Vijay Kumar Gaba

Friday, November 25, 2016

Good times for realty market around the corner

Thought for the day

"Gardening is not a rational act."

—Margaret Atwood (Canadian, 1939)

Word for the day

Savoir-faire (n)

Knowledge of just what to do in any situation; tact.

Malice towards none

PM Modi has played the trump card, which AK played in last Delhi election - "Anyone who does not support me is corrupt!"

If this card works - expect 280-290 seats for BJP in forthcoming UP elections, and a majority in Goa and Uttrakhand.

Punjab is tough and Manipur unpredictable.

First random thought this morning

The move to abolish the extant currency notes has seemingly brought the opposition parties together for the time being. However, it appears more as a floor management strategy than a political game plan.

Imputing any larger motive to this or expecting any substantial outcome from this may be political naiveté.

Except for few jokers, most of the opposition leaders have seen the Emergency in 1975 and the subsequent events. They know very well that two and a half year period (to the 2019 elections) is too long a period in politics. A majority of the voters would not remember the hardship they suffered due to this move.

Good times for realty market around the corner

Commenting on my yesterday's post (see here) Many readers have highlighted that one major source of land for real estate development is the surplus land with the civic administration. The civic agencies sell these land parcels to users or developers at a relatively lower rate, who in turn are able to sell these at the market determined rates, accepting the "gain" part of the compensation in cash. This cash adds to the stock of black money in the system and perpetuates the cash element in the real estate dealings.

In my view, this was true till a few years ago. Now a days, most of the sale by civic authorities, except housing for economically weaker section, is at near market price; and the sale is also through a mostly transparent process of computerized draw or auction. In Delhi, for example, many flats offered by DDA have remained unsold vs. 100x demand two decade back. Many commercial sites sold by DDA in past decade have also remained unviable for the buyers.

Now coming back to the main topic - I firmly believe that the expectations of a major correction in real estate prices in short term may not come true. To the contrary, after a short period of subdued activity, we may actually see prices firming up.

Top five reasons for my positive view on real estate are as follows:

(a) The real estate prices have been correcting in most micro markets since past 5years. In many markets, like NCR, Punjab, Haryana, UP, Gujarat, Rajasthan, West Bengal, MP, Punjab, etc. the prices have seen material correction. In many other markets, we have witnessed time correction. The commercial real estate prices have reacted fast to the interest rate cycle and have already started to firm up in past few quarters. The housing demand may have bottomed out. With rise in affordability, lower rates, and better tax incentives, this segment may also see better days soon.

(b) In many micro markets, the current market prices are not very far away from the cost of construction and government prescribed floor rates (circle rate or stamp duty rates). The scope for prices to fall further therefore is limited. The cost may actually rise in the short term.

(c) The stress in real estate market in past few years, new regulatory regime, new land acquisition laws and now currency abolition has ensured that the smaller, unorganized, inefficient developers go out of the market and the markets get consolidated with 4-5 large player in each micro market. This consolidation will bring the pricing power back to developers.

(d) More money in bank accounts, and better tax compliance will enable lot many more people for bank credit and demand for residential and commercial estate shall begin to firm up.

(e) There could be supply constraints in short term as the holders may be reluctant to sell for various reasons.

Thursday, November 24, 2016

Cash and Real Estate

Thought for the day

"Heroes need monsters to establish their heroic credentials. You need something scary to overcome."

—Margaret Atwood (Canadian, 1939)

Word for the day

Duende (n)

Charm; magnetism.

A goblin; demon; spirit.

Malice towards none

Who has created this illusion that the government has demonetize 86% of Indian currency?

The current effort is just an exercise to replace the old high denomination notes (HDNs) with the new HDNs.

The assumption that some of the existing HDNs may not be presented for replacement is just that - an ASSUMPTION.

First random thought this morning

Till May 2014 many termed PM Modi as divine intervention that will cure India of all its ills. The detractors termed him as Taliban, who will destroy the core fabric of the Indian society by communalizing it.

Both the extreme views have proven to be mostly wrong.

The history is repeating itself with Donald Trump.

Will history repeat again with Donald Trump?

Cash and Real Estate

Continuing from tomorrow (see here), I would like to share my understanding of the real estate market dynamics in India with the readers. Admittedly, my views do suffer from limited knowledge of the real estate markets, as I know about the practices only in 10 states. I assume the practices are similar in most states.

To estimate the impact of the abolition of old high denomination notes on real estate market in the country, it is important to understand the role of cash in the market dynamics.

· A large part of the land parcels for development of real estate projects, originate from the farmers or sick industrial units that have closed operations. In recent times, the government has also announced release of land parcels owned by CPSEs etc. for redevelopment.

In case of farmers, there is no capital gains tax on sale of agriculture land, hence no tax motivation to receive payment in cash. The farmers receive cash in consideration of land sale either out of habit of dealing in cash, or buyer willing to pay little extra so that he could save on stamp duty and registration fee etc. In some cases buyers are willing to pay little extra as they do not have sufficient white (accounted and legal) money to pay as consideration.

However, in case of sick industrial units, great motivation to receive cash is present due to (a) first right of lenders on any sale consideration received; (b) huge tax liability on capital gains; (c) unwillingness of promoters to share the sales consideration with minority shareholders; (d) corruption of the nominees of financial institutions on the board of such companies.

In case of redevelopment of government/CPSE properties, the role of cash is mostly limited to the corruption in the award of contracts.

· It is not necessary that the involvement of cash always leads to inflated value of the underlying deal. In many cases cash involvement leads to both parties agreeing to lower sales consideration as they save on taxes and duties.

· In many cases, the buyer has to convert his white money into black, as the buyer insist that a part of the sales consideration be paid in black money. In a large number of cases, buyers are black & white agnostic.

· The stock of black money perpetuates the role of cash in real estate deals as the seller insists on cash because he has to pay cash in the subsequent deal he is negotiating.

· The smaller developers accept cash from buyers, as they sell cheaper and try to save cost by saving on VAT, Service Tax, etc. payable on the construction material and construction related services

· The sources of cash that is used in the real estate deals are primarily (a) bribes received by public officials; (b) money earned through illegal means like smuggling, drugs, ransom, extortion; (c) tax evasion by not accounting the full revenue or accounting fake expenses...to continue

Wednesday, November 23, 2016

Cash is colorless, it takes color of the hand that is holding it

Thought for the day

"In the spring, at the end of the day, you should smell like dirt."

—Margaret Atwood (Canadian, 1939)

Word for the day

Ripsnorter (n)

Something or someone exceedingly strong or violent, e.g., a ripsnorter of a gale.

Malice towards none

From "Har Har Modi" to "Et tu Modi"; from "Great Expectations" to "Great Betrayal"; from "Divine Intervention" to "Ruthless Tuglaq" - the spring to autumn cycle is complete in two and half year.

Where do we go from here?

First random thought this morning

Economic reforms often mean transformational changes that may not necessarily lead to immediate rise in corporate profitability and aid in resource grabbing.

On the other hand these usually do lead to lesser protection, more competition, stricter compliance standards and larger accountability for businesses.

If you do not want to pay taxes, cost of compliance and market linked compensation for exploitation of natural resources and labor, clamoring for economic reforms would not yield much.

Cash is colorless, it takes color of the hand that is holding it

As I mentioned last Friday (see here), I totally disagree with the prognosis that the demonetization of HDNs by the government will severely hurt the real estate sector in the country.

I feel the sector that has been undergoing an overhaul since past few year will get a great impetus from the demonetization drive.

The arguments suggesting a collapse in the real estate market suffer from a multitude of wrong assumptions. For example, it appears to assume that—

(a) The pricing of real estate in India is predominantly a function of "cash component" involved in the deal.

(b) The demand for housing, commercial complexes (malls etc.) and office space is mostly discretionary and could be deferred/suppressed for a considerable period of time.

(d) A large part of the real estate stock is in the hands of financial investors who are all leveraged and stressed.

In my view, these assumption may not be completely fair. Property prices are usually a function of cost of land & construction, affordability (income and saving rate of the target buyer group) rental yields vs. mortgage rates. Black cash is only a top up and deterrent to fair price discovery.

In my view, the latest developments like (a) changes in laws relating to land acquisition; (b) regulation of real estate sector; (c) rising trend in urbanization; (d) rising demand for urban commercial real estate as self-enterprise accelerating; (e) rising growth in organized retailing; (f) need for development of logistic infrastructure (warehousing etc.) to reap the benefits of GST; (g) changes in regulation relating to foreign investment in real estate sector and institutionalization of real estate ownership (through REIT etc.) - are majorly positive for the real estate sector in India.

A significant impetus should be provided to the real estate demand by (a) rising affordability through higher income (e.g., pay commission, rise in minimum wages); (b) falling trajectory of mortgage rates; (c) consolidation of real estate development business through elimination of smaller, inefficient and weaker developers from the market; (d) better town planning under smart city initiative.

All cash component in real estate deals in not black (illegal or unaccounted money). Many a times home buyers are forced to withdraw cash from bank accounts to pay to the seller as seller does not want to pay tax on gains or he needs to pay cash to seller of the property he is buying in lieu of the property he is selling.

In the worst case, assuming 50% average cash component in the deal, it would be 18% higher cost for the buyer (15% tax on 50% cash component @30% and 3% higher stamp duty @6%) and 10% higher tax for the seller (@20%). If both buyer and seller have to share the cost equally, a 5% price correction should be sufficient....to continue

Tuesday, November 22, 2016

Don't underestimate the power of a common man

Thought for the day

"Once you publish a book, it is out of your control. You cannot dictate how people read it."

—Margaret Atwood (Canadian, 1939)

Word for the day

Incipient (adj)

Beginning to exist or appear; in an initial stage, e.g., an incipient cold.

Malice towards none

In twelve days of demonetization drive, the government must have found that it's not all Black & White. There are more than fifty shades of grey in Indian economy!

First random thought this morning

The execution of demonetization process since 8th November, and the rail accident near Kanpur last Sunday have made one thing amply clear - 'Planning' is something we are still not used to. The following five simple steps could have made the demonetization a relatively painless step:

1. Print new notes equivalent to at least 50% of old currency in advance. Double credit limit of all Kisan Credit Cards for three months.

2. Announce demonetization on the night of 28th of October or Nov. Provide enough cash to all bank Branches on 29th with instructions to all employers to withdraw enough cash to pay salaries on 30th in cash.

3. Announce one week holiday for schools. Deploy all teachers, Aadhar enumerators, and Banking Correspondents to go door to door with biometric devices and exchange 2k-4k cash. Each person covering 100 households every day. (Pulse polio volunteers have done this often)

4. Open 24*7 cash exchange counters at all police stations, & other civic offices; besides the facilities at bank branches and ATMs.

5. Engage all market associations for exchanging valid cash of their members with appropriate disclosures and undertakings.

Don't underestimate the power of a common man

Many highly learned fund managers, analysts, strategists, economists, and market observers have commented adversely about the demonetization of HDNs by the government. One famous fund manager has likened it to a running car (Indian economy) crashing into a wall. A very popular strategist with a brokerage house sees FY17 GDP growth rate falling to 3.5%. One popular economists and a regular weekend columnist finds it an exercise in futility. A global analyst of Indian origin finds it unprecedented in annals of global economic history; counterproductive and hence completely undesirable.

I have no issues with none of these experts. But my faith in the adaptability of fellow Indians to the change remains unflinching. I see no chance of trade disruptions due to demonetization lasting beyond 2-3months. There is no denying that the GDP of FY17 could be somewhat impacted. But I do not see any impact of this beyond this.

I would like to cite the following five examples in support of my view:

(a) Till 1994, the stock trading in India was done on the floor of stock 20 odd exchanges. The stock brokers were usually not professionally qualified & trained. OTCEI experiment had mostly failed. The clearing & settlement process of stocks was cumbersome, constricting, unsecured and totally non-transparent. NSE took off as BSE closed for two days due to MS Shoe fiasco. In next 3yrs India was the first country in the world to have 100% electronic trading. All dhotiwalla brokers were well trained in computers. Professionals were inducted as new members by the elite club called BSE. All floor boys (jobbers, market makers, traders, etc.) and many more got better employment.

(b) The doubts were cast on viability of Indian stock markets after trading in dematerialized stocks was introduced in late 1990s. All experts opined that since a majority of stocks are held as black money, no one would want it to be dematerialized and open up for scrutiny. Within 3years India became the first country to have 100% dematerialized trading. Everyone knows the story of capital market growth after that.

(c) With Rs18/min for incoming call in 1995, many wrote the epitaph of Indian mobile telephony industry even before it opened its eyes. Even in 2003, most optimistic investors were estimating two decades for full penetration. People were skeptic how the illiterate villagers will adopt to the technology and English. India achieved near full penetration in no time. I need not say anything further on this.

(d) Alarmed by the air pollution, in 2002 the Supreme Court ordered all public transport vehicles in Delhi to be run on CNG. There was utter chaos. The State Government tried it best to subvert the SC order. Bus, auto and taxi operators struck work. There were maddening queues in front of CNG pumps. But within one year the city was proud to win the US Department of Energy’s first ‘Clean Cities International Partner of the Year’ award in 2003 for ‘‘bold efforts to curb air pollution and support alternative fuel initiatives.’

(e) In 2003, the then home minister L. K Advani announced launch of a pilot project to issue Multi-purpose National Identity Card Project (MNIC) in a few selected sub-districts in various districts of 13 States namely Jammu & Kashmir, Gujarat, Uttranchal, Rajasthan, Uttar Pradesh, Assam, Andhra Pradesh, West Bengal, Tripura, Goa, Tamil Nadu, Pondicherry and Delhi.

Many (including the one economist mentioned at the begining of this post) saw this as a communal agenda aimed against Muslim and illegal Bangladeshi immigrants. The project was promptly abandoned by the UPA government as unfeasible. But six years later in 2009, the UPA government launched the UIDAI, which started issuing Aadhar ID cards in 2011. In less than 5years, over 85% population has an multipurpose ID card that is being efficiently used for opening bank accounts, taking mobile telephone connections, direct transfer of subsidies etc.

All the above five cited developments that sought to change the status quo were seen as financially unviable and causing avoidable inconvenience. The success and benefits are there for everyone to see.

I do not see any reason, why the demonetization shall not result in a revolutionary change in the ways of doing business in India.

One, adoption of electronic payment methods will not only accelerate the efficiency of smaller businesses and trade; it will also enhance security, scalability and their compatibility with larger businesses.

Two, with materially higher money multiplier in place, the economy may get the big push it has been looking for.

Three, everyone had been expecting better compliance standards with implementation of GST. This move may only prepare people in advance for whole hearted adoption of GST.

Four, those ruing the inconvenience to the people may please note that in past 30years, Mamta Banerjee and CPM have organized thousands of Bandhs in West Bengal. These Bandhs caused irreparable loss to the daily wage earners for three decades. The likes of JDU, AAP and Shiv Sena have also caused similar disruptions on many occasions.

Five, insofar as rural economy is concerned, (a) the media reports about rural distress due to demonetization are highly exaggerated; (b) Two years of drought did not impact GDP by more than 50bps. Real estate is down for past three years at least. How come demonetarization will cause 4% dent in the economic growth?

I am actually worried about the worsening global economy. Rising US yields and USD, collapsing CNY and trade are indicating towards a season of deflation - irrespective of Trump, Demonetization or Brexit.

These three in fact, I see as saviors for the global and Indian economy. Amen!

Friday, November 18, 2016

Sir, I beg to differ

Thought for the day

"It is a golden maxim to cultivate the garden for the nose, and the eyes will take care of themselves."

—Robert Louis Stevenson (Scottish, 1850-1894)

Word for the day

Pleonasm (n)

The use of more words than are necessary to express an idea; redundancy, e.g., Free Gift or True Fact.

Malice towards none

Politician hoping that the inconvenience caused to common people by demonetization will reflect in 2019 elections will do better if they recall that people forgot trauma of emergency in less than three years and reelected Mrs. Indira Gandhi with thumping majority.

First random thought this morning

Three key learnings from four hour trip to the town to assess the reaction of common people to the demonetization move:

1. A large number of common people are looking for a sense of purpose in their life. They no longer want to live like insects. This move has certainly stroked that sense in them. Many termed the wait in long queues as their contribution to the nation building.

2. Though most politicians claim to have risen from the lowest ranks in the society - their actions and reactions suggest a total disconnect. The preparation for demonetization suggest that PM and his team are no exceptions.

3. If demonetization is not followed by some tangible welfare schemes to give effect of wealth transfer, politically it may boomerang on BJP.

Sir, I beg to differ

In past one week or so, a number of experts have expressed their views on the effect of demonetization on various sectors and highlighted the opportunities and threats that may emerge out of it.

The consensus certainly seems to suggest that the real estate sector will be hit the hardest. Besides, this move is also expected to the consumption, especially the discretionary consumption, at least over next two quarters. The trade disruption caused by currency shortages could have ripple effect and impact almost every other sector.

On the other hand banks and NBFCs are mostly seen as gainers from the move as the move is expected to lead to transfer a material part of informal sector financial transactions to the formal sector; besides higher use of services like credit card and e-wallets (commonly referred to as 'plastic money'). Though there are concerns that in next couple of quarters the stress in the personal loans and MSME sector credit could rise.

Without getting into the popular views, I may share my subjective views by the readers. As these views are based on my personal assessment of the situation, these may suffer from my socio-economic prejudices and poor knowledge of finance.

I believe that demonetization of HDNs per se brings little change in the financial system. The market disruption is temporary and may not last beyond 2-3months. The ripple effect may also be limited to 4QFY17 and not beyond. Moreover, the effect of disruption would seen mostly in the unorganized sector.

Insofar as consumption demand is concerned, the demand for non-durable and staples could suffer for two months. After all, if I do not drink alcohol today, I usually would not drink double the quantity tomorrow.

The demand for durable goods however may just get deferred to FY18. It is pertinent to note that demand for motor cycle, smart phone, washing machine, water heater, etc. is no longer luxury for a large segment. It is rather becoming a necessity. A rise in tax-compliance will make at least 20mn more people eligible for higher bank credit at a time when rates may be moderating.

I therefore see the opportunity in consumer financing sector becoming even more attractive from structural growth viewpoint. Though the people who are looking for immediate gains may be subject to disappointment.

The largest opportunity I see is in the real estate sector. I mostly disagree with the prognosis that reduction of black money stock in the system will lead to material correction in real estate prices.

I believe that the sector is already going under an overhaul. In the process a large majority of smaller, inefficient and unorganized players are getting eliminated from the business. Demonetization may just accelerate the consolidation process. I see massive consolidation with 4-5 large players remaining relevant in each market....to continue next week

Thursday, November 17, 2016

Mistrust & Unpredictability

Thought for the day

"The Devil, can sometimes do a very gentlemanly thing."

—Robert Louis Stevenson (Scottish, 1850-1894)

Word for the day

Manna (n)

Any sudden or unexpected help, advantage, or aid to success.

Malice towards none

UP government, in contemptuous defiance of the Central Government notification, has declared that they will accept land registration fee in currency that is no longer legal tender.

Does this tantamount to sedition?

First random thought this morning

Many Indians who sounded like ardent devotees of PM Narendra Modi before 2014 Lok Sabha elections, are literally abusing and cursing him. Even some Gujaratis who cheered him at Madison Square in New York, are regretting their enthusiasm.

On the other hand, the world leaders who treated him like a pariah during 2002-2014, are embracing him like no one.

I ask - who was wrong about PM Modi before 2014 and who is wrong now?

Mistrust & Unpredictability

Indubitably, the demonetization of HDNs may go down as a watershed event in the India's economic history; that is even if the experiment fails

Beyond trade disruption and demand deferment for few months, it could bring some lasting changes to the economic behavior of the Indian consumers and businessmen.

This may provide some good opportunities to the investors. Assigning any more importance to this event at this point in time may not be relevant.

As I suggested yesterday (see here), the main challenge in formulating an appropriate investment strategy today is to incorporate the rising "mistrust and unpredictability" in the overall economic environment.

In an environment where the policy direction is totally unpredictable and you cannot trust, amongst other things —

· the commitment of politicians to their ideologies and long stated policy stance on even core issues;

· the experts' opinions about the socio-economic trends;

· corporate governance standards of most reputed companies;

the investment strategy, for a small investor like me, must include the following five doctrine, even if it makes the strategy little dogmatic:

1. The companies with business model that relies heavily on the policy arbitrage are to be totally avoided.

2. The companies that enjoy valuation premium based on the legacy of promoters should be adequately discounted.

3. The discount on the commitment of politicians to a particular ideology or policy stance should be raised to a minimum of 50%.

4. All expert opinions must invariably be backed by self assessment. In cases where self assessment is not possible, equal reliance should be placed on experts' views and traders' positions (fundamental and technical analysis).

5. Let your imagination run wild in making investment assumptions, leaving almost nil scope for a black swan event.

From the recent utterances of PM Modi, PM May, Chancellor Merkel, President designate Donald Trump, etc. it is clear to me that the global trade order is due for a reset. In my view, therefore, overwhelming the investment strategy by demonetization impact may tantamount to missing the forest for trees.

Tomorrow, I shall share the opportunities (and threats) I see due to demonetization.

I promise to share my updated investment strategy before end of this year.

Wednesday, November 16, 2016

Worrisome & encouraging

Thought for the day

"There is only one difference between a long life and a good dinner: that, in the dinner, the sweets come last."

—Robert Louis Stevenson (Scottish, 1850-1894)

Word for the day

Anathema (n)

A person or thing detested or loathed.

A person or thing accursed or consigned to damnation or destruction.

Malice towards none

Pak army claiming causalities and transgression on their sides and India rubbishing the claims with contempt.

The life comes full circle.

First random thought this morning

It is unfortunate that the government has to restore to "Marking" the people who have availed the one time facility of currency exchange.

This highlights the existence of wide trust deficit and continuing game of cat & mice between the establishment and the public.

The worst part - it is again the poor who is being used to further the interest of the non-compliant, to the detriment of the cause of poor in general.

The consolation is that this time the poor have (so far) not played the game with opposition parties which are trying to engineer riots by inciting the poor to advance their vested interests.

Worrisome & encouraging

Mistry, Modi and Trump have hit the Indian equity markets hard. The erosion in equity prices has been swift and material. Inarguably, there is a sense of disbelief and bewilderment amongst market participants.

As an investors I am naturally inclined to look for opportunities in the mayhem; and I already see some investment opportunities emerging. Though I am not too excited as yet. I am preserving some cash (20%) for even better opportunities that may emerge in next month or so.

But before I share my thoughts of the emerging opportunities, I find it pertinent to put the context in, what I believe is the right perspective.

Mistry episode has yet again challenged the faith of investors in the corporate governance standards in the country. After the AV Birla group announced group restructuring a few months back punctured the faith of investors, the Tata feud has widened the whole considerably.

· The corporate governance premium on Tata group companies and others like Infosys et. al. is vanishing fast.

The Army supported by the Narendra Modi led political establishment made first ever and most audacious official admission of the surgical strikes on PoK based terror camps. PM Modi followed the move by demonetization of high denomination notes (HDNs).

· These steps and political utterances after these events have completely demolished the predictability of policy. So much so that the defense minister brought the "no first use" nuclear doctrine under clouds; and tax officials are openly talking about retroactive amendment of penal provisions of IT Act to impose penalty on disproportionate rise in income declaration post demonetization of HDN.

The mostly unexpected victory of Donald Trump, after a surprising Brexit verdict in June this year, should challenge the confidence of policy makers and investors who rely on "experts" to gauge the mood of the public and socio-economic realities on the ground level; besides of course highlighting a perceptible shift in the public opinion.

· The two largely unexpected events have highlighted the widening chasm between the public opinion and the elite group that has been so far considered "opinion maker". The natural outcome of these has to be rising mistrust

The rising unpredictability and mistrust in the social order, and consequentially in the market place is worrisome as well as encouraging.

Worrisome, in the sense that it may deepen the chaos in the socio-economic sphere.

Encouraging in the sense that it will precipitate the corrective action and lead to emergence of a more robust socio-economic order.

...to continue tomorrow.