Balancing rates and costs

The government needs to work towards effective measures for faster approvals which will help developers save on time and subsequently money

In the past 18 months, the monetary policy has seen frenzied action in the interest rate scenario. In its latest monetary policy meeting, the Reserve Bank of India hiked reverse repo and repo rates by 50 basis points. This rise in rates has increased the borrowing costs for banks and has led to a subsequent hardening of interest rates for the consumer, causing a ripple-effect on the cost-sensitive real estate market.

The first to feel the impact of the rising rates is the consumer with a home loan who would have to battle higher EMIs, longer loan tenures while dealing with daily inflationary pressures. For the consumers planning to make a purchase, the increase will impact purchasing decision.

This rise, coupled with soaring prices, affects affordability. This is more evident in the mid-income housing segment as the buyer now has to make a higher contribution to the cost of homes.

For a 20-year loan, when the interest rate was 8 per cent , the EMI for a lakh was Rs 836. At 11 per cent on the same loan, the EMI has increased to Rs 1,032. A difference of Rs 196 a lakh. This will have a tangible impact on demand.

However, industry experts anticipate this impact to be short-term as with time the market is likely to absorb the changes and sales will grow with economic growth. Also, the job market is likely to see salary hikes which can offset the burden of incremental interest rates. The upward movement in interest rate will to some extent curb the rise in property price.

Hard on developers

Property developers, on the other hand, will be more impacted as borrowing rates increase with every instance of tightening money supply.

Banks are tightening the noose around the realty sector, by earmarking less for lending to developers. Many banks have shut doors for realty lending. Other banks have become choosy, lending to reputed developers only.

Average rate of interest has gone up from 12 per cent a year to 16 per cent in the last one year for top ranked developers. For others, it is an additional 2 per cent. Developers are resorting to borrowing at very high interest rates to avoid defaults, further adding to cost. In our opinion, overall impact on cost, due to interest rate increase would be about 5 per cent.

In addition to high borrowing costs, property developers also have to deal with high cost on the commodities.

Cost control

The biggest challenge before builders is not sale of projects, but to control construction costs that rose by 20-30 per cent in the past one year alone. Rise in prices of steel, cement and other raw materials are putting pressure on the profitability of developers. Between 2009 and 2011, cement costs have gone up 27 per cent per bag, steel 13 per cent and labour almost 50 per cent.

With these challenges, deceleration on the demand side would put operating margins under tremendous pressure.

If the interest rates continue to climb up, it will impact demand and lead to an increase in unsold stock. This in turn will force some builders to offload their inventory at a negotiated price, leading to an unhealthy scenario. It is important for the regulatory authorities to not just tackle inflation, but to also address its causes.

The government needs to work towards effective measures for faster approvals, which will help developers save on time and subsequently money — the benefits of which can be passed to the common man. On an average, it takes 2-3 years to start a project after land is acquired. Builders need to obtain more than 40 certificates and clearances.

According to a study conducted a while ago by McKinsey, land approval-related hurdles are adding 40 per cent to the home cost, making it imperative to remove these approvals and work towards a single window clearance system. Similarly, measures to control the cost of commodities, tax benefits will be beneficial.

During the next year, the industry believes RBI is likely not to revise the Repo Rates. On the contrary, it may start reducing the rates.

This may trigger reduction in interest rates by about 1 percentage point by March 2012 for construction as well as housing loans. We also feel that the developers are reconciling themselves to the situation of borrowing less for residential projects.

(The author is Director Marketing, Mantri Developers Pvt Ltd.)

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