Real estate and Black money – Does demonetization break this nexus?

At around 8 pm on the evening of November 8, 2016, I switched on the television to catch the latest buzz on the big event of the night, the US Presidential elections. Just then, Prime Minister Narendra Modi began addressing the nation. By the time his speech ended, the news cycle had changed completely. By demonitizing the ubiquitous Rs. 500 and Rs. 1000 notes with almost immediate effect, he left newsreaders, economists, business people and the common man scrambling to decipher the impact of this huge move. Brought in to curb the seemingly interminable problems of Black money, corruption and circulation of counterfeit currency in the Indian economy, this move effectively ‘trumped’ the happenings in the US of A (pun intended).

Carried out in the manner of a well-planned operation, the timing of the speech coincided with the period when most merchants down shutters for the day. The demonitization move had been kept secret for months. By setting the same midnight as the timeline for these notes to become invalid, not only did the announcement leave those with plenty of black money in shock, it virtually provided them no opportunity to get rid of some of it, rendering their vast stacks of cash worthless almost at one go.

armageddon-in-realty-sectorA SIT committee on black money had earlier this year, while submitting their final report, made this recommendation to withdraw these high denomination notes. However, many experts did not expect this to actually be carried out, owing to inconvenience to the public and the influential vested interests involved. Now that it is a reality, let’s examine its impact on the economy and our primary area of interest i.e. the property sector.

The size of the black money problem

The Domination of Cash in India

It is said, with good reason, that in India, ‘cash is king’. For many years, people in the country have preferred cash against other instruments such as cheques, demand drafts, plastic money and the recent introduction of online payments and mobile wallets have not stemmed this tide. The reasons for this are the convenience that cash offers and its acceptability everywhere, from local grocery shops and hand cart vendors to big departmental stores and high end restaurants. People and traders alike preferred to settle transactions in cash and save money on taxes. It is at this point that white money becomes black (unaccounted for money).

With a large number of transactions going unaccounted for, the loss to the government and the public exchequer is immense. It was observed that most of the black money hoarded as cash was using the old Rs. 500 and Rs. 1000 notes, which triggered this action. At the same time, these two (now demonitized) denominations account for a whopping 86% of all cash in circulation in the Indian economy, so wiping it out in one go has a major economic cost. One can also argue that the black money phenomena is a major driver of economic growth in the economy, particularly for making big ticket investments or purchases in items such as jewellery, gold and real estate.

An estimate on the black money in India

While the exact amount of black money operating in the Indian economy is hard to quantify, estimates range from 6% to a whopping 20-30% of India’s GDP. Considering the overall size of the Indian economy, which has a nominal GDP of $2.25 trillion, the black money can be estimated to be around $450 billion to $675 billion, a massive sum whichever way one looks at it. With a portion of this black money also being used to fund terror and other activities inimical to the country, the government felt the need to take this drastic step.

Black money and Real estate

If there is one sector which has become synonymous with black money, it is the real estate sector. The percentage of black money is estimated at a massive 40%, higher than the share in the broader economy. Insufficient regulation, lackadaisical implementation of laws and the necessity of securing numerous approvals and licenses made real estate a haven for corruption, mostly funded by black money.

Prime Minister Narendra Modi announcing the crackdown on black money
Prime Minister Narendra Modi announcing the crackdown on black money (Image Credit: The Indian Express)

Cash outflows for builders

Most real estate expenses are, till date, handled in cash. From payments made for land or raw materials, bribes paid to authorities for permissions or for changing the land use policy in their favour and even wages paid to labourers working on construction sites, most outflows of builders are settled in cash. Many politicians too ‘cashed in’ on this trend, by investing heavily in land and/or apartments. By accepting payments from customers in cash, builders sought to replace these outflows as well as invest the same in other projects.

Primary and secondary market

There has been some improvement in recent times with laws such as Real Estate (Regulations and Development) Act or RERA bringing in greater transparency in the sector. Most transactions in the primary market (purchasing directly from developers) are now carried out using white money by means such as cheque payments or loan disbursements directly from banks. However, the secondary real estate market, which refers to purchasing property from interested sellers, investors or from other sources, remains a big concern, with 40% or more of such transactions being carried out in cash.

People at times are forced to “convert” their white money to black to fund property purchase. For years the RBI and revenue department tried out several means to check this practice of transacting in cash in property dealings, but there were loopholes everywhere which were never plugged. There was seemingly a premium to “all white” transactions as people would want to defray the tax impact.

The Real estate ‘bubble’

The prevalence of black money caused a real estate bubble and pushed up land and property prices in the primary market as well. Things have reached such a pass that real estate in many areas of India is more expensive than that in developed countries. Though investors (who largely invest using black money) made a killing, most home buyers suffered. With incomes not rising to match up to the appreciation in apartment prices, buying a home, which is a dream for many, turned into a nightmare.

Mismatch between the market rate and circle rate

Adding to the problem is the wide variance between the market rates of a real estate transaction and the government mandated circle or ready reckoner rates. These rates, which form the basis for determining the stamp duty and registration charges applicable on the land, have not been updated for a long while and more often than not, do not reflect current market realities. With circle rates far lower than market rates, customers made some savings on these charges, but this lead to loss of revenue for state governments, while adding to the builder’s black money.

The Impact of the Crackdown

Having looked at the past, now let’s look at the future i.e. the impact this move will have on real estate. Is this move really the game changer that it is touted to be?

Invalidated Rs. 500 and Rs. 1000 notes
Invalidated Rs. 500 and Rs. 1000 notes

Creation of a level playing field

One of the major positives of this crackdown on black money is that it would bring some order to this sector. A number of reputed developers, both listed and unlisted, struggled to compete with fly by night operators transacting primarily in cash, who were able to lure customers through various cash based incentives and then, leave them hanging either due to delays in possession or not providing what was promised. With RERA and the ban on high denomination notes for transactions taking away any such incentives, all developers will be forced to adopt transparent means, with all transactions being noted by the authorities.

Correction in property prices

The real estate market has been rather sluggish over the past couple of years as the general economic slowdown has seen housing demand fall. However, the inflated property prices have stayed more or less stable, due to the black money menace and in anticipation of a demand pick-up. With this announcement, a long overdue correction in prices is expected. Investors in “cash” will resist further investments or end up risking disclosing their net worth to the taxman.

Mr. Pankaj Kapoor, a respected analyst in the real estate sector, has predicted a 30% fall in property prices. For prospective buyers looking for good value for money, this anticipated correction is a welcome opportunity.

Greater transparency

For developers, it would be extremely difficult (if not impossible) to be able to conceal details of their transactions from the authorities, whether in terms of purchases or payments made or the actual sale cost of properties. With strict limits set on transactions and with all notes in circulation being monitored closely, in combination with the upcoming Goods and Services Tax (GST), greater transparency will result. Home buyers too would benefit from the same, with developers being held accountable for any unkept promises or delays.

More tax revenue for governments

With authorities getting far better visibility on the inflows and outflows of developers, tax evasion should come down sharply. Improved tax compliance and a desire to claim the input tax credit benefit offered by the GST will serve as incentives for developers to comply with all taxation demands. The governments will get greater taxation revenues, which can be invested in boosting the economy and improving the lives of people.

Another benefit of this increased visibility of transactions is that the state governments will be able to determine the actual market rate of land in an area and accordingly, revise the circle rates to reflect the same on a regular basis. This should close another avenue for black money in this sector.

Change in financing methods

Many developers have demanded a portion of the down payment from customers in cash, which they could use for other purposes. This should, now, become a thing of the past, with payments being made either by cheque or by loan disbursements directly from banks or financial institutions. The housing loan products will probably need changes to reflect the same.

Increase in project delays or abandonments

This move is expected to hit the small time players or fly by night operators in the real estate sector hard. With cash flow getting hit, they are likely to face a serious liquidity issue. Investments made in new projects with such cash may be delayed or scaled back sharply, with the possibility of project abandonment also quite high. For those home buyers, who have already invested in such projects, it may not be good news.

In the long run, however, the elimination of such players from this sector would be a major boon. In the interim, customers will need to be on their guard and do all necessary due diligence on the builder before booking a property.

Greater overheads for developers

Developers will no longer be able to pay their labourers or for their raw material in cash. Account transfers and cheque payments will be the way to go. It’s likely that they may have to open bank accounts for those labourers, who don’t have one currently, for making salary payments. This will bring the labourers under the formal banking system and enhance financial inclusion. If these accounts are registered under the Jan Dhan Scheme, they will also be able to avail of benefits and subsidies provided by the respective governments.

Conclusion

One can say that this crackdown on black money by demonetizing high denomination notes is a welcome step towards cleaning up the Indian economy and the real estate sector in particular. As mentioned by the Prime Minister in his speech, some short term pain is expected but in the long run, the benefits to the country far outweigh the initial discomfort. Unsurprisingly, the real estate stocks have fallen by around 14% following this move, but one should see the stronger listed players bounce back soon.

The importance of transparency in real estate transactions has been reinforced, as also the need for home buyers to check the antecedents of the developer and their projects carefully, before finalizing a purchase. An overdue correction in prices will be a big boon to those looking for greater value in their homes, while also indirectly helping in financial inclusion of the hitherto unbanked labourers. It’s important that this scheme is implemented properly and any loopholes are plugged for it to achieve its objectives and the country to benefit.

The information has been curated from various sources and may not be verified as per RERA guidelines *
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3 Replies to “Real estate and Black money – Does demonetization break this nexus?”

    1. Thank you Mike. At Prop Story, it is our endeavour to provide a platform where home buyers or those generally interested in developments in the real estate sector get the information and analysis they are looking for, to aid them in making any decisions. Appreciation from our readers like you is what drives us.

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