The coming property bust

While there’s been talk of the property bubble bursting for quite a while now, and even the RBI has commented upon this, the recent Rs 702 crore DLF bid for NTC land in Lower Parel in Mumbai as well as the news that Calpers, the biggest US pension fund, will enter the Indian realty market, has got the market buzzing once again.

If the Sensex can cross 7,000 despite analysts warning that prevailing interest rates in the country don’t warrant such a high level for equity, why can’t the property market go higher?

Every quarter, or thereabouts, as and when reports are put out by property consultants like Knight Frank talking of the huge boom in the number of malls being constructed, sentiments get a further boost—while you keep reading news on how India has among the more expensive residential real estate prices in the world, the latest Knight Frank report shows India has among the lowest retail rentals globally, indicating lots of head room for growth!

Though it’s impossible to predict what is going to happen to the property market, indeed any market, given the levels of what’s now popularly called irrational exuberance, an interesting exercise is to examine the market for organised retail, and shopping malls, since this is a big driver of the property boom—how many reports have you seen which link the property boom to, primarily, the increasing number of tourists, or BPO units for that matter?

Before we start, it’s useful to look at average mall rentals in places like Delhi and Gurgaon; they’re in the region of Rs 70 per square foot per month or thereabouts (they’re double in some properties), which means that in order to be viable, a shop in a mall needs to earn around Rs 10,500 per square foot per annum based on the assumption that it can afford to pay around 8 per cent of turnover as rentals, though this is lower for shops that stock mainly manufactured brands (like Shopper’s Stop, for instance) where margins are lower, and as low as 3-4 per cent in the case of F&B outlets.

For the country as a whole, Knight Frank tells us there will be around 7.5 crore square feet of mall space by 2007, which translates into a required mall spending of Rs 78,750 crore, a figure that is around 45 per cent more than the projections for the entire organised retail industry in 2007, which includes the shops in high-street locations like Connaught Place and South Extension in New Delhi and Kemps Corner in Mumbai!

Clearly there’s a huge mismatch somewhere—either the mall numbers are way out of line, or the organised retail industry is going to grow at a mindboggling 50-60 per cent per year in order to keep the balance between malls and high-street locations at the current levels. You take your pick.

At the level of the individual cities, which is where the demand-supply match really matters, things are far worse. Take the National Capita Region (NCR), which is Delhi and neighbouring areas like Gurgaon and Noida. According to Knight Frank, from around 3.7 million square feet right now, the mall space will add up to around 23.2 million square feet by end-2007.

Based on the numbers just cited, that means Delhi and its surrounding regions will have to spend around Rs 24,360 crore in buying goods sold in shopping malls two years from now. Assuming that as many as half of NCR-ites (that’s 1.5 million families) go shopping in malls in 2007, and that’s a huge assumption, it means the average family will spend around Rs 160,000 in a mall.

Now you need to look at what today’s shopping malls really provide that families can spend on. Today, data from the National Accounts show, families spend around 48 per cent of their monthly expenditure (after removing around 25-30 per cent or more for savings and taxes) on food and beverages and fruits and vegetables—this, at least right now, is something that malls hardly cater for, and cannot in future either if rentals remain what they are today.

Another 11 per cent or so gets spent on rents and electricity, again something that can’t be spent in a mall; around 8 per cent is spent on medical care and health, 3 per cent on education, 13 per cent on transport and communication, and so on. In other words, in their current formats, malls are just trying to cater for items which account for 10-15 per cent of all household post-savings and post-tax expenditure, maybe even 20 per cent in the case of slightly well-heeled families.

Let’s assume, to keep the story simple, that all such expenditure will be done in malls, that is, no one in the NCR will buy any furniture in inexpensive Panchkuian Road or clothing in Sarojini Nagar market in Delhi in the year 2007. Even then, if 1.5 million families in the NCR are to spend Rs 160,000 in 2007 at malls, this means their income will have to be in the region of Rs 8-10 lakh or thereabouts.

Well, according to the projections made by the National Council of Applied Economic Research (NCAER), Delhi had just 2.2 lakh such families in 2001-02, and even if you apply very generous growth assumptions, Delhi and the rest of the NCR cannot have more than 6-7 lakh households with such an income by 2007, a figure that’s roughly half what is required for the malls and their occupants to break even.

Indeed, even today, big malls in Gurgaon, such as the DLF Mega Mall, have huge spaces that are still not occupied (others in the region are delaying opening due to the paucity of tenants) more than 18 months after opening and the number of shoppers there is also pretty low.

A similar logic of a huge potential demand-supply mismatch applies to Mumbai and other areas where the pace of mall development is expected to be as brisk as is being made out. If the malls, which are the biggest driving force behind high property prices, are unlikely to achieve the projected potential, it is difficult to see how the realty market isn’t headed for a major correction.