People, in general are of the view that that real estate prices cannot fall in India because India has a huge population and there is scarcity of developable land, high inflation and lot of black money involved in real estate asset class. In few others’ opinions, the real estate prices are not likely to fall since they have gone up in the past.
Many of us wouldn’t be aware that in the year 1997 real estate fell almost by about 50% in different parts of the country especially in Mumbai where the population is enormous and there is huge space crunch. Metro cities like Delhi, Hyderabad, Pune, Bangalore & Chennai, which are still the most sought after cities, were left with unoccupied apartments, unwanted commercial complexes and office spaces which were purchased by investors at very high rates.
It was between mid-1995, when the real estate boom peaked and distinctly, by mid-1997, prices fell by a bruising 50 percent. We hereby learn that real estate prices may not fall as quickly as stock markets, but they do fall. For those who yet believe in buying real estate in anticipation of huge gains, have little or no memory of the real estate crash of the late 1990s; for them, the real estate prices never fall. Another characteristic of real estate asset class is that when transactions stop price discovery becomes very difficult since there is no public exchange to monitor prices or make deals happen.
The collapse of residential and commercial real estate market in the 1990s led to the banks and financial institutions taking over the distressed assets from failing lenders and owners. This brought misery to the investors who had invested in real estate for huge gains. Leave alone the gains, there were many investors and borrowers who had to part with their properties as they could not pay in time and the banks had more power for recovery during that period. In contrast, today there is pressure from the banks to foreclose on troubled properties.
Before the Real Estate Slowdown
The lending institutions provided bulk funding to investors, industries; commercial & residential builders as well as individuals held mortgages on their balance sheets that matched their long-term liabilities. In the wake of the 1990s collapse of real estate, these lenders pulled back, sharply focusing their capital on refinancing of existing assets. Eventually, new capital began to flow into the market to take advantage of distressed pricing, with valuations falling up to 50%. This capital came from opportunistic investors who took advantage of the situation. In some cases, bankers refinanced or re-structured the loans giving a bit of relief to the borrowers. Many people also took advantage of the situation and the rate of defaulters in the bank increased. Bankers had to settle the amount between 20-50% of the total outstanding amount of loans which were taken.
The main reasons that attracted the borrowers were low interests and huge funds that helped easy loans for people. With attractive promises, people took more and more loans to build houses and invest money. Since there was surplus amount of money in the banks, all the terms were relaxed and the banks looked for borrowers irrespective of their background, returning capacity or poor credit history. The interest rates were kept low initially and were meant to increase after the initial period. The house prices started to soar due to huge investments.
The splurge proved a good time for all. The lenders and borrowers believed that the interest rates that would increase gradually or the soaring house prices will help in recovering the loans. In case the borrower was unable to pay the interest, the house could be sold off until the prices soared.
Post the Real Estate Slowdown
Thus began the complication when the over-construction of houses caused a decline in the real estate prices, thereby grasping the returning capacity of the borrowers. The borrowers had no money to repay the loans and meanwhile the interest rates continued to hike. The situation became worse when the loan amount exceeded the total cost of the house and gave way to recession.
Investors from all over the world who took loans, faced major losses. The losses trickled down to other banks that were in chain with the international banks in the US who formed the backbone of money banks. As the banks were left with no money, the major industries and companies worldwide who depended on loans from these banks for their activities faced closure and the recession became hazardous for the entire world market. Comparatively, India faced a much lesser repercussion from this hazard whilst on the other hand, countries suffered deep losses and thousands of people lost their jobs.
Recession or slowdown especially in case of real estate is not something which can be dealt with easily. Major economies and renowned economists are still working upon solutions to manage this phenomenon and to mitigate the occurrence of any such probable event in the near or long-term which could prevent the real estate bubble burst.