a familiar means of investing in real estate, which would provide an impetus
to the existing real estate market. 18
Indicators of real estate cycle: Implications for India
Indu real estate research chairFiscal Incentives for supply creation
Tax holiday of 100% for profits derived by an undertaking engaged in developing and building housing
projects in the country.
The new SEZ Act, 2006 has also provided for 100 per cent tax holiday for profits derived by an
undertaking engaged in development of a SEZ, exemption from levy of MAT etc.
Focus on Urban Infrastructure Development
The increased focus of Indian government on urban infrastructure development has led to emergence
of newer locations and has significantly induced the real estate activity.
Public authorities like housing boards and development authorities are now taking special initiatives for
provision of housing, which creates strong competition to the private developers and also provide a
wide range of options to the urban consumers.
3.4 Real Estate Cycles: India v/s the global market
The above table signifies that the indicators have similar impacts on the property prices during the real
estate cycles across global property markets. One remarkable result which comes out of the econometric
exercise is the similarity in the magnitude of impact of interest rate movements on the real estate price
trends, observed between India and USA.
Table 4 - India v/s global market
United States Japan UK India
Boom Bust Boom Bust Boom Bust Boom Bust
Indicators phase phase phase phase phase phase phase
phase
House Price
Net Rental Yield Not Not Not Not
available available available available
Price to Income ratio
Interest Rate / Mortgage
Rate
Disposable Income and
Gross Domestic Product
Supply and Demand
Scenario
The R square estimate and t statistic between interest rate and price trend, in the case of both the
country, is almost the same for the period between 1994 and 2006.
In case of the impact of disposable income on the trend in the price of housing units, though there seems
to be a valid one to one relationship between the two in the case of both India and USA, but disposable
income seems to be having more strong effect on the prices in the case of USA, than in India. Which also
holds true, as the trend in the case of India happened more because of the stock market bubble.
It is evident that the Indian real estate cycle was an unnatural occurrence whereby property prices were
artificially corrected due to a boom in the stock market. After a brief period of stabilization in these prices,
a significant boom can be seen over the past few years. There is no significant rise in the prices of
residential property over the past six months and these prices are expected to stabilize in the next few
years.
19
Indicators of real estate cycle: Implications for India
Indu real estate research chairReferences
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