Realty bubble set to burst?

The high appreciation rates that India's property market is currently witnessing, is due to the interest rates reduction that the National Democratic Alliance government instituted after 2001.

In early 2004, home loan rates sank to a record low of 7.5 per cent and this paved the way for the alarming spiking that typified the country's property rates in many Indian cities.

The very amenable borrowing rates encouraged individuals to avail of home loans to buy residences, while up to then actual property purchase had only been an option for the considerably rich.

This resulted in a huge demand for quality real estate all over the country post 2003. Since March 2005, Indian real estate rates have displayed an unstoppable upward curve. This is directly related to the opening up of foreign direct investment in real estate. The market has been expanding at an unbelievable rate of 100 per cent plus. This can also be traced to the heightened NRI interest in real estate.

Many presently feel that the Indian real estate market is a bubble, and will eventually burst. It is true that residential rates in many Indian cities like Mumbai and Delhi are comparable with property rates in the West now. However, let us take an investor's point of view of this phenomenon.

Behavioral finance has repeatedly proved that whenever asset prices start escalating, the initial interpretation has been of a 'bubble'. In-depth analysis of price appreciation in real estate and the reasons thereof would help in comprehending these fears. Price appreciation in real estate is backed by the following fundamentals:

• Rising income levels, resulting in increased demand for quality constructions and aspirations for better locations in residences. This has also been made easy by nuclear families and double-income households.
• IT / ITeS continues to be a major revenue driver and rising outsourcing trends have driven demand for office space.
• Hospitality industry is operating on more than 85 per cent occupancy in major metros and rising business activity is resulting in increased investment in hospitality
• The organised retail industry is in its infancy and with huge investments from major corporates the demand for real estate is rising. The focus on 'Location, location and location' is leading to an increased appetite for developing area-specific shopping complexes.

With land always being a scarce resource, property prices would follow basic economics of demand-supply and pricing, whereby property prices seem to have increased.

Normally, real estate returns are in line with inflation and if we look at the current price rise, the returns which real estate has delivered in this rally seem to just compensate the investor against inflation during the longer holding term.

The author is chairman and country head -- Jones Lang LaSalle Merghraj