The residential property market in India, particularly in the Tier I cities, has remained sluggish for the past 12 months, with significantly lower sale volumes when compared to the high absorption rates of 2010. Home loan interest rates now seem to be at their cyclical highs (but should soon decline) and unforeseen tax levies have come at a time when the industry is facing its moment of reckoning.
In these uncertain times, the question arises whether strategic decision-making for residential property developers to improve sales should follow the ‘root method’ — a comprehensive evaluation of options, or the ‘branch approach’ — a process of muddling through. In a multiple stakeholder environment with several large uncertainty input parameters, the branch approach seems to be the instrument of choice.
In adverse market conditions, developers want to ascertain facts on some key issues. They consider whether they should:
Lower prices in on-going developments
Proceed with construction
Launch new projects at lower prices
Sell non-performing assets such as land
The ‘Logic’ Of Home Pricing
While others require comprehensive evaluation, determining residential property prices usually entails a trial-and-error approach. During good times, prices are invented. When the going gets tough, prices are discovered (hence the term ‘price discovery’). Developers continually assess the market with trial price levels to increase sales in on-going projects. To avoid adversely signalling the market (which could lead to a downward spiral) prices in on-going projects are kept ‘sticky-upward’.
In the first phase, negotiations are held behind closed doors to test the market’s appetite. If sales do not recover, discounts are offered up-front on the table.
If there is still no perceived recovery, discounts are advertised to increase visitors to the sales office. At this stage, the market is said to have witnessed a correction.
This is fundamentally a process of ‘muddling through’, in which residential prices offered by developers in on-going projects rise like rockets but fall like feathers.
However, during a slowdown, developers try to register sales by launching new projects which are different from on-going projects – and priced much lower than the market average (the price levels being decided by the root method of decision making). Since new projects have a high construction risk, the lower price is somewhat justified and avoids the signalling effect to the market.
Is the Indian residential property market headed for a hard landing?
During the slowdown in 2009, prices in some on-going projects witnessed corrections while a large number of projects maintained stable prices. New launches were made at highly discounted prices; subsequently, a significant rise in absorption was observed as prices were termed ‘affordable’. Prices then increased rapidly by as much as 30-40 per cent (mostly in newly-launched projects) across Indian Tier I cities until end-2010, followed by slower growth in 2011.
However, all predictions of a hard landing for the residential property market in 2011 have failed to come true. Despite slow sales, highly leveraged balance sheets, expensive finance in a high interest rate environment and rising input costs, developers have been able to avoid a market-wide crash. They have been able to generate sufficient cash flow through the gradual process of price discovery, and several factors are in their favour in the near term.
Over 60 per cent of residential launches in the top seven cities (mostly in cities other than NCR and Mumbai) are priced in the range of Rs 2,000-4,000 per sq ft, which meets the demand of middle-income buyers.
The RBI’s rate cuts will improve affordability for home buyers and provide lower interest costs for developers.
Prevailing absorption rates at nearly 10-12 per cent translates into an average absorption period of 8-10 quarters for a residential project. This implies that at average prices, any average residential project should be sold out before construction is completed.
New project launches, slow in Mumbai and NCR due to approval and land acquisition issues have started to pick up and should improve cash flows for developers with land banks in the current year.
With rising input costs, developers do not want to sell below a threshold which does not justify their minimum replacement returns.
This leaves home buyers with a small window of opportunity —the next six months, when home prices should witness marginal appreciation. After six months, a second wave of high appreciation is predicted. Are you geared for it?