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20 JUN 2018

Demonetisation & its impact on black money in real estate

In November, 2016, the Government announced demonetisation of high value currency notes of Rs 500 and Rs 1000, which eliminated 86% of currency in circulation. This had widespread repercussions on the real estate sector.

The Economic Survey of 2017 said the impact of demonetisation on real estate could be seen from reduced property prices. The survey said, “Property prices fell due to cash crunch following demonetisation and could decline further as investing undeclared income in real estate becomes more difficult. Prices declined, as wealth fell while cash shortages impeded transactions. Prices could fall further as investing undeclared income in real estate becomes more difficult”.  The Survey said tax evasion would diminish with curbs on unaccounted wealth and financial transactions would increasingly take place through electronic means.

While the Economic Survey 2017, believes that demonetisation had a positive impact on the real estate sector, it is not clear to what extent this exercise flushed out black money from the sector. Indian real estate sector is a significant repository of unaccounted money, usually by way of property purchased in ‘benami’ form in cash. ‘Benami’ is a transaction, where the person who pays for the property does not buy it under his/her own name. A key purpose of demonetisation was to eliminate such unaccounted cash changing hands during real estate transactions. This however had both positive and negative consequences.

In the immediate aftermath of demonetisation, there was a severe cash crunch in the economy. Residential real estate was hit hard, both in terms of new project launches and home sales. The impact was felt more so in the secondary or resale market, which has a high cash component in transactions. Primary market performed relatively better since it mostly caters to end users, who typically buy property through home loans from banks or financial institutions. While sales in this segment did decline in the months following demonetisation, the market has recovered.

Almost two years after demonetisation, home sales are showing signs of recovery. Demand for homes is however skewed towards affordable housing. This is probably because affordable housing segment has a low cash component in comparison to high end segment. Developers have been quick to capitalise on this demand by launching projects in the mid income segment.

In many ways, demonetisation changed the way real estate business is traditionally done. Developers now prefer joint venture projects over outright purchase of land, because they now have less liquidity. Real estate is a capital intensive sector and demonetisation worsened cash crunch of developers. This was more so for developers in the National Capital Region and Mumbai markets, which saw home sales dive after demonetisation because both these markets are investor-driven. Developers from South India fared relatively better than their peers in NCR and Mumbai markets. The end effect of demonetisation is that developers now prefer to invest less capital in projects. The advantage of joint ventures is developers with limited capital can develop multiple projects at the same time.

From a home buyer’s point of view, the positive effect of demonetisation is a fall in home prices. Speculative investors, who bought property and flipped it over for a profit in the short-term, exited the market, because of the overall shortage of cash. This put an end to speculative pricing, which was pushing home prices up.

Post-demonetisation the real estate sector saw a drop in prices by up to 5%-10%, according to data shared by the housing and urban affairs ministry. Real estate developers also offered freebies to lure home buyers, which brought the overall cost of homes down. Residential market is now predominantly driven by genuine buyers with less of speculative purchases. Demonetisation exercise however had no impact on land prices, which are expected to remain the same.

Home loan rates have also dropped, which has lowered Equated Monthly Instalment (EMI) for home buyers. Rates are now at a decade low in the range of 8.35%-8.5%. Lower interest rate, means lower EMIs, which increases the budget of home buyers.

It is a known fact that globally the property sector is used as a conduit to legitimise or “clean” the proceeds of illegally obtained funds. This holds true for India as well. The Modi government has made its intention abundantly clear. It wants to go after such illegal financial activity through measures such as demonetisation and Benami Transaction (Prohibition) Act. While it is difficult to quantify the impact of demonetisation on black money transactions in the real estate sector, there can be no denying that demonetisation has institutionalised the real estate sector and made cash transactions difficult.

The biggest positive effect of demonetisation is a cleaning up of the sector. Real estate sector is expected to become more transparent with more sales happening through banking channels. Demonetisation along with other reforms - Real Estate (Regulation and Development) Act and Goods and Services Tax (GST), will help in bringing in transparency and efficiency in real estate. While reforms can make a big difference, the sector should also look at adopting global ethical practices to tackle black money and reduce instances of corruption.

As a professional body, which stands for ethics and standards in the built environment space, RICS, is consulting on a new professional statement designed to help property professionals address the risks posed by bribery and corruption, money laundering and terrorist financing. The statement will provide professionals with a clear description of how to manage such risks. Adoption of ethical practices will increase transparency in the sector. It will align the industry with global standards and put it at par with developed markets.

Ashwani Awasthi is Chief Operating Officer, RICS South Asia