Real estate cycle

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<ul><li>1.Dr V Chandrasekar, Professor, Executive Advisor, ICREI, ISB Gaurang Sanghvi, Research Associate, ISB Indicators of real estate cycle: Implications for India Indicators of a Real Estate Cycle - Implication for India </li></ul><p>2. Indicators of real estate cycle: Implications for India Indu real estate research chair Disclaimer This paper attempts to serve as the background note on the global real estate market and cycles. The paper provides an overview of the real estate cycle and market dynamics therein, and explores the imperative indicators which affect the real estate cycle. The paper also makes an effort to provide general information on dynamics of a real estate cycle. The paper tries to provide information on matters of interest to readers. The implications of indicators can vary widely from case to case, based upon the specific or unique characteristics of a particular macro-economy. Readers are encouraged to consult with professional advisors for advice concerning specific matters before implementing any investment or tax strategies. While due care has been taken during the compilation of this paper to ensure that the information is accurate to the best of the Authors and ISBs knowledge and belief, Author is not responsible for the accuracy or appropriateness of the information in this paper and disclaims responsibility for strategies implemented as a result of any information provided herein. The Author and ISB neither recommend nor endorse any specific products or services that may have been mentioned in this publication and nor do they assume any liability or responsibility for the outcome of decisions taken as a result of any reliance placed on this paper. Neither the Author nor ISB shall be liable for any direct or indirect damages that may arise due to any act or omission on the part of the user due to any reliance placed or guidance taken from any portion of this paper. 3. Indicators of real estate cycle: Implications for India Indu real estate research chair Terms of reference R Square and t Statistic: Given the scope of the paper, we can establish that there is a relationship between house price and income by the exercise of regression, and the respective values of R square and t statistic which comes in the output of the regression. R Square: The estimated value of R square (also known as coefficient of determination), signifies the extent to which the variation in the movement of price could be explained by the income. The value of R square ranges from 0 to 1. We generally express R square as percentage. If the value of R square is closer to 1 or 100%; we conclude that the variation in the price is explained by the movement in income. e.g.: if the value of R square is 0. 95 i.e. 95%, this means that 95% of the variations in the dependent variable can be explained by the independent variable in the regression model. t Statistic: t Statistic indicates that whether or not the given two variables can be related to each other. If the t statistic is higher than 2, than our hypotheses that the variables are related is taken as true. 4. Indicators of real estate cycle: Implications for India Indu real estate research chair Approach The term bubble implies a transient state where a rapidly growing boom is not supported by economic fundamentals but is based on false assumptions and expectations and would eventually prove to become short lived. Dehesh, Pugh (1996) Countries differ in their institutional, structural and economic fundamentals, and any economic phenomena associated with a particular economy would typically have different characteristic features, which can be attributed to geographical diversities and structural differences such as supply responsiveness, housing markets liquidity and mortgage market completeness. Similarly, features of real estate cycle across different economies are supposed to be exhibiting at best a spurious correlation only. However certain macroeconomic indicators such as household disposable income and market specific determinants such as interest rate, debt service ratio, rentals trends, tend to exhibit similar pattern in terms of their impact on the price movements in the real estate sector. Given this backdrop, the report is an attempt at outlining the impact of these indicators on the price trends in different real estate markets. Indian real estate market has been analyzed with the backdrop of the global trends, and a possible trajectory for the Indian market has been examined. Section 1 gives a brief overview of the theory of real estate cyles and the various indicators that affect the real estate cycle. Section 2 studies the real estate cycles in USA, Japan, and UK. The main criterian that have been considered while choosing these case studies have been a) The real estate cycles should have lasted atleast for five years b) The real estate market should have global significance c) Statistical data availability across markets. In this section we would separately analyse the pattern of real estate cycles in the respective economies, and would try to see similarities, if any, in the indicators responsible for the cycle and also in their respective magnitude. Section 3 analyses the Indian real estate cycle under the above select indicators. The opportunities and risks in Indian real estate market have also been analysed. The case of the Mumbai real estate market has been considered for the analysis, since it is believed to be the most burgeoning real estate market in India. Mumbai is also a mature, demand led market, where end users are higher as compared to other speculative markets in the country. We try to establish the presence or possibility of any similarity between the trends in the price movements in the real estate sector in India and the respective trends in the US, UK or Japan. The role of Government vis--vis policies, both fiscal and monetary, in the price movements of real estate sector has also been analysed in this section. An attempt has also been made to forecast the possible trajectory of the Indian real estate, in light of the present demand supply scenario. Section 4 analyses the key findings of the report and also attempts at highlighting the strengths and possible challenges faced by the Indian real estate sector. 5. Indicators of real estate cycle: Implications for India Indu real estate research chair List of figures List of tables List of graph List of abbreviations 1. A brief background of Real Estate Global Cycle 1.1 Introduction 1.2 Real estate cycle 2. Real Estate Cycle : Case Studies 2.1 Indicators of the real estate cycle 2.2 United States of America - Real estate cycle 2.2.1 United States real estate cycle 2.2.2 Indicators of the real estate cycle 2.2.3 United States : Inference 2.3 Japan real estate cycle 2.3.1 Japanese real estate cycle 2.3.2 Indicators of the real estate cycle 2.3.3 Japan : Inference 2.4 UK 2.4.1 UK real estate cycle 2.4.2 Indicators of the real estate cycle 2.4.3 UK : Inference 3. Indian real estate cycle 3.1 Indian real estate cycle 3.2 Indicators of the real estate cyle 3.3 Demand supply scenario and policy perspective 3.4 Real estate cycles India v/s global market 4. India Road ahead Reference Table of contents 6. Indicators of real estate cycle: Implications for India Indu real estate research chair List of figures Figure 1 Phases of a real estate cycle Figure 2 Indicators affecting a real estate cycle Figure 3 Selected indicators and the pattern of their movement during a real estate cycle Figure 4 Timeline of global real estate cycles and macroeconomic events Figure 5 House price changes for United States (1975 2006) List of tables Table 1 Timeline of real estate cycle United States Table 2 House price appreciation in United States Table 3 Indicators affecting global real estate cycles Table 4 India v/s global market List of Graphs Graph 1 United States real estate cycle (1980 2005) Graph 2 House price (1985 1989) Graph 3 Net rental yield (1985 1989) Graph 4 House price to income ratio (1985 1989) Graph 5 Interest rates (1985 1989) Graph 6 GDP vs disposable income (1985 1989) Graph 7 Demand supply scenario (1985 1989) Graph 8 House price (1995 1999) Graph 9 - Net rental yield (1995 1999) Graph 10 House price to income ratio (1995 1999) Graph 11 Interest rates (1995 1999) Graph 12 GDP vs disposable income (1995 1999) Graph 13 Demand supply scenario (1995 1999) Graph 14 - House price (2000 2005) Graph 15 - Net rental yield (2000 2005) Graph 16 House price to income ratio (2000 2005) Graph 17 Interest rates (2000 2005) Graph 18 GDP vs disposable income (2000 2005) Graph 19 Demand supply scenario (2000 2005) 7. Indicators of real estate cycle: Implications for India Indu real estate research chair Graph 20 Japanese real estate cycle (1985 - 1999) Graph 21 House price (1985 1999) Graph 22 House price to rent index (1985 1999) Graph 23 Household debt service ratio (1985 1999) Graph 24 Interest rates (1985 1999) Graph 25 GDP vs disposable income (1985 1999) Graph 26 UK real estate cycle (1986 1991) Graph 27 House Price (1986 1991) Graph 28 Interest Rates (1986 1991) Graph 29 Disposable income vs GDP (1986 1991) Graph 30 Indian real estate cycle (1990 1999) Graph 31 House price (1990 1999) Graph 32 GDP vs disposable income (1990 1999) Graph 33 House price to income (1999 1990) Graph 34 Interest Rates (1999 1990) Graph 35 Housing shortfall in India Graph 36 Demand for new housing (2005 2030) List of Abbreviations CAGR Compound Annual Growth Rate FDI Foreign Direct Investment FII Foreign Institutional Investors GDP Gross Domestic Product INR Indian National Rupee IPO Initial Public Offerings NBO National Building Organization REIT Real Estate Investment Trust UK United Kingdom USA United States of America USD United States Dollar VC Venture Capital 8. Indicators of real estate cycle: Implications for India Indu real estate research chair The real estate cycles involves periodic shifts of rapid growth of output (recovery and prosperity), alternating with relative stagnation or decline (contraction or recession) over time. Historically, in early 1980s and 1990s the price of new houses appreciated by 300 percent whereas prices of raw land appreciated by 1000 percent. Both subsequently depreciated, ushering in a recession that bottomed out in 1992. The trend post 1993 witnessed an even keel in the house price. (source to justify 300 and 1000 percent 1.1 Introduction: 1. A Brief Background of the Real Estate Global Cycles: 1.2 Real estate cycles: Real estate cycles are described as cyclic movements of price in the real estate market which, over a period of time, causes fluctuations in the residential and commercial property market. This is a result of the economic, demographic and/or policy changes in the overall market environment. The four phases of a real estate cycle viz. Recession, Recovery, Expansion, Contraction. While phases 1 and 4 (recession and contraction) are characterized by rising vacancy rates, phases 2 and 3 (recovery and expansion) demonstrate falling vacancy rates as shown in figure 1. Figure:1 Phases of a real estate cycle 1 Expansion is accompanied by job and population growth along with high demand on the infrastructure. Equilibrium occurs when prices stabilize. Prices, having reached their maximum limits, less businesses move into, or expand in the area. Recession occurs due to declining job growth, relocation of businesses and depreciating housing demand. During this time, prices become stagnant or even decline as rents and occupancy depreciates. Absorption occurs as prices and occupancy depreciates and the area becomes attractive again to the market. In growing economy, the rising phase dominate the declining phase of the real estate cycle and on an average, there are more years of good times than bad times for investors. Source Journal of real estate research, Volume 18, No 1, 1999 9. Indicators of real estate cycle: Implications for India Indu real estate research chair In attempting to identify real estate cycles across global markets, certain key indicators have been chosen. Analysis of these indicators across select markets signify whether a given real estate market is experiencing a boom or a bust phase. The various indicators which affect a real estate cycle are as follows: 2. Real estate cycle : Case Studies: 2.1 Indicators of Real estate cycle: Figure: 2 Indicators affecting real estate cycle 2 1) Population growth 2) Employment rate 3) Gross Domestic Product (GDP) 4) Household disposable income 5) Stock Market values 6) Average House price movement 7) Price to Income ratio 8) Net rental yield 9) Household debt service ratio 10) Interest rate/mortgage rate 11) Demand- supply scenario The above figure illustrates the various indicators affecting a real estate cycle, their corresponding impacts on the real estate cycle and their inter dependency on each other. 10. Indicators of real estate cycle: Implications for India Indu real estate research chair 2. Real estate cycle : Case Studies 5) Interest rates / mortgage rates 6) Stock price values 7) Demand supply gap 3 The markets selected for analysing real estate cycle are United States of America, Japan and the UK. The various macro-economic events that have affected the above mentioned real estate cycle are as follows: 1985: Plaza agreement and Japanese asset boom - The Plaza Agreement was signed by five countries ie France, West Germany, Japan, United States and United Kingdom and it was agreed to depreciate the US dollar in relation to the Japanese Yen by intervening in the currency markets. 1986-1993: Increase in Japanese foreign investment This period was considered as the year of massive Japanese dominance over the world financial market, whereby Japans net long term capital outflow among the G 7 countries appreciated by 90% from 1982 to 1987. Figure: 3 Selected indicators and the pattern of their movement during real estate cycles The indicators chosen for the purpose of analysis are as follows 1) Average House price movement 2) Price to income index/ ratio 3) Price to rent ratio / net rental yield 4) Debt service ratio The figure 3 illustrates the indicators selected for the analysis of real estate cycle and the pattern of their movement during the boom and the bust phase of a real estate cycle. 11. Indicators of real estate cycle: Implications for India Indu real estate research chair Figure: 4: Timeline of global real estate cycles and macroeconomic events 1987: Deregulation in real estate market and stock market crash in UK The stock market crash resulted in wealth losses on consumption. Thus the financial institutions eased credit which fuelled the on going real estate boom 19881992: Large inflow of capital in United States of America led to increase in gross national product Accelerated capital inflows started in 1989 which was affect...</p>