It Would Cost the Govt Just Rs26,000 Crore to Save Real Estate Industry That Contributes Rs12.5 Lakh Crore in the Economy: Liases Foras
Indian real estate sector, which was already struggling in the last three years in dealing with demonetisation, goods and services tax (GST), Real Estate Regulations Act (RERA) and the financial liquidity crisis, is now set to suffer more turbulence.
 
Pankaj Kapoor, managing director (MD) of Liases Foras hosted a webinar recently to discuss an empirical assessment of the immediate and long term outlook of the residential and commercial real estate market. He offered suggestions on how the government could help boost demand and also explained how it would cost the government just Rs26,000 crore to save the country’s real estate industry that contributes Rs12.6 lakh crore to the Indian economy. 
 
Significance of real estate market to India’s GDP:
The real estate sector contributes 6.1% (Rs12.58 lakh crores) of India’s GDP. It employs 2.2 crore people and contributes Rs 1.10 lakh crores to the government in taxes and duties. 
 
Chart 1. Contribution of real estate industry to India’s GDP
 
Chart 2. Contribution of real estate industry to employment
 
Chart 3: Contribution of real estate industry to taxes and duties
 
Covid-19 impact on job market affecting commercial office space:
Almost 55% of global outsourcing work handled by Indian IT companies is generated mostly from US and Europe. Both US and Europe have been reeling under Covid impact. Fresh orders and renewals will suffer. Every passing week of the lockdown is painful. Companies are likely to reduce their expenditure by 25-30%, which is likely to induce pay cuts, job cuts. This will have repercussions on new absorptions of commercial office space as well as increase in vacancy levels of commercial office space. To reduced costs, companies will reduce employee costs. 
 
Scenarios based on when the lockdown ends:
 
The research company made an assessment of different scenarios of how companies will reduce employee costs based on when the lockdown ends. Every additional month of lockdown will lead to a spike in reduction of employee costs. Reduction in employee costs is directly proportional to vacancy levels and will thus impact the demand for office real estate and the lease rates.
 
 
 
The current office market inventory in Top 8 cities:
Ahmedabad has the highest percentage of vacant office space (35%), followed by Kolkata (28%) and NCR (24%). In Mumbai, which is one of the most expensive cities, 15% office space is vacant. 6% office space is empty in Chennai and Pune while 7% is empty in Bangalore and Hyderabad. 
 
  
 
According to their research and calculations based on the different scenarios, if the lockdown continues upto September then the vacant stock levels could increase by almost 32%. By June, 21% increase in vacancy levels will be seen if the lockdown is not lifted.
 
 
Excluding NCR all cities have more than 60% of the clients from the three segments (IT + BFSI + Coworking)
 
2008 Experience 
Economic meltdown during the 2008 financial crisis had brought down the rental values to the extent of 40% to 50% in the commercial office space segment. Interconnected sectors of IT and BFSI  (Banking, financial services and insurance) segments were the first ones to go down and will most likely bear the brunt again. Cities having higher concentration of these segments are likely to experience jitters before others.
 
City wise cumulative increase in Vacant stock
 
If the lockdown continues, vacancy levels will continue to increase and  the highest quantum of vacant supply will be present in Mumbai and NCR.
 
Residential Market in India
 
 
Mr Kapoor said the only segment of residential real estate industry where there were sales was the affordable housing segment. “But I foresee a reduction of almost 30 to 40 per cent in sales in the upcoming financial year, in comparison to last year in the affordable housing segment". 
 
The situation now is so severe that there is four to five years' worth of real estate inventory across India - an all time high. This is in line with a report in January by Prop Tiger which reported that India’s nine major residential markets have unsold units worth some Rs 6 trillion ($80 billion). Buyers can expect steeper cuts and sellers will have to cut their prices if they want to complete the deal. Banks are also worried that if developers can't liquidate their stocks, it could lead to defaults and add to a $140 billion pile of bad loans. 
 
 
Maximum share of annual residential sales (for last FY) came from MMR, NCR and Pune. But Hyderabad and Ahmedabad which had lesser residential sales also hold less inventory overhang of 27 months only. All other cities have inventory of over 40 months and Chennai has inventory overhang of 73 months. According to Mr Kapoor, an inventory overhang of 12 to 15 months is productive and sustainable, anything more than that suggest that we have high inventory overhang, unsustainable  and will continue to put pressue on the prices. Pre Covid itself, prices were not positive on growth and post Covid, there would be increased shrinkage in demand, adding to price pressure.
 
The lockdown has stopped all the on-site sales activity. Construction has halted not just till the lockdown ends, but also till the migrant labour gets confidence to return to the city. The consumer sentiment is also at an all time low with fear of job cuts, pay cuts and job insecurities.
 
 
Every month of lockdown is equivalent to 8.3% of loss of revenue. The lockdown till 3rd May is a straightaway dent of 11% on the revenue as can be seen in the chart above. 
 
 
By June 2020, if the lockdown continues, the market would shrink by 33% and if it continues till September it would shrink by 65%. Even if lockdown ends, there might be another one or two months of inertia before things can pick up again.  There are two customer segments: investors and end users. In cities where the investors are more active participants (mainly North India) in buying, lesser adverse impact will be seen. The compulsive investor from North tends to be less rational and they are more prone to believing in market stories that investment will move from stock market to property.. 
 
  
Price correction is imminent
According to Mr Kapoor, developers will have to provide discounts to re-ignite demand. Some might have to face losses too. But the only two options they might have are either lose to the customer or lose to the lender but they will need to make their choices. A price correction of 15% will further shrink revenue to 57%. Even if the sales increase by 20% each quarter post lockdown (assuming that the lockdown ends in June 2020), it will take at least 4 quarters after June to reach the stage of Dec 2019. 
 
How Covid-19 will alter real estate demand?
According to Mr Kapoor, the pandemic will initiate the process of de-densification. Contribution of large cities to the housing sales will reduce from its current share of 75%. Larger, denser, expensive cities will lose to smaller cities. He said that spatial diffusion of jobs is expected not just to the periphery but also to smaller towns. Land prices will undergo sharp corrections. Businesses too will focus on cost rationalization.
 
He said that luxury housing might suffer larger corrections than the affordable and mid-segment housing. Distress sales can be expected. On a specific question about whether ready reckoner rates should be decreased, he said that ideally ready reckoner rates should be calibrated to the market rates. Maharashtra and Gurgaon have made amendments in the past. If ready reckoner rates are retained, it somehow restricts the buyers and sellers from carrying out the deal. The government needs to reduce ready reckoner rates and reduce the premium they charge. 
 
Measures that Government can take to boost demand and the potential associated costs for the Government:
 
Mr Kapoor also discussed what possible measures and initiatives the government could take to boost demand. He said over 92% of the supply is lying in under-construction phase. He said the government needs to consider waiving off the GST for under-construction property. 
 
He suggested a waiver on stamp duty as well. Interest exemption limit under section 24 of Income Tax Act (currently at Rs2 lakhs) can be increased to Rs12 lakhs. Meanwhile, builders also should reduce prices by 20%. With these measures, the rental yield can go upto 3.6%.
 
According to him, current rental yield is 2.40%. “The optimum yield is 5.5% but at a rental yield beyond 3.5%, generates demand.” He drove home his point by mentioning that he went through an HDFC presentation recently, which shared very startling facts. He said “In 2006-07, the average consumer / end user age for property was 28 to 30 years. Now it is 39 years. That clearly indicates that very large sections of consumers are unable to purchase property despite four years of price moderation in the industry and unaffordability continues”.
 
Impact (Costs) of the potential measures on Government:
 
Table above shows the details of the calculations
 
He calculated that it would cost the government just Rs26,000 crores to save the country’s real estate industry that contributes Rs12.5 lakh crores to the Indian economy. 
 
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    COVID-19 and Its Impact: The Experiences of US and India
    The coronavirus (COVID-19) has proved that it is a once-in-a-lifetime situation with its multi-faceted impact set to render the world into pre- and post-COVID-19 eras—and there is no better example of the devastation that COVID-19 is unleashing than in the US, where president Donald Trump’s administration, the Congress (with bipartisan support) and the governors of the various states have taken major steps to contain the impact on health as well as the economic scenario, despite early blunders.
     
    As of 11 May 2020 (02:59 GMT), the total worldwide COVID-19 cases stood at 41,80,305 with 2,83,860 deaths. In the US alone, there have been 1,367,638 cases with a total of 80,787 deaths. Although the spread of COVID-19 in the US has been contained somewhat in recent times,  there were reportedly 20,329 fresh cases coupled with 750 deaths during the previous 24 hours. The US has been doing a lot of tests, especially recently, and the total tests are close to 9.5 million (9,444,525 to be precise) while tests per million population stand at 28,533.
     
    In countries where data is available, the situation on the economic front is clearly devastating. Again, take the US for example, which confronts unmatched unemployment levels not witnessed since the Great Depression of the 1930s. Both the Trump administration and Congress face a crucial choice—either keep pushing trillions of dollars trying to support workers and businesses, or simply hope that the reopening of various activities in the different states will kick-start the US economy, which is perhaps at its nadir, since the Great Depression.
     
    Without a doubt, the month of April 2020 was simply devastating for the American economy as it sank deeper into the pits—an estimated 20.5 million jobs were reportedly lost even as the unemployment rate is said to have peaked at 14.7%, which is the highest in the past 75 years. 
     
    And, to make matters worse, it is reported that more Americans (millions of them literally) have apparently filed unemployment claims since the data was collected and compiled in mid-April. According to observers, this should enhance the unemployment rate to as high as 20%, leaving just over 51% of Americans with a job.
     
    So, what do we have in the US? Unemployment for at least 20 million Americans, with a vast majority of the nation’s small businesses being shut and many of them likely to become bankrupt.
     
    This is where policy action is really crucial and errors by the Trump administration and Congress could turn the 20 million temporary job losses into permanent ones—which, in turn, could sink the US into its deepest and longest recession, possibly unmatched over the last 75 years.
     
    Having said that, the US has so far spent nearly 14% of its GDP as a direct stimulus—i.e., almost $3 trillion—to assist companies, workers and the unemployed. That is phenomenal by any standards and as far as I can see the US is not done as yet. 
     
    Additionally, the Federal Reserve has undertaken several astonishing steps—this includes actions to ensure that the financial system functions very well, purchase of government-sponsored securities and operationalising strategies to purchase corporate and municipal debt so that credit can flow seamlessly.
     
    On their part, the governors of various states have promulgated stay-at-home orders in an effort to retard the growth and spread of the virus.
     
    Now, if this is the situation in the US, imagine how other countries, especially emerging economies like India, can manage the fallout of COVID-19 and its health and economic impacts. 
     
    India has been under lock-down since the midnight of 24 March 2020 and has been fighting hard in its battle against the virus. Apart from the healthcare strategies and three phases of lock-downs, India has allocated between 0.7% - 0.8% of its GDP as a direct stimulus (Rs 1.7 lakh crore) and the Rreserve Bank of India (RBI) has taken several actions but a lot more is required. 
     
    That apart, while the total number of cases in India stand at 67,161 with about 2,212 deaths (as of 11 May  2020, 02:59 GMT), the levels of testing are low, despite having been ramped up recently. As on date, the total tests in India stand at 1,609,037 and tests per million population stand at 1,166. As India tests more, it is expected that the number of COVID-19 cases would naturally go up.,
     
    Now, the key question is, how can countries like India win the battle against COVID-19, both health-wise and in an economic sense especially, when countries like the US are themselves struggling. Health-wise, we have a long way to go as our health infrastructure is woefully inadequate. 
     
    I was informed by a colleague that his relative in Mumbai heard the authorities stating over loud speakers that the paucity of beds means that positive COVID-19 cases will have to stay at home and take care of themselves—that is indeed a sad state of affairs, if true. 
     
     
    If this is the situation in Mumbai, which is India’s financial capital with unparalleled medical facilities in comparison to the rest of the country (barring Tamil Nadu, which also is reportedly known for its strong healthcare infrastructure), then imagine what the circumstances could be in other states of India, especially as testing is ramped up and the number of cases also commensurately rise. 
     
    This calls for the government of India and respective state governments to immediately requisition the services and infrastructure of all private healthcare providers. At least 40% capacity of corporate hospitals and individual healthcare clinics and practitioners need to be made available so that we have the necessary health infrastructure to tackle the COVID-19 cases. COVID-19 is a national health emergency and the private sector must be roped in to play a bigger role. 
     
    Apart from the brutal individual and corporate distress, many SMEs are on the verge of closure because they don’t have the much needed liquidity to survive. Likewise, there are many poor and vulnerable people who are suffering as are companies in key sectors of aviation, hospitality, travel, tourism etc. 
     
    All of them need substantial levels of on-going economic support (this should equal at least 5% of the GDP, if not more, for it to be effective) by way of direct money transfers to the poor and the vulnerable people, enhanced liquidity and other support for MSMEs and corporations and direct subsidies for the hugely impacted sectors of aviation, hospitality, travel and tourism. 
     
    Failure to act now is likely to push India into one of its deepest recessions of all times. 
     
    (Ramesh S Arunachalam is author of 12 critically acclaimed books. His latest release in January 2020 is titled, “Powering India to Double Digit Growth: Five Key Steps To A Robust Economy”. Apart from being an author, Ramesh provides strategic advice on a wide variety of financial sector/economic development issues. He has worked on over 311 assignments with multi-laterals, governments, private sector, banks, NBFCs, regulators, supervisors, MFIs and other stakeholders in 31 countries globally in five continents and 640 districts of India during the last 31 years.)
     
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    The Key Role of Liquidity and Possible Policy Interventions to Ensure It Amid COVID-19 Crisis
    I cannot imagine any event in recent times that has impacted the corporate sector so intensely on a worldwide scale as has the corona virus (COVID-19) crisis in terms of macroeconomic supply and demand side shock. So what has been the blow on Indian small and medium enterprises (SMEs) and other firms?
     
    Worldwide, many SMEs and larger corporations are now confronting unparalleled and phenomenal falls in revenues as country-wide lockdowns (that are indeed necessary) have been instituted to prevent or contain the spread of COVID-19 and safeguard the health of the general population. Many countries are yet to fully open up (as is India). 
     
    The key question here is whether these companies, including the SMEs, have the ability to wade through and overcome these truly extraordinary circumstances and survive the long-drawn and uncertain impact of COVID-19. If not, then what policy measures could possibly salvage them out of the COVID-19 crisis? 
     
    In the short-term, the COVID-19 crisis impacts corporate liquidity by denting corporate cash-flows significantly. Cash-flows have already become profoundly negative for many companies, and especially for those that have not been able to reduce costs commensurately, especially in the context of the huge fall in revenues. It is set to worsen, if there is no strong and immediate policy intervention.
     
    A number of issues further compound this aspect. As a result of restrictions against commercial activity, many companies have not even been able to borrow against the existing inventories, let alone sell them. Trade credit has also stalled as companies have started deferring the making of due payments—this has further exacerbated the woes of the corporate sector and deprived it of an important lubricant, which is very necessary for smoothing functioning. 
     
    Third, while it is normal to expect existing (institutional) credit lines to provide companies with the much required additional resources—often to meet short-run liquidity aspects—increasingly, banks and financial institutions (FIs) are reluctant to lend further to these companies as they do not find it worthwhile to put good money out in the current very uncertain and stressed environments. 
     
    It is here that policy interventions could make a substantial difference.
     
    First and foremost, it would be very appropriate for the respective central banks to intervene and ensure that 'bridge loans' are provided to all companies so that there is no further breakage in corporate cash-flows. This will help ensure that companies do not default on operating expenses, wages, salaries and short-term obligations. This is very, very critical to keep the engine of the economy running in good and lubricated condition. 
     
    That said, let us not forget that such (exceptional) credit will unduly enhance corporate leverage, which, in turn, could possibly create solvency problems later on. But, let us leave that aside for the moment as companies have to survive to fight another day. 
     
    Bridge loans, with sunset clauses can be guaranteed in part or full by the central banks (say from 60% – 90% as appropriate) through special purpose vehicles (SPVs) that can be capitalised in eclectic ways. These bridge loans can be made available through banks, non-banking finance companies (NBFCs) and alternative finance institutions including FINTECH companies, which are new kids on the block.  
     
    Second, governments must provide subsidies for firms in the hardest hit sectors like aviation, hospitality, tourism, travel and the like. This must be conditional on these companies maintaining or reinstating employment, which, in turn, will ensure stable income for wage earners and prevent sudden lay-offs. It should also help prevent corporate bankruptcies. 
     
    Of course, much of this will depend on how long the lockdowns last. Indeed, recovery of these subsidies is very much possible as in the case of the global financial crisis of 2008, when many large banks that owed their existence to bailouts by governments using tax payers’ money, eventually turned the corner and paid back the subsidies in good measure.
     
    Alternatively, the subsidies could also be treated as quasi-equity and sold off at a later date, when these companies have turned the corner and become profitable. Remember, there is huge cost to recreating institutions with the right set of people and that is why governments must do all that they can to help companies) survive. 
     
    The existing corporate infrastructure is far too valuable to discard as the trickle-down effects will be huge. And make no mistake, it cannot be rebuilt that easily again. This is a key lesson from the Great Depression of the 1930s as well as the 2008 global financial crisis. 
     
    Third, we also would need ways to prevent the stalling of trade credit. For example, special schemes that can help corporates and SMEs dispose of their receivables or at least receive specialised credit against them, would be helpful and required here. Here again, there is ample scope for central banks to intervene. 
     
    This would entail central banks, offering through an SPV, a specialized facility where certain short-run claims collateralised with certain types of assets can be rediscounted. This again could come with a specific sunset clause on when this scheme would come to an end as also other conditions to prevent free riding in common economic parlance. 
     
    Without a doubt, corporate liquidity is more important than ever before as COVID-19 has caused brutal corporate distress for many companies and SMEs the world over. Before the spillover impact becomes huge and percolates to the entire global economy, it is imperative for central banks and governments to be bold, unconventional and take a key lesson from the 2008 global financial crisis—where many firms were brought back from the brink of disaster to succeed—and the same lesson is very relevant today. 
     
    If institutions and people don’t survive, nothing will, and we will have to rebuild from scratch after the holocaust caused by COVID-19 is over.
     
    (Ramesh S Arunachalam is author of 12 critically acclaimed books. His latest release in January 2020 is titled, “Powering India to Double Digit Growth: Five Key Steps To A Robust Economy”. Apart from being an author, Ramesh provides strategic advice on a wide variety of financial sector/economic development issues. He has worked on over 311 assignments with multi-laterals, governments, private sector, banks, NBFCs, regulators, supervisors, MFIs and other stakeholders in 31 countries globally in five continents and 640 districts of India during the last 31 years.)
     
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