Reorienting real estate
THERE is a memorable image in the aspirational Bollywood hit from last year Gully Boy where the protagonist Murad scribbles graffiti on a wall ‘Roti, Kapda Aur Makaan’. It was a fitting reference to the enduring slogan of Manoj Kumar’s 1974 classic, that dissected middle class struggles of a supposedly bygone age. Fitting especially for the continuing struggle with Makaan – most relevant for Murad who is from Dharavi, the infamous million-person slum with a population density of over 2.7 lakh people per square kilometre. Shelter may have been considered a basic need since more than five decades ago, but Indian cities still seem terrible at providing it.
The most extreme manifestation of this supply shortage is in Mumbai, where its residents live in less than 31 square feet per person of built-up living space on average.1 Just to put that in context, the Maharashtra Prison Buildings and Sanitary Arrangements Rules (1964) require a minimum of 40 square feet of ground space per inmate in state prisons.
The acute lack of affordable shelter in cities goes far beyond Mumbai. Twenty-three per cent of all urban households in India are estimated to be facing a housing shortage, 95% of which are among either the Economically Weaker Sections (EWS) or Lower-Income Groups (LIG).2 Almost one in five urban households lives in a slum,3 half a million households are homeless, with an additional one million living in kaccha and another 2.3 million in ‘obsolescent’ houses.4
There is a total housing shortfall of nearly 19 million homes in Indian cities.5 This shortage is also reflected in the high price-to-income ratios for housing in Indian cities relative to cities across the world.6 So despite repeated attempts at closing the affordable housing gap since the first five-year plan, why does this goal remain elusive? The explanation, as it usually does in India, may lie in the role of the state in housing markets.
The problem begins with how our policymakers continue to approach urban planning. The paradigm of city planning in India is almost universally considered to be Chandigarh: wide avenues, large green parks and little traffic, but ultimately a taxpayer-funded bureaucrat retirement home, without any of the usual urban squalor. Chandigarh was famously designed by French architect Le Corbusier in the 1950s on Nehru’s request. James Scott, in his must-read Seeing Like a State, described the ‘high-modernism’ ideology of Le Corbusier as the following:7
‘High modernism implies […] a rejection of the past as a model to improve upon and a desire to make a completely fresh start. The more utopian the high modernism, the more thoroughgoing its implied critique of the existing society. Some of the most vituperative prose of The Radiant City was directed at the misery, confusion, "rot", "decay", "scum", and "refuse" of the cities that Le Corbusier wanted to transcend. The slums he showed in pictures were labelled "shabby" or, in the case of the French capital, "history, historic and tubercular Paris". He deplored both the conditions of the slums and the people they had created. "How many of those five million [those who came from the countryside to make their fortune] are simply a dead weight on the city, an obstacle, a black clot of misery, of failure, of human garbage?"’
The ideology of Le Corbusier, fit for purpose in many ways during those heady days of post-colonial individual expression, continues to echo with bureaucrats, zealous politicians and elites in cities across the country. That is a belief in a top-down order emerging directly out of a brilliant master plan designed by technocrats. This belief sees the city as an independent island to preserve from unplanned chaos.
As a result of this exclusionary mindset, India’s urban policymakers have sought to limit population densities in cities through strict rules on new buildings. Indian metros continue to have some of the most restrictive land-use regulations for cities around the world. Rules around Floor Space Index (FSI) are the most widely discussed – Mumbai infamously still maintains a basic free FSI of 1.33,8 contrasted with cities such as Singapore (25), Tokyo (20) and New York (15).9 Delhi (3.5), Bangalore (4) and Chennai (2.5) are not too further ahead.10
But beyond just the tight limits on FSI, at blame are also a slew of other zoning rules – for instance, Delhi has a height restriction of 15 meters (approximately four floors) in most of the city.11 Such an inexplicably low maximum height for buildings in the capital has led to a flat built-up structure that sprawls far and wide into the satellite cities of Gurgaon and Noida. Residents commute longer, often in private vehicles, leading to dire environmental outcomes (including contributing to the capital’s winter smog crisis every year). By some estimates, the Delhi NCR region might become the most populated metropolitan area by 2028. Yet, one would need to look way past the smog to be able to find a tall apartment skyscraper within Delhi, disallowed by the master plan in most core areas of the city.
Even within Chandigarh, housing has become so limited and inaccessible that Mohali developed outside the city jurisdiction where the grand master plan does not apply. The only affordable housing to be found in the broader Chandigarh metropolitan area is outside of its municipal boundary. As satellite imagery over the last four decades has shown, most of the urban growth in other Indian metropolitan areas has been concentrated in areas outside formal municipal boundaries as well (such as Gurgaon or Noida in the case of Delhi).12
There is a similar high-handed obsession in cities with constituting a slew of restrictive and gratuitous building rules to regulate the types of construction permitted. These rules often include highly unfair requirements such as those mandating minimum parking for cars to be built in buildings. Due to the failure of urban local bodies to muster the political will and regulate private vehicles on the road, they have taken the easy way out by simply mandating requirements for buildings to do so.13 Unfortunately, such regressive mandates only pass the costs of constructing parking in the building to all residents, effectively subsidizing car owners at the expense of those who rely on public transit. Which then further promotes car ownership and hurts housing affordability at the same time. India’s cities take these requirements even further to the extreme – Delhi now requires two parking slots per 100 sq m of floor area and Mumbai 2.07, contrasted with London (1.43), New York (0.4) and Tokyo (0.2).14
Rules to limit building density are not the perfect pill to limit population density. People have a constitutional right to move, and as long as a significant wage advantage remains in cities, they will continue to do so. With such strict limits to new construction, they just crowd into smaller spaces, informal settlements with poor sanitation or commute for hours from the outskirts. What these exclusionary policies do is raise the cost of formal housing space for everyone. Mumbai, which offers a path to social mobility unlike anywhere else in the rural hinterland, now has one of the highest price-to-income ratios for housing across global cities.15
Real estate has historically been viewed as a den of corruption, where the evil nexus of rich developers, powerful politicians and dangerous criminals conspire to make shady deals and cheat the common man. Everyone can agree to hate on builders in India. In effect, the uncertainties associated with project completion have now made the construction of physical infrastructure as the sector with one of the highest risk-adjusted costs of capital.16 And the building and transaction of real estate have become the golden goose for political parties and governments alike.
The permit system for construction in Indian metros has been notoriously complex and costly when compared to other countries. Studies have documented the labyrinthine approvals process required for building housing from local, state and central authorities, which can often take 2-3 years after land acquisition.17 Moreover, the uncertainty associated with the process, especially since it relies on multiple agencies at different levels, can create holdout problems where an individual department can threaten to block an entire project and extract higher rents. According to the World Bank’s Enterprise Surveys, 38.6% of Indian firms reported having to give ‘gifts’ to officials to obtain construction permits.18 It is this regulatory cover that allows electoral finance to rely substantially on builders in return for promises for fast-tracking approvals for construction.19
Capacity-constrained Urban Local Bodies have similarly identified charging for new construction to bolster strained city finances. The Municipal Corporation of Greater Mumbai (MCGM) instead of increasing the free FSI available for everyone, now has strong incentives to maintain the artificial scarcity and instead charge builders high fees to auction fungible FSI or Transferable Development Rights in the city.20 Due to the high demand and resulting inflated prices, the only bidders for this premium FSI usually end up being high-end residential or commercial projects instead of the broad-based affordable housing development needed in the city. From the perspective of the municipal governments, this channel of raising financing is far easier politically and administratively than the traditional route of property taxes and user fees.
However, just because the costs are abstracted away does not make it better policy. The literature on urban political economy and finance from around the world has repeatedly highlighted the need for progressive systems of property tax collections, user charges and betterment levies as the primary instruments of municipal finance. A vicious cycle has now set in, exacerbated by our municipal administration model – where the chief executive of the city is the Municipal Commissioner, a lifelong bureaucrat appointed by the state government for a fixed tenure of usually a couple of years rather than a directly elected Mayor with political accountability to the city’s residents. As a result, there is further perpetuation of the tight restrictions on new development which hurts the availability of affordable living and working spaces.
In addition to the direct costs, the uncertainty and the time delays further increase the (risk-adjusted) cost of capital of housing construction projects. They also raise the barriers to entry for smaller builders to participate in the market, thereby limiting competitive pricing. All these costs get passed on to either home buyers or onto those priced out of the formal housing markets due to the unavailability of an adequate supply of affordable housing.
In such a low-level equilibrium of public policy, even a much-touted reform such as the Real Estate Regulation and Development Act 2016 (RERA) – by itself can be insufficient to bring the sector above the threshold towards socially desirable outcomes. RERA mandates penalties on builders for delays in completion of projects but does not put any onus on local authorities to ensure files get moved on time and projects don’t get held up for obscure clearances or bureaucratic wrangling across multiple agencies. And since RERA increases the costs of regulatory non-compliance, barriers to entry for smaller developers go up further, especially during a time when the economy is slowing down with a severe credit crunch.
In the absence of other reforms to democratize the supply of greater built-up space across the value chain, RERA may end up having the perverse effect of reducing competition rather than increasing it, especially in the near term.21 Indeed RERA has been heralded by the prominent voices of the real estate sector, as those usually represent the largest, most influential builders whose dominant market position this act may further embolden.
Public Finance 101 prescribes taxing the appreciation in values of assets rather than transactions, both from an equity and efficiency angle. Indian states do the opposite in real estate – they require high rates of stamp duties and registration fees on property transactions, at levels substantially higher than in other countries. For instance, in urban Maharashtra, the stamp duty rate is 5%, and in Punjab, it is 9%. By contrast, stamp duty in China is 0.05%, in Spain it is between 0.5% and 2%, while in New Zealand stamp duties are entirely abolished.22 States have come to rely substantially on these property registration taxes as sources of revenue, something that even a requirement (albeit optional) by the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) to cap stamp duties to 5% could not change through the course of the scheme.
According to the World Bank’s Ease of Doing Business 2020 Report, the cost of registering a property in Delhi is 8.1% of the value of the property, and in Mumbai, it is 7.4%. India ranks 154 out of 190 countries in the survey in terms of ease of ‘Registering Property’. Such high rates either limit transaction frequency or discourage buyers from declaring the real value of the property while reporting a transaction. The substantial ‘black’ money component of property transactions continues to be a common occurrence across the country, even in the age of ‘digital India’.
According to a study by HDFC, the market prices of houses in Mumbai were 61% higher than their guidance values on average.23 This under-reporting of property values further hinders property tax collections by the municipalities and hurts the prospects of municipal finance to be driven by taxes on value appreciation of real estate over time. It is well known that India relies too little on property tax revenues for public finance (0.2% of GDP overall vs 3-4% in the US and Canada). There is a significant question of equity here since public infrastructure investments disproportionately benefit owners of property in the core urban regions.
Foreign Direct Investment for real estate effectively got liberalized in 2005 by the Department of Industrial Policy and Promotion (DIPP) under the Ministry of Commerce and Industry, permitting ‘FDI up to 100% under the automatic route in townships, housing, built-up infrastructure and construction-development projects.’24 Foreign capital began flowing into real estate generously, reaching a peak of $3.14 billion in 2011-12. Domestic capital followed, and developers borrowed heavily to build multiple large projects across the country. The FDI rules required a minimum built-up area of 50,000 square meters for each project to be allowed.
Since constraints to land acquisition and development continued to remain high in the core regions of most large cities, a lot of this new construction, often claiming to be ‘affordable housing’ ended up locating in the urban peripheries. In some cases, this went too far: luxury projects started in the middle of nowhere with nothing but a highway nearby and empty fields. Inevitably, a substantial number of these homes remained unsold and eventually even the most reputable builders in the country ended up with failed projects.
There was top-down pressure from the government to encourage affordable housing, the banks wanted to finance it, and the builders had enough cash to build. But no one wanted to admit that affordability was conveniently defined in the absence of that most critical ingredient in real estate: location. An apartment in the middle of the Mumbai-Pune expressway cannot be considered affordable just because it is clubbed with prices of similar apartments in Andheri. No buyer makes a calculus of affordability independent of accessibility to employers, community or urban amenities.
Similar trends occurred in the peripheries of NCR, Pune, Kolkata and other major cities.25 High-end apartments in the middle of nowhere, where the cost of land was much lower, simply had no market. Indeed, current data shows how unsold housing inventory is mostly concentrated on the high end of the housing price distribution, and spatially located on the outskirts of metros.
These failed real estate projects soon manifested on the books of banks and NBFCs as Non-Performing Assets (NPAs). Even though NBFCs increasingly financed more projects directly over time, they were in turn funded by the banks, so the latter indirectly ended up stuck with these NPAs as well. As of 2018-19, banks and NBFCs had around Rs 5 lakh crore loans outstanding to the real estate sector.26 We are now facing both a severe economic as well as a banking crisis, with more pain for real estate developers yet to come, which would then further strain bank balance sheets.
Real estate bubbles occasionally occur in other parts of the world, most notably in the US in 2008. But for India, the lesson going forward is that the constraint towards greater supply of affordable housing is not the availability of capital as much as the regulatory barriers to acquiring land and building on it in the parts of the country where the jobs are. Thus, recent developments in real estate project financing such as Real Estate Investment Trusts (REITs) are no cure for the affordable housing crisis. While the availability of REITs may help investors by opening a new channel of investing in the real estate asset class, the net effect on the residential real estate, especially in the short-to-medium term, may be negligible.
Given the vast chasm that exists in rental yields between commercial and residential real estate – 6-10% vs 1.5-3% – REITs are expected to be concentrated primarily on large commercial projects (such as the Embassy Office Park REIT – the first one in the country). Residential projects, especially in the primary urban markets, will simply not be able to generate enough recurring cash flow to serve as an attractive investment medium-term investment for retail investors. And affordable residential projects will hardly be affected.
Seventy per cent of new employment in India is generated in cities.27 Cities are the lynchpin of the Indian economy, more so perhaps than even in other countries, as well as the primary source of financing public services for everyone. Mumbai pays a third of all direct taxes collected by the central government. The wage premium for workers in urban vs rural areas is higher in India (122%) than it is in the US (30%) or China (45%).28 The moral imperative for planners is to ensure equal access to these opportunities through adequate, affordable shelter in cities.
According to the McKinsey Global Institute, between 700-900 million square metres of residential and commercial space needs to be built in India every year to keep pace with population growth and urbanization; this is equivalent to building a new Chicago every year.29 As decades of housing programmes have shown, the Indian government simply does not possess the state capacity to construct and deliver housing at this scale, and certainly not without significant leakages. In any case, it should focus on providing essential public infrastructure such as sanitation, clean water and public transit that only the state can build. Instead, the approach of urban policy has been to keep people out and make building new housing costly.
From a longer-term social development perspective, constraints on new housing supply also pose a concern for equity and intergenerational social mobility. Without a vibrant property market, those who end up inheriting land in prime urban centres benefit disproportionately from its appreciation as public resources are spent on upgrading infrastructure – a socialized loss for private gains.
India’s urbanization is much more skewed towards the largest metros than in countries such as the US and China.30 The stark effects of these insecure tenures, crowding and uninhabitable living conditions are coming sharply into relief for the broader public as the coronavirus pandemic threatens dense urban clusters. The recent jarring images of migrants walking home hundreds of kilometres from Delhi or crowding at the railway stations in Mumbai is a consequence of this dependence on our largest metros for the few (relatively) well-paying jobs that are available for the millions of youth coming onto the labour force every year. Due to the absence of a distributed, broad-based industrial growth model, secondary cities continue to remain limited in their employment-generation potential. It is time that the state stops viewing the real estate business primarily as a source of rent extraction, and instead as a means to build adequate housing where it is needed most.
1. A. Bertaud, ‘Mumbai FSI Conundrum: The Perfect Storm; The Four Factors Restricting the Construction of New Floor Space in Mumbai’, January 2004.
2. Technical Group on Urban Housing Shortage, 2012. The McKinsey Global Institute separately estimated that 28 million households were living in ‘substandard’ housing in 2014 (McKinsey Global Institute, 2014) and The World Bank (2013) reported that the housing shortage in urban India was 24.7 million in 2007.
3. 13.8 million households or 17% of all urban households lived in slums (Census, 2011). This number is likely higher in reality as the Census only counts ‘Identified Slums’, and that too only in Statutory towns and not Census towns.
4. Technical Group on Urban Housing Shortage, 2012.
6. IDFC Institute, ‘India Infrastructure Report 2018: Making Housing Affordable’, 2018. http://www.idfcinstitute.org/projects/transitions/india-development-report/
7. J.C. Scott, Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed. Yale University Press, New Haven, 1999.
8. 1.33 is the maximum free ‘basic’ FSI. In Mumbai, Fungible FSI and Additional FAR can be purchased to build higher to an extent, but at a high cost.
9. IDFC Institute, 2018.
12. See http://www.idfcinstitute.org/Web-map/IndiaMap.html.
13. K. Batra and R. Shridhar, ‘The Burden of Free Parking on our Cities’, Livemint, 12 January 2018. https://www.livemint.com/Opinion/8S9LnrOPWGOcvid6gzD74I/The-burden-of-free-parking-on-our-cities.html
14. IDFC Institute, 2018.
15. Ibid. Studies have found that land-use regulations were responsible for raising housing prices in Mumbai by at least 15-20% of median household income, and in Bangalore by 5-6% of median household income (Buckley and Kalarickal, 2006).
16. Reserve Bank of India, ‘Affordable Housing in India’, RBI Bulletin, January 2018.
17. IDFC Institute, 2018.
18. Higher than the global average (20.8%) and the average for all South Asian countries (30.9%). https://www.enterprisesurveys. org/en/data/exploreeconomies/2014/india# corruption
19. D. Kapur and M. Vaishnav, ‘Quid Pro Quo: Builders, Politicians, and Election Finance in India.’ Center for Global Development, 2011.
20. V.K. Phatak, ‘Land Based Fiscal Tools and Practices for Generating Additional Financial Resources.’ 30 August 2013. https://smartnet.niua.org/sites/default/files/resources/Final-Report-LBFT_28Aug2014%20% 281%29.pdf
21. K. Batra and R. Shridhar, ‘Will RERA Embolden Powerful Builders?’ Livemint, 18 September 2017. https://www.livemint.com/Opinion/ARG5EDR3Ow6VD45FDi7ooL/Will-Rera-embolden-powerful-builders.html
22. World Bank, Ease of Doing Business Report 2020.
23. HDFC Securities Institutional Research, ‘Real Estate: New Mumbai DP 2034’, February 2015.
24. Press Note 2 (2005). DIPP.
25. It is worth noting that Hyderabad was somewhat of an exception as it had more liberal land-use regulations and better infrastructure, and thus saw greater availability of affordable housing within the city.
26. A. Subramanian and J. Felman, ‘India’s Great Slowdown: What Happened? What’s the Way Out?’ Harvard Kennedy School, CID Faculty Working Paper No. 370, December 2019. https://www.hks.harvard.edu/centers/cid/publications/faculty-working-papers/india-great-slowdown (Accessed on 5 June 2020).
27. McKinsey Global Institute, ‘India’s Urban Awakening: Building Inclusive Cities, Sustaining Economic Growth’. McKinsey and Company, 2010.
30. J.P. Chauvin, E.L. Glaeser, Y. Ma, and K. Tobio, ‘What is Different About Urbanisation in Rich and Poor Countries? Cities in Brazil, China, India and the United States’, Journal of Urban Economics 98, 2017, pp. 17-49.