New Delhi: We all know somebody who has made a mini fortune by investing in a flat or residential plot at the right time. Despite the usual ups and downs, there exists a deep-rooted sense among Indian investors that residential property is a sure-fire investment which delivers excellent returns. This wisdom has been passed on from generation to generation.

Yet, unless you’ve been living under a rock, it’s evident that residential real estate has been down in the dumps. According to National Housing Bank data, property prices in Mumbai and Bengaluru increased annually by just about 7.50% and 5.75% respectively between June 2013 and September 2017. In Delhi, prices actually fell by -0.70% annually during the same period. Beyond the data, we hear numerous stories of investors in distress with their money stuck in delayed projects. There are also stories of many brokers, in fact the entire realty ecosystem, struggling to cope with this slowdown.

However, many feel that real estate has bottomed out. Their logic is that from now on, or soon, the cycle will reverse and prices will start moving upwards. In reality, this is either wishful thinking by people who are stuck with depreciated assets or an illusion created by stakeholders. The fact is, investing in residential real estate will not get you 20-30% annual returns or double your investment in about 3-5 years any more, as it did back in the golden days of 2001-2007.

This time it is different. There are various factors which indicate that the lull in the real estate is here to stay. Therefore, it certainly does not make sense to buy a residential property from an investment point of view at this point in time. “Considering the rising interest rates and high maintenance cost and tax on rentals and capital gains, I would not suggest investment in physical real estate,” said Nishant Agarwal, managing partner and head, family office, ASK Wealth Advisors.

The reason low returns are expected from real estate is that there has been an irrational increase in property prices in the past. Moreover, even after prices have remained largely stagnant for few years now, in many locations property is overpriced. Many investors who bought property 3-4 years ago are finding it difficult to get a buyer even after reducing the price lower than the purchase value.

Remember, any asset class, be it realty, gold or equity, has its own cycle. No asset classes will give you positive returns forever. Nor will it constantly give you a negative return. With that caveat out of the way, read on to understand why real estate will take much longer to recover.

Black swan moments

Demand in real estate started declining from 2013. By 2016, it had hit an all-time low. The overall market was going through a bearish phase when it was impacted by two major ‘black swan’ events. In May 2016, the Real Estate (Regulation and Development) Act or RERA was enacted. And six months later, the government demonetized high-value currencies—it washed out 2016 and 2017 for residential real estate.

One of the aims cited for demonetisation was that it would help curb the rampant use of black money in real estate transactions, especially in the secondary market. Black money is what lubricates the real estate sector, as anyone who deals in cash finds it the easiest investment to channel funds into. This is so because of the difference between the circle rate, which is fixed by the government, and the market rate of properties. For instance, in Delhi’s posh Defence Colony, circle rates are around ₹2.45 lakh per sq. m whereas the market rates are above ₹5 lakh per sq. m. This is why homebuyers, who don’t have unaccounted funds or cash, find it difficult to buy properties in these localities.

“Initially, there was a setback, but once again cash is back in the market. However, the magnitude of cash proportion has declined to some extent,” said Vasant Kumar, a south Delhi-based real estate agent. But the general attack on black money has had some impact. Many buyers and sellers are now not comfortable dealing with cash. What this translates into is a lower supply of money flowing through the real estate segment—many feel that this will continue for a long time.

On another front, it will take years for RERA to make any significant impact on ground. Only a few states have implemented RERA effectively; many have diluted the key provisions of the central act. These dilutions include exempting a majority of under-construction projects from RERA’s purview as well as easing penalties for builders who do not comply with the act. Once all states implement RERA, developers will take time to comply with the regulations. It is expected that homebuyers or investors will also wait for things to settle down. Effective implementation of RERA is important to restore confidence among homebuyers. Until then, demand will remain muted.

Relax, pay more tax

The tax man has not been kind to the real estate sector. Now investors have to calculate how much profit can be retained after taxes. The implementation of the goods and service tax (GST) from July 2017 disturbed real estate transactions, stretching the lull. In fact, over the past few years, the government has introduced many changes in the tax regime, which have negatively impacted homebuyers and investors.

While earlier, a service tax had to be paid for under-construction properties, now GST has to be paid. The effective rate of service tax was 4.5% of the property’s value, while the effective rate of GST is 12% with inputs tax credit (ITC). Though the government believes that after taking ITC into consideration, the tax proportion would be lower. But, “there is still confusion about the amount of rebate that a prospective homebuyer is entitled to on the back of the pass-over of ITC. The confusion is not only about the percentage of ITC but also the mode and tranche of the rebate,” said Anuj Puri, chairman, ANAROCK Property Consultants.

In addition, after buying a property, the buyer has to register it by paying stamp duty and registration fee, which are in addition to GST. Stamp duty is levied by state governments and usually varies between 5% and 8%. This means that GST and these other fees constitute about 20% of a property’s value. Such high transaction costs make real estate unattractive for investors. Worse, there are other taxes: income tax is levied on rental income as well as capitals gains made from property transactions. But, many tax benefits and exemptions of have been scrapped or restricted in the last couple of years. In short, investing in real estate is no longer tax friendly.

Supply, over supply

The slowdown will also linger because of an over-supply—a huge inventory pileup—at developers’ end. What makes it worse is the mismatch in demand and supply. For instance; there are about 120,000 apartments in Pune lying unsold, followed by Bengaluru with about 100,000 units lying unsold.

When the going was good, most developers were focusing on mid-category, luxury and premium-housing projects. At the moment, the demand is for affordable housing units. Therefore, there is huge unsold inventory of other units across most micro markets, mostly in the suburbs and far-flung areas of metros. “The developers failed to ascertain the need of homebuyers and launched projects which were not in line with their demand,” said Samantak Das, chief economist and national director -research, Knight Frank India.

It’s obvious that when there are few takers for the current inventory, developers will not even think of launching new projects. Even clearing the inventory will take time—at the current sales volume, it will take 85 months to clear the current inventory in Greater Noida. Obviously, prices will remain subdued.

Clearly, greed, over-ambition and financial indiscipline of developers are the main reasons investors are shying away from realty. According to 360realtors.com, a real estate portal, there are about 340,000 residential units running behind schedule of construction in Mumbai. The situation is similar in many other cities. There are many homeowners and investors who are stuck in real estate projects, with their finances in a mess. They are paying rents and paying off their loans, but possession is a distant dream.

The number of projects running behind schedule is reducing because developers have stopped launching new projects. Even so, it will take a long time to bring the sector back on track. As per ANAROCK , “During 2017, out of the total 5.8 lakh residential units slated to be completed across the top seven cities in India, 4.3 lakh units (74%) actually missed their stipulated completion deadlines.”

Even big developers like Unitech Group, Jaypee Group and Amrapali Group have failed to deliver projects. The impact of long delays, poor quality of apartments, failure to deliver the amenities promised and non-compliance with rules and regulation will take a long time to fade away. Homebuyers will wait till things improve or buy only ready-to-move-in apartments.

The investment scenario

To make matters worse for real estate, other investment avenues are flourishing. According to data from Association of Mutual Funds in India (AMFI), total assets under management by assets management companies (AMCs) as of 31 May 2018 was about ₹22.6 trillion. On 31 may 2013, this figure was about ₹8.68 trillion— that’s an average year-on-year increase of 21%. During the same period, according to www.valueresearch.com, hybrid equity oriented funds had given an average annual return of 16% and liquid funds around 8% per annum.

Since 2001, real estate has performed poorly in comparison to equity and gold. “Real estate as an asset class has lost its sheen (in terms of investment asset) given the various reforms (demonetization, RERA and GST) introduced in the last two years and especially when other asset classes like equities have been doing well,” said Rahul Jain, head - Edelweiss Personal Wealth Advisory.

With all these factors working against real estate, we can at best expect a nominal return in next decade or so. A low rental yield of below 3% is also a big deterrent. At best, experts feel, one should invest in real estate for diversification—irrespective of the low returns. “Equity is a highly volatile, whereas real estate is not that volatile. We must understand that real estate is cyclical in nature,” Binaifer Jehani, director, CRISIL Research, said. In the present scenario, “if you have a horizon of about 15 years, you can go ahead and invest in real estate,” she added. Clearly, invest in real estate only if you have the patience to play a very long waiting game.