In India, Real Estate is considered the epitome of ‘safe’ investing. One of our most entrenched beliefs is that property is a perennial safe haven that never goes down in price. However, this is far from the truth. Globally as well as locally, Real Estate isn’t insulated from the inevitable price shocks that characterize all asset classes. Here are a few reasons why property prices fluctuate.
Inflation has a direct impact on the long term trends in property prices, albeit not uniformly. It is commonly believed that inflation impacts property prices positively. In reality, property prices either fall or remain static as a result of inflation. How does this happen? Inflationary environments are typically characterized by high interest rates. When interest rates are high, investors become wary of taking loans. Given that the bulk of property purchases take place on credit – this lowers demand. In order to compensate for the reduced demand, developers tend to cut costs in order to clear out their inventory, leading to a fall in property prices.
Demand & Supply Dynamics
Real Estate companies are excellent at cranking out property after property in locations that are deemed favorable, and hence ‘in demand’. These ‘in demand’ properties could be located next to an upcoming expressway, metro station or upcoming large scale redevelopment. While the demand and supply are in equilibrium, all is well. However, when over construction leads to a glut in a particular location, it drives prices down. Locations where there’s no scope for fresh construction (hence having a constant supply) tend to enjoy more stable property prices over the long term.
The cost of building materials, construction equipment and wages paid to the construction workers has a direct correlation with property prices. The more expensive construction becomes, the more this price increase is apportioned onto end users.
The Reserve Bank of India periodically adjusts key interest rates, keeping in mind what’s best for the economy from the liquidity (availability of money) standpoint. Falling interest rates make home loans cheaper and increase the overall demand for real estate. It also enables real estate companies to borrow at cheaper rates and fulfil the increased consumer demand. In this way, it benefits the ecosystem as a whole and drives prices up – until the tipping point of oversupply is reached, of course!
In tough times, people tend to be more conservative when it comes to high ticket, indivisible and relatively illiquid investments such as real estate. Money tends to flow into smaller ticket size, traditional asset classes such as gold, bonds or deposits. This reduced overall demand and sure enough, property prices come down in tow.
Real Estate pricing is a complex matter that is subject to many push and pull factors. If you’re buying it as an end use, don’t bother about price fluctuations too much. If you’re in the tax-inefficient game of flipping properties, make sure you don’t get caught at the peak of the graph with, no buyers in sight! It’s a risk laden game.