Introduction:
The real estate sector has, prior to the recession in late 2008 and in 2009; had seen tremendous growth worldwide including in India. It is not without reason, considering that housing is one of the core sectors of the economy, and possessing a house, is considered as one of the most valued immovable asset that, apart from providing the core need of shelter and a definite identity in the society, is an asset that appreciates in value over time. So it is a bit disconcerting that, an asset that is in great demand, and appreciates in value over time, would come under the ill effects of recession, and in fact would be the cause for the current recessionary trend that has engulfed the global economy. All these require a thorough understanding of the real estate sector in modern times and discuss the various factors associated with it.
Real Estate Sector:
The real estate sector can be defined as a legal nomenclature given to a piece of land that is immovable, and has been improved and improvised by landscaping, building fences and constructions for a particular purpose or activity. The end result is that that piece of land acquires a totally new hue whose market value and usefulness for a particular purpose increases (2004). With passage of time the word real estate has primarily come to signify properties developed in pieces of land for various commercial and personal uses, like residential accommodation, industrial sheds and factories, shopping centres and malls which have been particularly developed for such purposes. The inference that can be drawn from the definition and the subsequent development in the term real estate and its meaning is that in the present context, real estate essentially means dealing with accommodation, be it for personal purposes, like a standalone residential property, a flat, apartment or penthouse, to that of a commercial or industrial shed, shop floor or shopping mall, department store and supermarket establishment etc, apart from residential, commercial and industrial plots. Real estate as is understood, therefore, is essentially concerned with the business of buying and selling of such properties in the market based upon their relative supply and demand, and which in turn, determines their value in the market. Apparently this definition or identity of the real estate sector gives it a rather smug feel, i.e. what would turn adverse in a sector having a perennial demand with a huge backlog of demand. All the same, it is the same sector that triggered the global recession in 2008 and 2009, which means that there ought to be some reasons behind it which needs to be plugged, rectified, removed or improved, in order not to repeat such spectre in future.
Global Real Estate Sector:
The global real sector is one of the vibrant sectors amongst businesses operating in the world. According to Brown et. al., the global real estate sector is one of the main stimulants for various infrastructure industries like steel, cement, iron and for other sectors like home fittings, sanitary sector, fabricated building materials, construction machinery & tools, paint industry and related consultancies in the field of engineering and architecture. Real estate sector by virtue of its perennial demand worldwide manages to sustain demand in all these sectors and all these sectors base their business plans majorly on the business outlook of the construction and real estate sector. But it is also a sector that faces a cyclical nature of demand and slump, which is inherent to this sector, as a result of which there comes periods when the real estate sector has to sustain on its own momentum of holding on to its core appeal of being a huge money spinner in terms of investments in general times (Brown et. al.,2001). Global real estate analysts rate the real estate market in the world as one of the largest markets for institutional and shareholders' funds. In terms of market capitalization the global real estate sector holds one of the highest attractions for investors. This is because this sector due to its inherent nature has the highest pull factor of exponentially increasing the value of assets in short period of time. The factors that contribute to this phenomenon are the burgeoning demand for quality real estate, the market value of prime real estate locations observed across the world, and the relative assured rate of return envisioned due to the perennial demand for real estate assets. In markets across the US, EU, S.E Asia and West Asia markets the real estate sector had witnessed a veritable boom prior to the recession that is experienced in 2008 and 2009. In the US real estate market, financial institutions like Fannie May, Freddie Mac and Bear Stearns had invested heavily in the real estate sector with anticipation and surety of handsome returns in their investments (Hage; 2008). The above-mentioned facts aver that whatever happened afterwards in the form of credit crunch crisis and consequent recession was not in their analysis of things during the time these financial institutions infused funds into the real estate sector. In fact their confidence in investing in the real estate sector was based on the fact that the real estate sector being a sector having a huge inherent demand is bound to give profits in their investments. What happened afterwards in that sector is either due to some inherent flaws in the business strategy adopted for profit in that sector or due to some strategies not functioning according to their plan. But the fact is that the real estate sector is an institutionalized form of business that has definite returns reinforced by its business performance. Globally, in every market the real estate scrip has been the most preferred scrip in terms of its returns on investment, which is true in every sense (Seabrooke et al; 2004). It means that left to itself the real estate sector has always been capable to generate demand and accruing business resulting in profits for thee investors in this sector. But all the same the crisis that resulted in the globe emanated from the real estate sector in USA. What was the cause for it?
Cause of Crisis in Global Real Estate Sector:
The genesis of this crisis can be found in the USA market, and in areas that are not part of the real estate market setup. The real cause as can be seen subsequently, occurred due to the modalities applied to cater to the demand existing in the real estate market by applying revolutionary and unmanageable financial schemes to finance real estate purchases to a section of customers that did not had the inherent strength to sustain themselves as buyers of real estate assets. The conditions for the occurrence of this phenomenon were being formed on a continual basis a few years ago in the USA lending and borrowing market. It is mainly concerned with the USA housing industry where the lending institutions indulged in large scale lending in the housing market. They provided housing loans to borrowers who did not qualify according to the terms and conditions of the prime lending rate (2008) but were given loans at a subprime rate, i.e. high rate of interest and certain conditions, that included applying the conditions of mortgage backed securities, which in such cases was the property for which the loan was being taken. The logic was that the borrower was taking loan for a property that had market value, and that value was going to increase in coming years thereby adding security to the loan, which the bank can convert into liquidity and get back its borrowed amount, or sell it in the securities market to companies trading in mortgage backed securities, and get back its amount.
The arrangement seemed perfect. But the moot point was that the success of this arrangement depended upon the continuous increase in value of the mortgaged backed securities i.e. the houses for which, and against whose potential value the loan was given. The crisis occurred because the value of the houses and real estate in the USA housing market did not increase as was expected. This phenomenon was felt in 2006 and the full effect of this crisis was felt in the USA market and subsequently in the global market, when the financial institutions operating in the USA market began to accept that they were in the middle of a financial where the money they had lent to the subprime market may not be recovered even by trading the mortgage backed securities (2008) because their value has fallen in the USA housing market and there were no buyers for them.
According to the Economist (2008) the probable subprime loan defaults was to the tune of $ 200 billion to $ 300 billion in the end of 2006. In order to contain the situation the lending institutions tried to protect whatever liquidity they had with them, and therefore increased the prime rates of lending besides making the other stringent terms and conditions. All these measures made the loans very expensive and uneconomical and borrowers could not get liquidity. This led to a situation of credit crunch in the USA and subsequently in the global market.
According to Das, (2007), sub-prime lending is one of the main causes of credit crunch in the market. This is echoed by Greenspan, 2005 where it is said that the sub-prime lending causes a disturbance in the smooth functioning of the debt cycle by sucking a large amount of funds into unviable debt contracts that do not have the capacity to fulfil their repayment obligations at face value ().
Most of the loans are taken for personal needs or to restructure an existing credit. In most of the cases this loan money is used to buy real estate, automobiles and household appliances thereby satisfying different consumer wants. But due to their weak financial condition they fail to repay the borrowed amount in regular instalments. They are thus notified as bad debts that cannot be recovered from the borrowers. This puts the pressure on the other remaining funds to cater to the whole market. At this point the natural demand and supply mechanism comes into force whereby the remaining funds automatically attract a higher rate of interest from the existing market in order to maintain balance.
The subprime lending is resorted to by mortgage brokers who sell these schemes especially in commercial and housing loans categories to borrowers having low income return with high yields that slowly become unviable for the borrower to repay them. This loan is then transferred into other financial return mechanisms that are serviced as bonds, securities and many such investment schemes and passed on to pension funds. Most of the subprime lending institutions are controlled by primary financial institutions to cater to the market of subprime borrowers. They remain as trustees of these loans and manage to earn significant amount of fees as custodians of these loans. In the USA many such institutions were established under the REMIC Scheme of Tax Reform Act of 1986 (Greenspan, 2005). According to this act the government allowed the setting up of institutions, trusts and organizations that can segregate mortgages of loans according to their nature of mortgaged securities and the due amount that has to be paid for final settlement and issue pass-through certificates that are similar to Collateralized Mortgage Obligations or CMO (Merrit et al 2005).
Apart from this, the American lending market works under the philosophy of asset backed securities. Asset Backed Securities are a type of bind where non-lucrative or minor investments by collateralized cash flows from a pool of underlying assets in order to make the loan a secured loan. The United States Securities Exchange Commission (SEC) has defined Asset Backed Securities in regulation AB of 2005, where it is defined as a security that is mainly serviced by cash flows from a fixed or moving separate financial asset that has a finite period of maturity and can be converted into liquidity upon completion of that period in order provide assurance to the holder of such securities regarding the remittance of such proceeds. This has greatly helped in the growth of the money lending market in USA especially of the sub-prime category where the lenders were assured of a return on their lending amount by the provision of such asset backed securities in a loan deal.
One of the systems for categorizing asset backed securities and giving it an acceptable face in order for it to be accepted as collateral or a security are Collateralized Debt Obligations (CDO). They are a form of asset backed securities that are given ratings as per their marketability and their convertibility value. As a result they are divided into different categories like 'AAA', 'AA' to 'BB' and 'Unrated securities. Here the assets that are given 'AAA' rating attract a lower rate of interest in case of failure to convert into liquidity than a security that is marked as unrated. In other words it is easy for an asset having a rating of 'AAA" to be accepted as an asset backed security than an asset that has been marked as unrated (Greg, 2005). These asset backed securities can be traded in the secondary market just like any other bonds.
So, in other words, apart from providing back-up to the investments done by the lenders it has other appeal quotient in the form of its eligibility of being traded in the securities market that has prospects of enhancing its value. In other words these assets backed securities were also a source of revenue for the lending institutions in the immediate sense. Apart from these the financial markets in USA operated on the universal premise of 'risk versus reward' theory i.e. higher is the risk then more should be the reward (Bethany, 2007). Accordingly the USA lending market developed a cause alibi to provide loans and credits to the subprime category of borrowers with the logic that they are securing their investments by higher rate of interest for these loans. In fact it was a mutually beneficial relationship that developed between the lenders and the borrowers with each fulfilling its own objective, but oblivious to the larger picture that their activities influenced. So the USA lending market offered every type of consumer and housing loans that can be possible, to the American consumers with innovative interests and repayment schemes to suit each category of borrowers.
One of the main markets of these types of loans in the American market was the housing loan market. The American housing industry operated under the premise of assured increase in value of real estate in future. Within that premise it became acceptable to provide loans even to subprime borrowers as the companies were assured of the increase in value of the asset backed securities or collateralized debt obligations that in this case were the property itself that they were financing (Bethany, 2007). If in the case the borrower fulfilling fails to fulfil his or her repayment obligations the investment company can simply bundle off theses 'AAA' securities by selling it in the secondary market or to other such institutions dealing in buying such securities, as all of them were assured of their future value. This was one of the main causes for the unprecedented rise in subprime lending in the USA market as all the investment companies wanted a share of the future windfall that was purported to occur to these 'AAA' securities and the rise in value of the real estates in USA. But the reality is that this did not happen as expected. There developed a glut in the assets market as the value of the real estate in America did not increase as expected. This triggered a panic reaction amongst all the investment companies that had indulged in giving such loans to the subprime lenders. According to various reports (Litterick, 2007) the crisis developed as the sub-prime borrowers expectedly, failed to repay their loans at regular intervals and the lending institutions also failed to get the estimated value from the collateralized debt obligations having 'AAA' ratings. The securities lost their value and the real estate did not increase in value. As a result the lending institutions like Bear Stearns, BNP Paribas, i.e. both American and foreign financial institutions fell into a situation where they were saddled with a lot of asset backed securities that had very little value on the market. It was a situation of bankruptcy for many organizations. According to information received (Financial Times, 2008), most of the leading American financial and lending institutions have filed for bankruptcy in the year of 2007, prominent among who include New Century Financial, American Home Mortgage, Ameriquest, American Freedom Mortgage Inc. Terra Securities etc. Besides, to tackle the situation, the financial institutions increased their rate on interest and stopped giving borrowings on general terms, therefore leading to a situation of credit crunch and subsequent recessionary periods.
All these discussions on the genesis of the crisis in the real estate market in USA that generated recession in the global economy show that the cause did not lie in the capability of the real estate sector to generate business, but in the application of unrealistic finance and inc\vestment strategies on a weak buyer base having low buying per that could not sustain the churn that emanated from the application of such strategies in the real estate market in USA. But, this, though applicable in some degrees to some other markets in the world, was not entirely applicable to the Indian economy in general, and the Indian real estate market in particular, though it was also affected to some degree as a result of the effect of the crisis in the global real estate sector.
Real Estate Sector in India:
The Crisis Period:
The financial meltdown that that happened due to the sub-prime crisis in USA turned into a global crisis which did not leave the Indian real estate market also. But, in normal circumstances also, the real estate sector would have faced a downturn in line with the nature of this industry, which regularly experiences cycles of growth and slump. This situation was however aggravated by the subprime crisis and the Indian real estate sector experienced slump in 2008 and recession slowly crept in this market. This phenomenon particularly affected the cities where the real estate was being witnessed. Part of it was attributed to the hyped up demand by the real estate brokers to gain maximum leverage out of the need of customers to possess real estate assets. In that way it can be said that such phenomenon was not different from what happened in the US market. But the difference form that lied in the fact that unlike in the US market, the real estate market in India did not had the concept of subprime lending, and neither it was as open as the US market. In fact in India the real estate market is sufficiently overseen by the government agencies and is debated elaborately as part of the overall planning process of Indian economy (Sardesai; 2008). Nonetheless, the real estate market was affected, and real estate companies that had projects that were halfway to completion, or companies that are stuck with cash flow issues on businesses that are yet to reach breakeven, ran out of cash, and real estate companies, whose building projects were half-done all over the country and some property and land developers who marketed their assets as land banks, slowly found out that they were not bankable after all. The only option left for the real estate companies was to drop prices that had reached unrealistic levels and assumed the characteristics of a property bubble in order to lure the buyers back into the market. This effect was heightened by the Reserve Bank of India (RBI), who in their endeavor to contain the inflationary tendencies in the market, increased the interest rates and restricted the flow of funds to the real estate sector, which necessitated a hasty correction in the market prices of real estate assets. Real estate analysts always knew that the Indian real estate sector had great attraction for the foreign funds inflow and depended on it for fund requirements, considering that the RBI had already put restriction on Indian banks to finance real estate companies in the country. However, following the subprime crisis in USA, many of the private equity funds are returned back to their mother countries, as many of such funds were launched by investment banks, which were uncertain about the return accruing to the funds and their capability to raise funds. All these factors put severe constraint on availability of funds in India and led to the occurrence of recession in this sector. This led to many real estate companies to take funds from high net worth individuals at very high interest rates, thereby further lowering the returns of this sector (Sinha; 2008). The above-mentioned information shows that the crisis that engulfed the Indian real estate market was characteristically different from what happened in the US real estate market, as discussed in the previous section. The significant difference was that in the Indian context the government, in the form of its financial institutions and policies maneuvered the operations of the real estate market with a view to protect it from becoming financially perilous and risky. So, whatever effect was being witnessed was due to the reining in process adopted by the central bank to protect this sector form the vagaries of global recession and financial bohemianism. This had happened due to the overall supervision of the economy by the government, which includes the real estate sector also, and which was instrumental in keeping on track the real estate sector during recessionary times. So, what are the policies and steps of the government with regards to the real estate sector?
Role of Government:
The real estate sector in India has assumed significance with the liberalization of the economy as a result of an increase in business opportunities, This has led to concentration of prospective customers in urban centers, which in turn has increased the demand for commercial and housing space, especially rental housing. Developments in the real estate sector are being influenced by the developments in the retail, hospitality and entertainment industries information technology (IT) enabled and software services.
Source: Real Estate; Planning Commission Report, 2007
The above-mentioned table shows that growth of real estate and related market in India post liberalization phase with the growth in economy. During the period 1994-95 to 1999-2000 the real estate services, housing and construction sector grew by 4.6 per cent. The housing sector grew by 2.8 per cent only while the construction sector grew by 6.4 per cent. The table indicates that the share of real estate services, housing and construction in GDP declined steadily from 1993- 94 to 1999-2000. Several factors have contributed to the decline in share of real estate market prominent among which are the plethora of rules and regulations that restrict the growth of this market, like the Indian Contract Act of 1872, the Transfer of Property Act 1882, The Registration Act 1908, the Special Relief Act 1963, The Urban Land (Ceiling & regulation) Act 1976, Land Acquisition Act 1894, The Indian Evidence Act 1872 and the Rent Control Act. Added to these are the Stamp Duty Act and the Property Tax issues that burden this sector and make its growth regressive (Padhi; 1999). But at the same time a comparison with the emerging markets of Brazil, Russia and China shows that the share of real estate in the Indian market will be double that of Brazil and one and a half times of China. The market share of listed real estate companies is 2.13% in Brazil and 2.63% in China. In Russia, where only five real estate companies are listed, it is 0.08% of the total market cap. In the global arena, the real estate market grew from $368 billion in 2002 to $1.2 trillion in 2006. Among this, $651 billion was in Reits and $563 billion was in non-Reits. In 2002, comparable figures stood at $211 billion for Reits and $157 Billion for non-Reits. In comparison to the Asian markets, property stocks have higher weightage on the index in Hong Kong. The real estate stocks there account for 10.83 % of the total market cap. In Singapore it is 12%, Taiwan 11.5% and Thailand 6.5%. In Japan, however, property stocks are 3.09% of the total market cap and in Indonesia it is 3.6%.
In fact there is an indication that that the doubling of the market cap of Indian real estate stocks would send a positive signal to investors worldwide that the Indian markets have come of age and that real estate in India is no longer a small business and is capable enough to attract the big developers in Europe to India (Saxena; "2007). The information shows that despite the restrictive policies of the government, the real estate sector has been able to grow in India and attain a prominent place amongst the real estate sectors in the world.
Current Status of Indian Real Estate Sector:
Currently, the real estate sector has been able to shed of the recessionary pangs and able to resuscitate itself into a position where it is again seeing the signs of growth. Many national and international real estate companies are making ambitious plans to tap the next phase of growth in the real estate sector and tap the profits accruing from it.
So far, two of the biggest developers from the US, Tishman Speyers and Hines, have set up India offices. The DLF group of India has drawn up ambitious plans to bring new real estate properties both in the residential and commercial space and provide new type of properties for the customers. The initial response of the investors and the customers to these plans shows that they have belief in the strength of the Indian real estate sector and the success of the Indian real estate market. In fact the recession-hit Indian real estate sector is crawling towards recovery with the return of end-users as well as institutional investors in the market. According to the consultancy firm Ernst & Young the real estate sector is generally looking positive now. End-users are back in the market. Several developers are announcing new projects. Institutional investors, particularly private equity funds, are starting to look at projects for investment. The sector fell into a deep crisis after the economic meltdown and coming back to buoyancy was delayed as buyers' preferred to "wait and watch" before taking the buying decision. Now end-users are no longer shying out of the market as the fear of further economic slowdown and job losses have subsided. Developers are also now more focused on the need of the consumers and a few of them have announced new projects, particularly in the affordable housing segment. Though price wise, there is some upside, yet it is not significant and is surely going to touch the pre-recession phase. Market capitalization of the real estate sector in India will more than double, from Rs 80,343 crore to Rs1.7 trillion, even if the Delhi-based realtor DLF Ltd stock gets listed on Thursday at its issue price of Rs525 a share (Ramakrishnan; 2010 ).
The above-mentioned information shows that the Indian real estate sector has been able to pull itself out faster than other economies of the world and put itself into the path of growth. The reasons for this though resting on the enterprise of companies like DLF, Unitech, Ansal and Raheja Developers, is also due to the control and management of this sector by the government. The other factors that might have contributed to the quick recovery of this sector is that already existing demand for housing in this country followed by the trend of customers to save their incomes for acquiring permanent assets of which housing forms a core part.
But what actually led to this recovery can only be explained by getting information from the key companies engaged in this sector prominent among which is the DLF, along with the key persons of the various government departments regulating this sector.
Conclusion:
The Indian real estate sector is one of the highest growing sectors in the Indian economy, due to various inherent reasons. But due to the integration of the economy with the global economy, this sector came under the baneful effect of global recession of the year 2008 and 2009. However it is now showing signs of recovery, the reason for which are being seen in the dynamism of the Indian real estate companies and the protective and nurturing policies of the government towards this sector. But what actually led to the crisis and what led to its quick recovery, can only be explained by talking to the key persons in this sector. This has been analyzed in detail in the next section.
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