The actual meaning of ‘value of real estate going down’

The commonest question that is asked is whether the prices of real estate would ever fall like the prices of equities (stocks), interest rates (fixed deposit rates) and gold & silver prices (commodities prices). Except for the year 2008-09 when the entire world went through one of its worst financial crisis which dragged the value of all assets to new lows, there have been no significant instances of the value of real estate going down to unmanageable levels.

Let’s try and understand the actual meaning of “value of real estate going down”. Assuming you had purchased a vacant plot or an independent house or a flat about five years ago for Rs.25 lakh, if you are planning to sell now and if the price of your property has become Rs.20 lakh can we term it as “value has come down”?

The answer could be yes but is this a standalone case of price fall only in the area that you had owned the property or is it a systematic risk where the property prices across the city have fallen? If the price has fallen only in your area we cannot term it as a case of “market has fallen”; it could just have been a bad investment choice. Then what could be termed as a critical situation for property investment?

Crucial factors

When the price of any type of property starts crashing due to lessening demand with more supply; when cash is not available on demand for builders; when borrowing becomes costlier; when income has receded due to economic factors; when people are overweight on real estate without hedge across other investment class; when higher inflation has begun to eat into the savings; when property prices have escalated to such levels that it becomes completely unaffordable to own — then perhaps the crash starts manifesting.

Another reason that can be attributed for the crash which could happen simultaneously along with the above mentioned factors is that when the financial institutions that have loaned across types of borrowers with higher loan to value (loan limit on the valued price of the property) start witnessing the first sign of borrowers being unable to meet their loan commitments. When mass default starts, the financial institutions would start selling or disposing of the underlying collateral (property) to recover their balance receivables, such mass defaults leading to rush in property sale also leads to a crash in real estate prices.

Yes, this can lead to subprime kind of situation. Since most financial institutions bundle their receivables and securitise them for liquidity it might lead to even more complications under such situations which could result in severe problems at the micro level as also at the macro level.

Barring such critical situations (RBI has been managing this deftly ever since the developed economies witnessed the worst-ever crisis) real estate continues to a dependable investment. Though there could be price stagnation or the value may not appreciate significantly, but as an investment it offers a lot of financial security and comfort to people because living in their own home is the ultimate dream which scores over other financial assets.

It would be a wise decision if people start considering real estate investment as part of their overall asset allocation rather than having a concentrated investment which could lead to irrecoverable damages in case of crisis.