Painful Reality

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For a large number of Mumbaikars owning a property in the city has become a distant dream .


A quick search on a couple of real estate portals reveals that median prices for two BHK apartments is Rs. 1.5 crore in the western suburbs . Buying properties involve a  black component the percentage  of which  can be as high as 60% to a reasonable 30%. A mere  30 % black component in a deal of  1.5 crore  equals 50 lakhs . This becomes part of the money that  a home buyer funds from his savings . The real bummer is that  the bank will provide loan only on the white component . Which means it will fund only 80% of the 1 crore white component in our example . Thus over and above the 50 lakhs( black) , our home buyers will have to fund a further 20 lakhs from pocket . (No wonder  home loans are the safest assets for bankers !!)

Isn’t it wonderful that such a large number of Mumbaikars seem to have this kind of money to buy homes?. Reality is that it is small number of investors who are keeping reality prices sky high in our City . Willingly or otherwise these investors have put property prices into a upward spiral . Picture this . An investor buys a property of Rs.2 crores and in three years his property appreciates to 3 cr. If he chooses to sell he ends up paying long term capital gains tax. To save this tax he has only three options

1.. Invest in Rec bonds – However there is a cap of Rs.50 lakhs on such investments per annum . Also the yields are very poor not to mention taxable . Post tax yields work out to about 3.99 % for those in the highest tax bracket .Not really an option when compared to option 2.
2. Invest in another Property- Investing in yet another residential property will ensure that you pay no tax on the capital gain 
 3. Take the capital gain in black -Now this amount, being 1 crore in our example,  needs to be deployed somewhere . Where else can one deploy such a large amount of cash but in another property !

All three option lead to only one door , i.e buying more property .

Sadly even end users, often salaried individuals are forced to convert their hard earned tax paid white money into black, in order to buy real estate. Because buying a bigger property involves cash  they are forced to ask for cash in the sale transaction of their existing property( if at all ).

This rotation of black money in residential real estate has been partly responsible for escalating prices. (The other big part being dirty money, thanks to politician-builder nexus, that gets invested into real estate)
An efficient market works on the principle of demand and supply and price is a reflection of the same. Since black money is what drives real estate in Mumbai, property prices will never reflect the true picture of demand and supply.

Lack of better opportunities to deploy capital gains from residential property sale  and needless to say  black money , has been the cause of  this upward spiral in prices .Curbing the  latter is a matter of political will for its roots are entrenched in corruption and opacity of our laws  .For the former ,it is beyond comprehension as to why the government seeks to retain this limit of Rs.50 lakhs for capital tax savings in REC and other similar bonds. One of the simplest things the government can do is get rid of the cap on investments under section 54  . If full tax saving is allowed  for investments in bonds issued by infrastructure companies/projects coupled with reasonable returns , funds would flow from non productive and currently speculative reality sector to more productive and fund starved  sectors like infrastructure. Also the option to save capital gains by investing in another property should be given only for self-use properties.

In any case overpricing in any asset does correct itself in due course of time . Gold is a case in the point . Indeed real estate prices in our city will sooner than later succumb to the law of economics . It’s only a matter of time and patience.

PS :came across a wonderfully written article on the same lines .. do read http://www.firstpost.com/investing/why-property-is-the-biggest-con-job-on-investors-696373.html

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