Showing posts with label real estate. Show all posts
Showing posts with label real estate. Show all posts

Monday, June 03, 2013

Should policy makers favour home ownership?

The argument in favour of home ownership

Many people believe that more home ownership is a good thing. It is felt that people who own homes have a greater incentive to get involved in local politics as they have a stake in higher house prices. In contrast, people who rent lack this commitment device. Indeed, in a short run sense, a person who is renting benefits when the neighbourhood goes bad : his rent goes down.

From the viewpoint of the individual, renting is always better as it preserves flexibility. Owning a house imposes limitations on the locations where one could live and work, as the frictions of moving home are substantial. This biases individuals in favour of renting.

In the four-part classification scheme of market failures (monopoly power, asymmetric information, externalities, errors by consumers), this falls under the heading of externalities. If home owners become better citizens and better voters and induce better urban governance, this induces positive externalities upon all residents of cities. To the extent that this is the case, some elements of State policy should favour home ownership, so as to counteract the market failure.

This argument has limited value in India today, given that urban governance is organised in a terrible way. We have just not established the feedback loops of accountability from voters to the city mayor. Even if a voter wanted to get involved in more political action, and wanted to nudge his city administration forward, he does not have the levers to do so. If one only looked at the India of the present, we would reject this externality argument and say that there should be a pure level playing field between owning and renting.

Or, one could be an optimist and think that in the future, as the political system is reformed, these feedback loops will fall into place. One could then argue that large scale home ownership sets up interest groups today that have a stake in cities doing well in the future, as their portfolio value is bound to the quality of the city. The presence of such interest groups may help increase the probability of political system reform, when households get worried about potential damage to their portfolios as a consequence of urban mis-governance.

Today we're highly distorted in favour of owning

If one started out at a undistorted market, one could have a reasonable discussion about whether there is something intrinsically good about owning as opposed to renting, and possibly envision whether levers of policy might be applied to favour home ownership, and the scale of intervention that is justified. In India today, unfortunately, the game is highly stacked against renting:
  1. Tax policy favours owning in the divergent treatment of interest payments as deductible versus deductibility of rent.
  2. Rent control laws inhibit renting.
  3. High inflation disrupts rental contracts by forcing repeated renegotiation
  4. House owners that are corporations have not yet emerged. It is, hence, hard to find professional contracting in this field. Search costs are high, and there are often restrictions such as owners that won't rent to single women or muslims out of social conservatism. Our failures on property as a fundamental right, and on achieving a capable judiciary, have led to the risk of expropriation when the renter is elderly, a journalist or a lawyer. This has the perverse effect of diminishing access to rented houses for such persons.
  5. Contracts are frequently disrupted, which induces costs of moving and frictions such as fees to brokers.
  6. Less than professional owners imply that many practical issues such as smoothly functioning utilities don't work out properly. Under home ownership, a person has the incentive to make sure that utilities work correctly. With renting, this falls between the cracks and the service level is often poor.
The game is thus highly stacked in favour of owning. We need to level the playing field in favour of more renting.

The problems of home ownership

From first principles, the ownership of an illiquid asset (a home) diminishes flexibility. A person who lives in a home is much less likely to move.

In India, we need to achieve massive migration flows. Large scale migration will generate better matching between the requirements of the labour market at various locations all over India, and the requirements of production. Large scale migration will break down tribal and ethnic loyalties.

A country where people easily up and move is one in which the labour market is more flexible. This is a blessing and has consequences such as milder business cycle fluctuations. That's a different kind of market failure. The State should favour renting as this gives a more flexible labour market which yields milder business cycle fluctuations, which induces gains for all. Every person who owns a house imposes a negative externality upon everyone else in the form of a more inflexible labour market.

On this theme, here is a fascinating new NBER WP by Blanchflower and Oswald. The abstract says: We explore the hypothesis that high home-ownership damages the labor market. Our results are relevant to, and may be worrying for, a range of policy-makers and researchers. We find that rises in the home- ownership rate in a U.S. state are a precursor to eventual sharp rises in unemployment in that state. The elasticity exceeds unity: a doubling of the rate of home-ownership in a U.S. state is followed in the long-run by more than a doubling of the later unemployment rate. What mechanism might explain this? We show that rises in home-ownership lead to three problems: (i) lower levels of labor mobility, (ii) greater commuting times, and (iii) fewer new businesses. Our argument is not that owners themselves are disproportionately unemployed. The evidence suggests, instead, that the housing market can produce negative ‘externalities’ upon the labor market. The time lags are long. That gradualness may explain why these important patterns are so little-known.

Turning to international finance, the objective of international risk sharing is to remove home bias. In the real estate context, what works best is for a person in Bombay to rent a flat owned by Japanese investors and for a person in Tokyo to rent a flat owned by Indian investors. This achieves risk sharing: each party avoids the risk of real estate fluctuations that are correlated with the main portfolio which includes human capital. Capital controls that interfere with such investments are an obvious mistake that need to be removed. But as in trade integration, once overt restrictions are removed, an array of institutional factors that impede cross-border interaction come to prominence.

For the risk-sharing outcome (homes in Tokyo owned by investors in Bombay and vice versa), we need real estate to be owned by professional companies that rent it out. The shares of these professional companies, or securitisation instruments that generate cashflows out of rental streams, can then be purchased by foreign investors. As long as real estate ownership is in the hands of individuals in India, we will suffer from home bias with too much of the portfolio of residents being invested in local instruments. This is another dimension of owning versus renting that we need to keep in mind; we are better off when there is less home ownership.


Most people assume that home ownership is a good thing, that a country is better off if more people own homes. Like most interesting questions in public policy, the story is more complex than meets the eye. There are two different externality-based market failures running in different directions.

At present, in India, the first externality (more home ownership makes people better citizens) is absent since urban governance is unresponsive to voters. The only externality at work is running in the opposite direction (more home ownership gives a less flexible labour market). In the short term, policy should work on pushing towards more renting.

In the long run, urban governance in India might improve, and then we would need to understand the magnitude of these two opposing effects, and then one could choose whether it's worth pushing in one or the other direction. If one can't quantitatively estimate these things, then a cost benefit analysis is not feasible. The best thing is then to do nothing.

In either event, the mainstream view -- that policy makers should push in favour of more home ownership -- needs to be questioned.

Saturday, May 11, 2013

Real estate in India is not a great asset class

Most people in India are convinced that investing in real estate is a great idea. In the Economic Times today, I have an article titled Real estate in India is not a great asset class.

Economic Times had carried this as a `poke me' feature, where reader comments are invited. There are 186 comments there as I write this, and they are broadly hostile to what I have written. I would get nervous about the price of any asset where a strong majority of market participants think there are great returns in store.

Thursday, January 12, 2012

The resource curse of land ownership

Land ownership in pre-modern India

In India, 50 or 100 years ago, land was a defining feature of wealth. The stock of land generated a flow of income. The landless were low-paid agricultural labour. The landed gentry of rural India were the kings of their heap. They had power, prestige, position, prosperity.

In the eyes of many, the initial conditions of high inequality of land ownership were a key barrier that held India back. It was argued that a one-time bout of bloodshed was essential, to expropriate the rich, and to transfer land ownership into a more equitable distribution. In India, this capacity for State-inflicted bloodshed was present in some places only. In much of India, the unequal distribution of land ownership found in 1947 was left intact.

Fast forwarding into the present, there has been a sea change in the fortunes of the owners of agricultural land.

Agriculture is less important

Particularly after we escaped from the Hindu rate of growth (3.5%) in 1979, the share of agriculture in GDP has dropped sharply. In relative terms, the wealth created through firms in industry and services has dwarfed the wealth of the landed gentry. The richest man in India today is born of one who started out with no land. Government interventions continued to stifle agriculture, but shifted to a greater laissez faire approach in industry and services; this helped accelerate the decline of agriculture.

The plight of those who stayed back

Rural to urban migration has unleashed new forces on the role and status of the landed lords. Within rich families, high IQ children may be going off to the city to a greater extent, e.g. based on the filtration by competitive examinations where outcomes are correlated with IQ. To the extent that such a process has been afoot, it has given a selection bias where the low IQ children were the ones more likely to stay back in the `idiocy of rural life' (as Marx characterised it). Over a couple of generations, the interplay of nature and nurture can add up to substantial effects.

That there was an easy option - to live off the land - was a `resource curse' which afflicted the households who had land. In contrast, for landless households, there was no conflict of interest in moving to cities (other than the recently introduced NREG, which tries to perpetuate poverty by hindering rural to urban migration).

The power and status of the landed lords was now twice undermined. Their quick-witted cousins who established themselves in the cities were connected into capitalism and getting ahead. Families of the landless have tended to move to cities, connect into capitalism, and get ahead. The erstwhile lords have started looking nervously at both groups of escapees, wondering whether land ownership was such a nice initial condition.

In a fascinating recent article, Devesh Kapur, Chandra Bhan Prasad, Lant Pritchett and D. Shyam Babu gave us some insights into these changing social structures. In their survey data, in 2007, 98.3 per cent of Harijans were contracting-out the work of tilling their fields to their erstwhile lords, the upper-caste men who owned and operated tractors. The upper tail of the Indian income distribution has, in a few generations, been reduced to operators of agricultural equipment.

The importance of engaging with the market

A defining issue of modern times, for an individual, is a continued and deep engagement with the market. For insights into this idea, see this interview with Tom Sargent. The Ljungqvist/Sargent story matters even more in India, when compared with what has happened in the West. At 7 per cent GDP growth, every few years, far-reaching change comes about in technology and processes. Each individual builds knowledge and human networks by continually engaging with the market. If a person is cut off from engagement with capitalism for even a few years, this generates a lot of human capital depreciation. At that reduced human capital, the person has to either accept an offer at a much reduced wage, or stay unemployed (which further undermines human capital).

The Ljungqvist/Sargent story helps us understand the plight of adivasis in India, who have been away from the market economy, and are unable to plunge into it. It helps us understand the plight of the unemployed of Europe: the welfare state pays them dole to stay warm and well fed for many years of unemployment, but after this they are unable to come back into the labour market.

In this setting, consider the plight of a land owner, who has been living off the land, and has never engaged with modern India. Particularly in the post-1979 period, when India has experienced relatively rapid growth, each year of being a country hick owning land meant being further away from the skills required to participate in the contemporary Indian economy. The landed gentry of India lacks the skills to participate in the market economy. Income from the land, their resource curse, dulls their incentive to overcome the barriers. They are often too proud to accept low wage assignments which are the starting point through which the unskilled connect to capitalism. These problems have come together to give a unique vicious cycle of dis-engagement with modern India.

Sale of land in the outskirts of cities

At the edges of all cities, urbanisation is proceeding through developers buying land from the local landed rich and transforming it into the endless suburbs. In the short term, this has generated immense windfalls of wealth for the landed rich. But in some ways, this is a bit of a disaster for many of them. Lacking in knowledge about the market economy, they are scammed by insurance salesmen and such like. Much of this newfound wealth tends to get dissipated in a few years.

Urbanisation and land development throws open vast opportunities for trade and industry. But the erstwhile landed rich tend to be uniquely ill equipped at harnessing these opportunities. They tend to be too proud to work for someone else, and inadequately equipped to stake out on their own. They experience a brief blaze of glory when paid fabulous prices for their land, and then fade away into insignificance.

Some politicians have been moved to advocate special legal protections for the hapless rural rich who sell land to the modern sector. It's quite a turnabout within a few generations: from landed elite that oppress the others, to witless folk who need to be protected by special laws that inhibit the sale of land.

The curse of land

A few decades ago, the left-of-centre view dominated the thinking in India. It was felt that inequality of land was a major bottleneck that held India back. Many argued that the failure of Indian democracy to engage in a one-time bout of class warfare through `land reform' was a major mistake that was holding India back. It was argued that the Chinese path was the right one: to expropriate the landowners and then start a capitalist economy under conditions where everyone is equal.

With the benefit of hindsight, things look different. I think this story reiterates the dangers of social engineering. We are dealing with enormously complex systems that we only dimly understand. As far as possible, it is wise on our part to use the force of the State as little as we can, and to always avoid treading on fundamental human rights such as property rights.


I am grateful to K. P. Krishnan, Suyash Rai and Mihir Thaker for insightful conversations.

Saturday, December 24, 2011

Uncomfortable times in real estate in store?

Patrick Chovanec has a fascinating article in Foreign Affairs, titled China's Real Estate Bubble May Have Just Popped. This is interesting and important from two points of view.

First, bad news for China is bad news for the world economy. We are already in a bleak environment, with difficulties in Europe, Japan, the US, and India. It will not be pretty if China runs into trouble as well. I am reminded of the feeling of carefully watching real estate in the United States in 2006, with a sense that the future of the world economy was going to turn on how it turned out.

Second, it made me think about real estate in India. As with China, one often sees buyers of real estate in India have the notion that this is a safe financial asset. This is a questionable proposition. Real estate is perhaps not an asset class with a positive expected return in the first place; and it is certainly not a convenient asset class with features like liquidity, transparency, diversification and easy formation of low-volatility diversified portfolios. I find it hard to explain the prominence of real estate in the portfolios of even educated people in India.

In the article, Chovanec says:

For more than a decade, they have bet on longer-term demand trends by buying up multiple units -- often dozens at a time -- which they then leave empty with the belief that prices will rise. Estimates of such idle holdings range anywhere from 10 million to 65 million homes; no one really knows the exact number, but the visual impression created by vast `ghost' districts, filled with row upon row of uninhabited villas and apartment complexes, leaves one with a sense of investments with, literally, nothing inside.

This has not happened in India. So in this sense, the situation in India is not as dire. But his second key message seems uncomfortably close:

As 2011 progressed, developers scrambled for new lines of financing to keep their overstocked inventories. They first relied on bank loans (until they were cut off), then high-yield bonds in Hong Kong (until the market soured), then private investment vehicles (sponsored by banks as an end run around lending constraints), and finally, in some cases, loan sharks. By the end of last summer, many Chinese developers had run out of options and were forced to begin liquidating inventory. Hence, the price slashing: 30, 40, and even 50 percent discounts.

Part of this looks familiar. There is a lot of leverage in Indian real estate development and speculation. Real estate speculators and developers are finding themselves in a bit of a scramble hunting for credit. One hears about very high interest rates being paid by developers. Other sources of financing are also weak. This reminds me of the dark days before the global crisis, when borrowing by real estate companies was the canary in the coal mine.

If business cycle conditions and financial conditions worsen, the problems of borrowing by real estate developers and speculators will get worse. How might this turn out? Perhaps the borrowers will merely get uncomfortable. Or, a few firms could really get into trouble, and start liquidating inventory. That would have substantial repercussions.

Suppose there is a situation where there are many people who have speculative positions in real estate, but significant selling of inventory has not yet begun. The longs would then be nervously looking at each other, wondering who would be the first one to sell, to take a better price and exit his position. The ones who sell late would get an inferior price. In such a situation, conditions could change sharply in a short time.

On a longer horizon, I would, of course, be delighted if real estate prices are lower. This would help shift the supply function of labour, reduce the cost of setting up new businesses, etc. But that's more about the long-term policy changes, which would remove barriers for converting land into built-up housing, while rising vertically into the sky with FSI in Indian cities ranging from 5 to 25.

Thursday, May 05, 2011

Solving the problem of black money in real estate

by Shubho Roy and Pratik Datta.

Manmohan Singh as finance minister killed off smuggling, by eliminating customs duties. Black money in the real estate sector recently attracted his attention. He suggested lowering of stamp duties to check the flow of black money in this sector. But will this solve the problem of black money? And how will the State compensate for the loss of revenue collected from stamp duty?

Stamp duty is a transaction tax; it is charged as a percentage of the transaction value of the property. Public economics teaches us that all transaction taxes are bad taxes, that the right level for the stamp duty is zero (as it is for all taxation of transactions).

The stamp duty distorts the behaviour of parties to the transaction. Stamp duty on property is usually paid by the buyer. Hence, the buyer tries to coax the seller to agree to undervalue the property on paper (the transaction value declared to the government) and accept the rest in black money. On the other hand, sellers have an incentive in accepting black money from the buyer in order to evade the taxation of capital gains. As long as real estate capital gains are taxed, eliminating the stamp duty will influence the behaviour of the buyer but not that of the seller.

Hence, modest changes in the stamp duty rate will not solve the problem of black money in real estate. When stamp duty is eliminated, the buyer will be comfortable with zero evasion, but the seller will still urge him to take some black money.

Bad taxes should be eliminated because they are bad taxes. There should be no attempt at finding a direct replacement. As an example, India largely phased out customs duties, because the economists said these are bad taxes, without specifically trying to find a replacement. The elimination of customs duties enabled high GDP growth, and the main pillars of taxation (income tax and the VAT) generated bountiful revenues. A similar story will hold for stamp duty.

The economists teach us that all taxation of transactions is wrong. The property tax suffers from no such problems. Much work is needed in India in building a sound property tax system. In some countries, property tax revenues can be as large as 1% of GDP, which is a very big number compared with the financing of local government in India. The key issue is that the average value of property in each micro neighbourhood (e.g. a 200 metre stretch of road) needs to be assessed correctly and revised every year. This should then be used as a preumptive property tax rate, per square foot, for that micro neighbourhood. Once this is done, property tax collections will be a powerful source of revenue for local government.

There is a link between these two issues. As long as there is a stamp duty and high taxation of real estate capital gains, the reported data will understate property values. This will hamper the revenues obtained through the property tax. To the extent that we solve the twin problems of stamp duty and capital gains taxation, the data in the hands of government about real estate prices will improve, and this will bring property tax to life as a significant revenue source.

Tuesday, October 07, 2008

The four stages of the global financial crisis

As this crisis has evolved over the years, I find my set of tabs in firefox has changed. The evolution of this set of things-to-watch is mildly interesting.

  1. The first place to focus on was US housing construction. US housing was clearly in stratospheric territory. Once the US Fed started raising rates, and Mortgage Equity Withdrawal became less important, trouble was going to come about in US home construction. In this period, I watched the DJ US Home Construction Index.

  2. By mid 2006, it was clear that big damage had taken place in this industry index. (E.g. see this article in Business Standard in September 2006). The next shoe to drop was the firms that had financed homes. Hence, my focus then shifted to US housing finance companies. By mid 2007, it was clear that big damage had taken place in this industry index.

  3. Now the question became: where in the world of financial firms does the damage go? My focus then shifted to the DJ US Financial Services Index. And, by this time, it was clear that there were deep problems in the money market, so I started watching the TED spread. At first, after the death of Bear Stearns in March, US Financials bounced back and it looked like the trouble would subside.

  4. And then, after the death of Lehman, the real question became: what would this do to the broad US economy. Now we're all down to watching the S&P 500 and VIX.

With VIX at 58, isn't it time to be shorting VIX? (You might like to see this slideshow on the global financial crisis, from a few weeks ago).

Monday, October 06, 2008

Cash crunch at real estate companies

I am anxiously scanning the money market looking for dislocations. The closest that seems to be found is the funding crisis of real estate companies who appear to be facing a cash crunch. I have heard of interest rates going all the way to 36%. These are really attractive returns, but then there is the possibility of default.

I looked up accounting information about one such firm, Unitech, as an example. A glance at the liabilities shows a lot of leverage: net worth of Rs.2143 crore is supporting a balance sheet of Rs.17,327 crore. Current liabilities are Rs.7,069 crore, so there must be a lot of stress rolling these over. At the same time, the market value of equity is Rs.18,000 crore. From this perspective, the leverage is not particularly high (Jayanth Varma had made a similar point recently) even though the stock price has lost 67% in the latest 12 months. In a KMV/Merton model world, you wouldn't think this firm was particularly likely to go bust.

There is one problem in the measurement of accounting `equity' capital for some of these firms which needs to be borne in mind. India has capital controls against debt flows. There are many mechanisms for getting around these restrictions, for equity and debt are ultimately intimately intertwined [link, link]. One mechanism is for founders (`promoters') to sell shares to a foreign investor and have a private contract to buy these shares back at a future date. I have heard that quite a few small Indian promoters have done such deals with private equity funds and other funding sources. These transactions are really debt transactions, being disguised to look like equity transactions.

While such transactions are in flight, the accounting data for `equity' capital is overstated. And, given the drop in stock prices in recent terms, the cost of this borrowing for the promoter will prove to be very high. Such promoters must be in a tough spot looking for personal money to do the buyback, at a stock price well above the market price.

None of these particularly attenuates the stock price, though, once there is adequate stock market liquidity, for speculators on the market know all these things. So I would still maintain that by market value measures, there is a lot of equity in Unitech. If you have insights to offer on the funding crunch of real estate companies, and why they're paying as much as 36%, do tell.

Sunday, September 14, 2008

What does it take to make a land market work?

Writing in Hindustan Times, Gautam Chikermane ruminates on the legal dimensions of India's eminent domain crisis. You might like to see two blog posts on this in the past: link, link.

I feel that the lack of property as a fundamental right in the Indian constitution is a key flaw in our situation. Power corrupts, and it is not surprising that the State has abused this power. But if we go one step further and think: Suppose property was made a fundamental right in the Constitution, does this get the job done? Why is it that one can landup in the US and buy 2000 acres of land while it's hard to do this in Maharashtra? What else is required by way of making a land market work, other than strengthening the property rights of citizens? And in a well functioning land market, what is the appropriate `eminent domain' mechanism that should exist?

Monday, June 30, 2008

The two hot spots in improving governance in India

In India, we often have a broad notion that the performance of government at producing core public goods is bad. In order to make progress, it helps to focus on the hot spots, where things are extremely bad, so that the maximum bang-for-the-buck can be obtained in return for applying scarce resources of money, top management time and political capital.

Today in Mint there is a very interesting set of statistics showing results from a household survey focusing on poor people, done by Transparency International India and Centre for Media Studies, focusing on corruption. See the results and associated interview with Bhaskara Rao who heads the Centre for Media Studies.

The main result of this survey is:

Police 78 52
Land records 69 36
Housing 70 32
Water 42 12
Hospital 46 11
Electricity 44 11
NREG 47 11
Forest 36 11
PDS 54 8
Banking 26 7
Schools 28 5

I would take away one key message from this: the two areas where the maximum focus is now required are the police and land/housing. These are the hot spots with the worst corruption. Making progress on the police is inevitably tightly interlinked with the larger justice system, which includes the judiciary.

The larger discussion on `improving governance in India' would hence benefit from a focus on these two hot spots: making the police and judiciary function properly, and ending the corruption of the land market. If a prime minister or a chief minister or a mayor has to prioritise the use of his resources, these are the two areas which deserve top priority.

Thursday, February 07, 2008

Real estate - an asset class?

Many people are increasingly comfortable treating real estate as `an asset class'. It is argued that land isn't being produced, that as the population grows, demand for real estate only goes up. Astronomical prices of real estate in India encourage holding real estate assets in the hope of obtaining high profits in the future.

This proposition is debatable. There is actually ample land out there. A calculation shows that even if all of India's population had a dwelling of 1000 square feet per family of 4, this requires only 0.76% of India's land area, assuming a low FSI of 1.

In the case of equities, we know that in all countries, a diversified portfolio of equities earns a few percent per year in real terms over long time periods. Some papers show that this is not the case with real estate (!).

If land isn't scarce, then the cost of built-up housing isn't much, it's just the cost of steel and bricks. To think of it as an asset class is as odd as treating (say) a car as a financial asset. The only challenge is one of overcoming government zoning restrictions, and building enough property, so that prices can then crash.

This is part of the story of the US housing market in recent years. Thanks to sound urban policies, there are no real entry barriers to building houses in the US. Zoning rules are sensible, and the policy framework supports easy extension of urban areas into outlying barren land. When houses could be sold for more than the price of cement and steel required to make them, this kicked off a massive supply response. This kicked up GDP growth for a few years. It took a little time, but this killed off the phase of rising prices. For some time now, house prices in the US will be low because of this overhang of supply.

There are legitimate concerns about bank exposures to real estate, since the market is non-transparent and marking to market is difficult. I think it is easy to build a risk management system governing loans against shares or bonds, but I'd worry about loans against houses or cars.

There are strong concerns about foreign capital coming into the real estate sector of a country like India. It is claimed that foreign speculators will drive up prices and thus make housing unaffordable. This needs to be questioned, for foreign capital that goes into development (directly or indirectly) ultimately drives up supply and thus solves the problem (see above link).

Transforming the real estate sector requires a sustained push in terms of financial capital in development, professional management teams that will build millions of square feet instead of thousands of square feet, and a big jump in the FSI. Once these initiatives are in place, real estate prices will drop, households and businesses will find space to be much more affordable, and it will not look so good as an asset class.

Some of these pieces are now coming together. A new breed of firms are now accessing public markets to obtain capital on a scale that was previously unimaginable, and bringing modern professional organisations to bear on the task of rapidly building properties. Foreign capital and foreign firms are increasingly coming into this area, though much slower than would be the case thanks to capital controls.

The CMIE executive summary for this sector shows a growth in total assets from Rs.22,156 crore in 2004-05 to Rs.53,522 crore in 2006-07. The market capitalisation of listed firms on NSE in this sector is Rs.3,13,981 crore, and the P/E of 37.3 will attract entry. Of the 80 firms in this sector, CMIE finds that 54 have adequate liquidity to make it into the price index for this sector. These are all still small numbers compared with the size of India, but it looks like serious firms are finally coming together, that might ultimately be able to pull off a massive supply response.

In this context, I was intruiged by this story by Raghavendra Kamath in Business Standard, describing incremental supply of ~ 15 million square feet in Bombay in a year. That sounds nice, it represents the kind of dent that is required on the part of supply to make a serious difference to prices.

Monday, January 21, 2008

Murky ethics on the part of the media, and the firms they cover

Bennett Coleman, a very big media house, is onto difficult ethical terrain with a concept of `private treaties'. Here, they get invested in some companies, and then these companies get favourable media treatment. Their media outlets trumpet these stocks, hopefully a good IPO takes place, and Bennett Coleman makes a good return on their portfolio. The expectation of free advertising and glowing editorial treatment probably leads to their purchases of these stocks getting done at bargain basement prices.


Sucheta Dalal says:

MoneyLIFE has in its possession a document to prove that journalists are being designated as champions for PT clients to tailor editorial coverage to enhance the value of these companies and TOIs investment. An e-mail by The Economic Times editor, Rahul Joshi (dated 29 November 2007), says, At ET, we are carving out a separate team to look into the needs of Private Treaty clients. Every large centre will have a senior editorial person to interface with Treaty clients. In turn, the senior edit person will be responsible, along with the existing team, for edit delivery. This team will have regional champions along with one or two reporters for help - but more importantly, they will liaise with REs (Resident Editors) and help in integrating the content into the different sections of the paper. In this way, we will be able to incorporate PT into the editorial mainstream, rather than it looking like a series of press releases appearing in vanilla form in the paper. He then goes on to name the PT champions for each region, who will advise the regional editorial chief to carry stories about PT clients. He also designates trouble shooters in each region, probably to ensure that no PT client is offended with negative coverage.

It reflects poor ethical standards on the part of Bennett Coleman to do such a thing. First, a question of fact: Do good papers in the world, such as New York Times, have private equity portfolios where editorial coverage and advertising are bartered in return for shares? Compare and contrast against the soul-searching that the New York Times has institutionalised on far more subtle kinds of conflicts of interest. I am curious about the role that law can play here. If the New York Times embarked on such a thing, would it be outright illegal? If it was not outright illegal, what else might go wrong for New York Times if they did such a thing?

The only saving grace lies in the fact that Bennett Coleman has put up their hall of shame, of firms who are willing to cooperate with such a scheme, on the web. Some names in there make no sense - e.g. I can't see how they can get a fabulous return on an investment in ISB. But many are recognisable targets of laudatory coverage.

I have often felt that in order to become a well functioning market economy, there has to be a culture of high ethical standards, a sense that certain things are just not done. While ethical standards require legal foundations, there is something about ethics which goes well beyond law. A go-getting atmosphere, where all kinds of behaviour is welcome, is a highway to becoming a banana republic. You may like to see something that I wrote in 1997, about how an atmosphere of low ethical standards induces entry barriers and hampers competition.

While there are signs of progress on the economy as a whole, in recent years, the scale of corruption in India associated with real estate and natural resources appears to be straight out of your worst stereotypes of a banana republic. CEOs have an incentive to do bad things: e.g. the stock market likes electricity generation projects which have locked down coal supplies, which favours entrepreneurs with a gift for manipulating the government. Ministers are rumoured to have become like Bennett Coleman, asking for shares in return for unethical actions. With natural resources and land, we are experiencing the well known pathologies of the `resource curse'. The only saving grace for us is that by now, the real estate and natural resource related sectors are a small part of the economy.

I'm not one of the proponents of the view that blogging fundamentally changes mainstream media. But in this one respect, I can see that it helps. The rise of the Internet in general and blogs in particular has helped to reduce the mindshare of Bennett Coleman. Blogs have helped make such murky practices more visible.

Saturday, July 14, 2007

Thursday, May 24, 2007

Property rights, eminent domain, and the land market

At the heart of the SEZ and land acquisition debate are the difficulties of the land market. Shruti Rajagopalan has an article in Wall Street Journal (via Mint) telling the story of how we landed in the present situation. You may want to see a previous blog posting on a related subject.

Saturday, March 17, 2007

`The mystery of capital' by Hernando de Soto

I must be the last guy in the world to read the famous book `The mystery of capital: Why capitalism triumphs in the West and fails everywhere else' by Hernando de Soto.

He says that the institutional and legal infrastructure surrounding the ownership of land and property makes possible a great deal of sophisticated things, far beyond the apparently mundane question of being clear on who owns what land. It becomes possible to borrow against land/property. I would go far beyond him in emphasising the vast sophistication of spot and derivative financial markets that can be built, which are ultimately founded on clarity of title and ease of transactions. Without clarity on title, and frictionless transactions, the great wealth that land ownership constitutes is frozen; transactions only happen with neighbours and family. Further, friction in transactions inhibits speculation and thus market efficiency.

I was witness to a similar transformation in India - the shift from share certificates printed on physical paper to ownership information maintained in a computer database. This eliminated the counterfeiting and theft, and made possible a superstructure of sophisticated finance. I am very much in tune with this first point of the book, that of emphasising the importance of clarity of property ownership and frictionless transactions. The task of maintaining these databases and ensuring frictionless transactions is a core State function, right up there alongside the police and judiciary.

I was recently in Ahmedabad and asked about the frictions of purchasing flats. Apparently they are used to paying 5-7% to a lawyer who does a `title check' and a bribe of roughly 2% in order to get the government to register the ownership in the name of the new buyer. These payments add up to 7-9%!!! Such a barrier to transactions and speculation is sure to yield a horribly inefficient market. Since land is one of the biggest asset classes, such inefficiency is costly.

The book then goes off into a fascinating ramble, which was fun to read. He asks the question: Where did the intricate systems of property ownership in the West come from? The practitioners of today have no idea about the rationale that led up to present institutions, and the compulsions that shaped present practice. I agree with this notion completely. As Lant Pritchett says, to ask a first world practitioner who operates a certain institutional infrastructure to then go on to design institutions is like asking a New York cab driver to design a car. To understand where first world institutions come from, one has to go delve in history, and think about incentives from first principles. Talking with contemporary practitioners is useful for obtaining a description of the present institutional structures, but not much beyond that.

There is a very interesting chapter about the history of land and the US. The basic story of the US appears to be one where settlers took what land they could, and the State later legitimised the facts on the ground as property rights. The book projects this experience as carrying important lessons for third world countries, who (the book suggests) should do as the US did when it was a developing country. Yes, this is certainly how the US evolved - but that is a very singular story in human history. It was perhaps like that in Canada and Australia also, where a tiny group of settlers faced quasi-infinite land and where State capacity was negligible. In a third world country there is no empty land to expand into. All land is owned by someone. I simply don't see how it is possible to make this analogy: squatters were legitimised in the early history of the US, hence there is a case for a benign treatment of squatters in the third world today.

If anything, there's a strong contradiction between the previous point (clarity of title) and this one (giving squatters rights). I personally do not dream of buying land in (say) Kanpur, since I'm not there in the neighbourhood to watch over it and ensure that squatting does not take place. The squatting equilibrium ensures that a national market does not develop, that a complex financial superstructure does not develop on the land market. With squatting, each person only thinks of owning land in an epsilon neighbourhood or in the epsilon neighbourhood of trusted family.

A side battle taken up in the book is the history of guilds and the `extra legal sector'. We all know the broad story - that the development of capitalism led to the breakdown of the guilds, which were anti-competitive. The book paints this as part of the saga of heroic squatters taking on entrenched wealth. I am quite unpersuaded. Yes, taking on the guilds was very important, but it is just a question of competition policy. (As an example, see this recent edit in Business Standard about allowing an `extra legal sector' of heroic small telecom companies to take on the guild of Indian telecom companies). Yes, I perfectly agree that at every possible turn in policy thinking, we must enshrine competition. But I don't see how singing paeans to the gritty entrepreneurs in the informal sector is consistent with supporting land grab.

The book draws on examples from a few countries like Egypt and Haiti and argues that Capitalism has failed. It ignores the history of country after country in Asia where Capitalism has worked. First Japan, then Korea and Taiwan, then China and now India are achieving a takeoff based on market-oriented economics, and many small countries have also done splendidly. The book may perhaps be excessively influenced by information from a few countries where Capitalism did fail. But the lessons are less general than meet the eye.

He makes much of the `bell jar' analogy, of a modern sector of a poor country inside a bell jar with the great unwashed masses outside clamouring to get in. His belief is that this bell jar will not grow by itself. Well, the data shows that in countries like Japan, Korea, Taiwan, China and India, the bell jar has grown wonderfully. A modern sector takes root in the country, plugs into globalisation, and then reshapes it's surroundings: we have seen this over and over, and have pretty much understood this process ever since Adam Smith, David Ricardo and Karl Marx.

We admire the grit, determination, and innovation of small entrepreneurs, but we should be wary in judging their economic significance. A lot is made of the size of the informal sector, but when you look at the data, SMEs just don't add up to much. In India, the mere 100 big firms (the firms in Nifty and Nifty junior, which have good stock market liquidity) account for a full 10% of GDP. And this is just the value added within the firms - given Indian labour law, these firms contract-out a large amount of production so as to steer clear of this law. The true economic footprint of these biggest 100 firms, then, well exceeds 10% of GDP. And I've only counted the biggest 100 firms. By the time you get to the top 10,000 firms, which (with the government) inhabit the bell jar, you get to a huge and growing slice of India.

Capitalism has not failed `everywhere else'. The bell jar is big; the bell jar is growing. I do not share the message offered by the book that the bell jar is stagnant; the bell jar has failed; that the only way to build a vibrant capitalism is to go outside the bell jar and enshrine the reality of the extralegal sector into the legal system.

The book claims that when law diverges from universal social practice, the law must inevitably give way. What about the campaign against sati? There was a time in India when after a husband died, the widow was urged, encouraged and pushed into the funeral pyre by immediate family. The prevalence of sati was the `facts on the ground'. The creation of a modern India critically relied on the Law saying that such practices were unacceptable.

I remember how, ten years ago, there were many fatalists who believed that counterfeiting and theft of physical share certificates was the inescapable reality of India. It was solved by a top-down reformative policy push, not by a process of law accepting theft, or giving partial ownership rights to the counterfeiter. The only way towards making progress on building a mature market economy is to go after these kinds of problems with passion and zeal. In similar fashion, squatting is the norm in India today, and no land is safe, but still there is absolutely no case for benign support towards squatting or `encoding the facts on the ground in law'. The success of the Indian development project critically requires achieving frictionless land transactions.

Thursday, January 25, 2007

What is wrong with Bombay real estate

There are few cities in the world where the situation on real estate is as bad as Bombay. Prices are sky-high and the quality of facilities is poor. Andy Mukherjee has a fascinating article on Bloomberg about this, where he says:

Draw a circle with a radius that takes in 25 kilometers (15 miles) from the middle of Mumbai's financial district. Sea and water account for two-thirds of the surface area of this circle, compared with 22 percent for Jakarta and 5 percent for Seoul, according to Alain Bertaud, a Glen Rock, New Jersey-based urban- planning consultant for the World Bank.

All major world cities where the geography restricts the availability of land tend to make up for it by growing tall. That's where Mumbai is an exception. Planners confronted a constrained city and flattened it.

The tool they used to create a stunted city is the floor space index, or FSI, which measures how much saleable area a builder is allowed to create on a parcel of land. A higher reading means taller buildings. The index, which ranges from 5 to 15 in most Asian cities, stands at a measly 1.33 in downtown Mumbai. In the suburbs, the figure drops to 1.

A sprawling city is easier to manage. Small piles of garbage, spread across the city, can be left to rot for longer than would be possible if the trash accumulated in large, stinking heaps. More importantly, when the municipality keeps floor-area restrictions tight, it has power over developers. This power can easily translate into bribes.


Global banks, brokerages and successful Indian companies are all jostling for rentable space in dilapidated buildings, which should have been torn down and built anew a long time ago.

The reason these eyesores still exist is because they were built before 1964 when the permitted floor space index was 4.5. Today, if a developer were to buy the land to erect a new building, he would lose most of the marketable area.


The supply of land has to rise to contain housing price escalation as well as to lower office rents, which are the third- highest in the Asia-Pacific region after Hong Kong and Tokyo.

That would require a repeal of the Urban Land Ceiling Act, a law that has ended up promoting what it was supposed to prevent: hoarding of real estate.


The time for half measures is over.

A floor-area index reading of at least 5 is required across Mumbai.

Mumbai needs to rise from the ground. The question is whether civic authorities will have the will and the ability to cope with the peculiar demands of a tall city.

Saturday, November 11, 2006

What google earth can do for illegal land development

Ubiquitous access to Google Earth has many interesting implications for the land market.

I have seen many signs where obscure little real estate brokers, by the road side, offer to show you properties through Google Earth.

Nancy Sajben sent me a pointer to a blog entry talking about how land acquisition for an SEZ was influenced by Google Earth: farmers were able to argue their position more clearly by utilising this information.

In cities like Bombay and Delhi, I sometimes think the resolution of Google Earth pictures are so high that one can even identify illegal construction where a house spills into the road. The puzzle is: who will do this?

I have long been highly conscious about illegal land development on the boundaries of national parks by developers who chip away, one acre at a time. I don't know the legal foundations surrounding Borivli National Park, but the amount of construction taking place at the edges of the park seems very, very suspicious to me. And this is Bombay - anywhere outside Bombay I'm sure the dangers of encroachment are much worse.

It would be wonderful if an environmental activist group would engage in the following steps:

  1. Utilise the public records to make a .kmz file of the boundary of all the national parks in India,
  2. Setup software which watches google earth, and throws up an alert when it looks like there is some habitation in what ought to be park land.
Update: I just noticed some work in South America which sounds like this.

Thursday, August 03, 2006

Problems of land acquisition by the State

Land is the most distorted factor market in India. The State is deeply involved in all aspects of the functioning of the land market. Particularly in a place like Delhi, one sees acre after acre of land which has been politically allocated to cronies of the State at some point in the past. In addition, the market features high transactions taxes and acute illiquidity.

The State routinely engages in forcible land acquisition, where traditional rural populations are displaced. This land finds its way into the hands of modern developers at below-market prices, with rents flowing into the State machinery. This is obviously unfair. Ila Patnaik has an article in Indian Express where she shows an argument by Shubhashis Gangopadhyay on how this problem can be solved.