Policymakers must release land

But it has to be done without triggering political agitations or crises in banking and real estate

"This time it's different" - those words are often spoken to justify prices hitting high levels, and staying there against all logic. It is true that every bull market has its special characteristics, though that doesn't make any uptrend permanently sustainable. In this bull market, equity has risen, while real estate has fallen. That divergence is unusual. The real estate sector is struggling. Since January 2012, the CNX Realty Index has returned 23 per cent, while the Nifty has returned 87 per cent. Multiple commercial and housing projects are stalled. Developers are cash-strapped and many have been forced to make asset sales. The US subprime crisis showed how catastrophic losses can be when real estate bubbles burst. The American market went topsy-turvy. In some urban areas, it became cheaper for somebody looking to rent for a given period to take out a mortgage and default instead.

Land prices should relate to productivity, which rises as usage gets more sophisticated. A rice field generates less income than an automobile plant or a luxury hotel and land prices should reflect that. On a large scale, 30 per cent of India's population lives in cities, which occupy far less area than India's villages. But cities produce 70 per cent of GDP and urban land is worth much more. But at some point, value addition saturates. For example, a luxury hotel might maximise potential returns from given acreage. Beyond that saturation point, bubbles might result. It might not be obvious when "value-saturation" will be hit.

There's a need to assess both legal issues and external factors carefully when looking at conversion. For example, a developer may try to convert an orchard into a factory or an apartment block. If he cannot do this due to legal issues, value saturation is hit. Even so, the orchard will be more productive if infrastructure improves. Better power and roads will allow fruit to be sold with less spoilage. Real estate project timeframes can be long and uncertain. For example, textile mills were shut in 1982 in what used to be central Bombay. These were re-developed 20-25 years later after multiple legal battles, to host Mumbai's posh new offices and nightclubs.

Complicated laws create scarcity and contribute to bubbles. Rent control acts, land ceiling acts, sundry environmental and other statutory clearances and other laws are all barriers to efficient land-usage and conversion. This is why Indian land prices match First World prices. Expensive, scarce land also means poor infrastructure. Bubbles can deflate or burst. There were corrections of 25-35 per cent in urban real estate prices in the mid-1990s. A huge bubble started to inflate in the 2000s as banks started offering mortgages. The past two or three years have seen prices stagnate, with some corrections.

Rampant tax evasion means land is officially under-valued. Getting accurate prices is difficult. Real estate developers operate on high leverage. They buy land (often borrowing cash or making part payment). They raise money to build by pre-selling to buyers. Housing demand has flattened and interest rates are high. Developers often borrow at very high rates. There are rumours that the NSEL scam (which featured speculation in non-existent commodities contracts) was triggered by real estate players seeking alternate borrowing mechanisms.

The Reserve Bank of India is wary of loans backed by real estate. Banks are reluctant to lend to developers. When banks do lend against real estate as in mortgages, they discount considerably. Bank exposure to real estate is quite high, nevertheless. So is bank exposure to infrastructure projects which are stalled due to land-related issues. There's an interesting conundrum. India needs better infrastructure, which means land must be acquired quickly, at reasonable prices. But if land prices drop and supply increases, banks must review real estate exposures, and developers must revalue land banks. Of course, bank exposures to infrastructure projects will also become less risky.

If land is forcibly acquired, Singur-style agitations can happen, or even Maoist insurgencies. The Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013, laid down consent norms and social impact norms to enable acquisition. This Act has been amended by Ordinance to remove the necessity for consent and social impact assessment in several categories.

It will be hard to get the ordinance ratified by Parliament but it would be a very positive signal for investors if it does pass. One way or another, policymakers must release land, without triggering political agitations or crises in banking and real estate. If this is possible, prospects will dramatically improve for infrastructure, real estate and construction.