MUMBAI, REAL ESTATE AND INFLAITON 💣💥

 What is the first thing that comes to your mind when I say Mumbai? It might be traffic jam for some, some might say humidity, Vada pav, Sea link, Antilia, fast life, cricket fans might say Wankhede stadium, the Gateway of India, Etc. But when you ask the same question to an investor, I am pretty sure that he would talk about the Rental yields and house rates. Why would anybody talk about stupid rental yields when you have the mesmerizing Marine Drive? The answer. 

For more than a decade now, Mumbai remains the dominant player when it comes to the top 10 most expensive cities to live in India. The cost of living in India, on average, has increased at an annual rate of 5.5%. When we apply the same metric to Mumbai, the numbers would make your investment returns feel awful. There is a reason why Mumbai is called as the city that creates a hole in your pocket. 

On the global basis, out of 227 cities spread across 5 continents, Mumbai holds the 127th spot of being the most expensive cities to live in. Mumbai has been the center of attraction for multinational companies since 90's. The city if often called as the city of dreams. It's because it is always flooded with opportunities in the commerce and the film industry, Mumbai attracts lakhs of people, especially youngsters, all around the country. Being close to the sea is an advantage as well as a disadvantage for the city. 

The city is home to 31700 people per square kilometers. This makes Mumbai one of the most crowded cities to live in India. We might have heard our grandparents or our parents fixating upon the fact that they should have bought the flat that was selling for Rs 5 lakh back in the 90's. Today, the same flat is worth Rs 3 Cr. I have already touched upon these rising prices in the previous blog. This blog will clarify how exactly the prices rise. 

To solve the equations of rising house prices in Mumbai, we need to consider 3 very important variables. The developer or the builder, politician and the mafias. No one is to blame for inflated house prices except for these 3 musketeers. Let's learn how these variables work collectively with an example. 

Cost of House = Rs 1 Cr 
GST + Surcharges = Rs 20 lakh     (*Surcharges include stamp duties as well as GST) 
Surcharge basically allows businesses to transfer the additional cost of raw materials to the final consumer. In simple words, we pay for their inflated raw material prices. 

Stamp duties are charged so as to show the evidence of sale. We don't have to pay GST on completed house. Only buildings under construction are charged 12% GST. Looking at this scenario I can only say one thing, high taxes breed high corruption. 

If a normal guy wants to buy a house, he will pay a certain amount as down payment from his own pockets and would opt for a long-term loan from the banks. Now let's look at how corrupt people with black money buy homes and inflate the prices. 

Let's assume that the guy's name is Nirav.
Income = Rs 10 Cr
According to the tax laws, he will have to pay = Rs 4 Cr in taxes. 
Now Nirav being corrupt, he would like to show more expenses and would try to decrease the taxable amount. He goes to another corrupt friend of his, Vijay and transfers Rs 10 Cr via bank account. On the other hand, Vijay would give Nirav Rs 10 Cr in Cash. 
This is how, Nirav transferred his white Rs 10 Cr and got back is Rs 10 Cr in Black. The IT department would say that he earned Rs 10 Cr, but his expenses also amount to Rs 10 r, hence no net taxable amount. 

Here, Nirav can't deposit that money in the bank or can't introduce that black money into the banking system. He will have to show his source of income which would get him in trouble. Now the game starts. Nirav would take that hard cash and go to a developer. Let's assume that the builder has built 15 flats worth Rs 1 Cr each. Nirav would go straightaway and ask for 8 flats with upfront payment of Rs 8 Cr. The builder would think that he has already sold his 8 flats at Rs 1 Cr each and he also has the money. Why not increase the price of the remaining flats? Guess what he does next? The builder increases the prices of the remaining flats by Rs 25 Lakh. 

From a common man's perspective, the house would now cost Rs 1.25 Cr. Common man was happy when the house was selling for Rs 1 Cr. He starts thinking about different ways of amassing those extra Rs 25 Lakh. He would probably give it another thought and might also postpone his flat buying decision. 

Now coming to Nirav, he would save a lot of money. How? 
According to the circular rate, at least 30% of the money should be in white and hence he would show Rs 30 lakhs in white on 1 house. But he bought 8. Nirav bought 8 flats is a fact that only the builder and Nirav knows himself. Look how much money Nirav saved in taxes.

Saved 40% tax on Rs 10 Cr = Rs 4 Cr (if kept that Rs 10 Cr as white) 
He paid Rs 30 Lakh as white according to circular rate. This transaction shows that Nirav bought the house for Rs 30 lakh and hence the government would charge GST and surcharge on that Rs 30 Lakh. 
Hence, GST = 20% on Rs 30 Lakh = Rs 6 lakh. 

If the cost of the house was Rs 1 Cr (it was but he showed Rs 30 lakh), then he would have to pay 20% on that Rs 1 Cr, i.e., Rs 20 lakh. Therefor he already got a discount of Rs 14 lakh in GST payment compared to common man. The house that costs Rs 1.25 Cr to a common man costs Nirav Rs 1.05 Cr. As stated earlier, he has already saved Rs 4 Cr in income tax.  

If Nirav was an honest man and if he would have paid 40% tax on his Rs 10 Cr income, he would have left with Rs 6 Cr. Hence instead of going for 8 flats, he would have gone for 5 flats for 1 Cr each. If this was the situation, the builder would have not increased the prices as he would have only sold 6 flats. 

The house was already costing Nirav Rs 60 lakh as he illegally didn't pay his income tax. He saved Rs 40 lakh in income tax. On per flat basis, he saved Rs 14 lakh in GST. In total, he saved Rs 54 lakh on per flat basis. The cost he will pay for the flat is Rs 66 Lakh which was Rs 1.25 Cr. 

The same house costs Rs 1.25 Cr to a common man and the same house costs Rs 66 Lakh to a corrupt man. Why wouldn't he invest more of his black money into the property market. He is getting a straight 50% discount. Hence, the more he buys, the more he saves, the more he creates black money, the more he increases his property portfolio and leading to inflated prices for common man. 

Corruption begets corrupt people. These politicians have the power to influence the builders and make changes according to their will. Let's take the example of one of the most prestigious builders in Mumbai, Mr. Hiranandani. The group owns more than 2.6 million sq ft of land in India. One of their projects in Powai alone is built on 250 acres of land. The government owned this land parcel. In order to build houses for economically backward people, the government asked the Hiranandani group to develop a township for them. Out of the 250 acres, the group allocated only 1/3rd of the land for building houses for EBP and the rest was used for the premium segment homes. In reality, the entire 250 acres of land should have been used for the EBP and not for the ultrarich. They sold premium apartments which also included 23 commercial properties and earned hefty revenues.

One of the biggest reasons why investors don't invest in real estate companies is because of this ambiguity. The builders can hire world class marketing agencies to broadcast their robin hood nature, but we can never predict their internal working when compared to companies from other sectors. We can never track their internal operations. Take any big shot investor and have a look into his portfolio. Mr. Warren Buffet has no exposure to real estate companies, neither did Mr. Peter Lynch. Forget Americans, Indian investors like Mr. Ashish Kacholia or Mr. Radhakrishna Damani or even Mr. Vijay Kedia for that matter, they have not even parked a dime in these real estate companies. 

 If prominent builders with decades and decades of goodwill like Godrej and Hiranandani can commit such activities, think about what "not-so-famous-builders" would do. The real estate market in India is not meant for the regular investors. It's like derivatives, only more disgusting and illiquid.