ECONOMIC POLICES & CAPITAL MARKETS: USEFULESS IN CONTEXT OF REALTY CYCLES

Objective of the write-up

There is widespread understanding that real estate sector’s market conditions determine the finances available to it at a particular time. Whenever the industry gains momentum (at the ground level), we see a spurt of financing in that industry. The situations contrary to this also exist widely.

The purpose of this write-up is to explore the inverse phenomena- the impact of financing on realty industry’s cycles and seek an answer to “Can policies (both fiscal and monetary) and change in market factors (capital markets) determine the course of real estate sector?”  

To answer this question, we explore use of monetary and fiscal policy (which impact the realty as well as capital markets) as tools for achieving the desired levels of realty industry activity. In other words, we see to what extent we may be able to alter realty cycles with a proper strategy for the capital markets and via conducive policy decisions.

The write up is divided into following parts

Part 1: An introduction of the current scenario of real estate market, role of capital markets and policy levers available for real estate markets

Part 2: Existing Linkage

Part 3: Measures to give impetus to Real estate: Tapping both the “Direct investment” and “Capital Markets Route”

Background: Nature of Finance in Real estate Sector

The Real Estate Markets operates in cycles (also true for any other asset class) and is in a phase of slump currently. If we see statements issued by stakeholders in the industry over the past two years, we get repeated claims of the market ‘picking up’. This can be true if we take a view of markets in particular segments, but an overall appreciation in realty assets looks like a far-fetched dream as of now.

How is financing for real estate sector different? Do we imply that financing can change the cycle of any industry? To answer this, let us take the case of technology industries, consumer industries and consumer durable, one at a time, to differentiate from real estate assets. This may not be a possibility in technology industry which has a finite life (e.g. 2G phones -an obsolete technology now) and cannot push up its demand however much we finance the industry. However, real estate differentiates itself here since it is an asset that is static in nature. It can create and be impacted by long term patterns and the decision making will be different. Comparing to consumption items realty is also a need based item. But unlike consumption goods, realty happens to be, simultaneously, an investment product as well. People buy and use realty over a very long period of time. This usage over a long period happens in case of durable goods (and even machinery and machinery) but realty does not depreciate like these mentioned assets.

Additionally, there can be a category of people who wish to take it for investment alone and another category that wishes to take it for only for usage (by paying rentals).  All these factors make this relationship of money and the asset interesting, unique and open to various combinations.

Background: Nature and purpose of Capital markets

The importance of Capital markets for any economic activity cannot be undermined. This importance can be gauged by the fact that as early as the 18^th century, it played a vital role for the Dutch to gather resources to defend the whole country against the British during wars. The British understood these ways and efficiently put to use the financing structures to create the large East India Company as well as the worldwide British Empire. Even the American economy flourished with the understanding of leveraging money in this manner.

This happens because capital markets distribute wealth of savers and put it into long-term productive use and in accordance with the larger policy framework of any nation. Both equity and bond markets constitute the “Capital Markets”. The route to capital markets is used by Governments as well as private players for raising money for long-term investments. The capital thus raised (through equity/debt instruments) its way into productive use on one hand and on the other hand gives the owners of such capital the return commensurate with the risk that is undertaken by them.

All offering (new infusion) in capital Markets begins with “Primary market” and then converted into “secondary market”, where trading between existing securities takes place. The secondary market is just as relevant to the primary market for several reason, which has been already been reasoned out by several experts. The benefits are easy liquidity (exit for exisiting investors), a guide to efficient deployment of capital in the economy, a check for government to enable long-term beneficial economic policies (vis a vis short term politically motivated policies) etc.

The Current State of “Functioning” of Real Estate Sector

Any sector’s state of functioning can be explained by analyzing the participants of the sector. There are three main participants in the real estate sector with respect to the assets created therein- user, investor and developer.  As the markets mature, it enables independent functioning of these distinct participants (variants of the three main participants):

·         Users: They own and use the property (user)

·         Small Investors:  They own real estate for gains or for letting out (investor)

·         Tenants: They can simply be called consumers who pay rent to the owners(user)

·         Real estate companies: They earn out the activity of manufacturing or development activity(developer)

·         Real estate funds: They invest in properties in order to earn from the investment activity and typically own property portfolios with multiple investors’ finances(investor)

A comprehensive ecosystem evolves for the real estate markets with many distinct participants and the Indian real estate markets are also headed in this direction in coming years

Current State Of “Financing” of Real Estate Sector

We can outline summarily, how financing has happened in real estate sector in India over the past several years, as below:

·         Pre- 2000 - self financing of real estate: The end-users, in these years ( ‘pre-2000 s’) were predisposed to equity financing in the case of their real estate purchases, which was mostly self-financed.

·         Years 2000-2015- growth of debt market: For the past 15 years in India, the real estate mortgage market has been extremely active. The end-users (especially home buyers) invariably finance their property with debt. This era was also marked by a huge surge in financing made available to the organized sector (builders). With home loans, extension loans, loan against property, etc.

·         2016- Global acceptance in financial community: Global Industry Classification Standard or GICS® was created in 1999 by MSCI and Standard & Poor's for use by the global financial community. The real estate as the 11th sector in 2016 to GICS (the first new headline sector added since its creation).

·         2017 onwards: Advent of Indian REITs and InvITs: The capital markets related to the realty assets have also been recently regulated by SEBI (Real Estate Investment Trusts) and SEBI (Infrastructure Investment Trusts) Guidelines. A couple of instruments are already in the capital markets (IndiGrid Invit and IRB Invit were listed at NSE and BSE in 2017) with several more to follow.

The above summary of real estate markets and its linkage to capital markets is explored in more detail in the next part i.e. part 2 of the write-up called “ExistingLinkage”