The Everyone Wins Indian Lottery

I was once offered a million dollar lottery for a thousand dollars with an assured prize of at least hundred thousand dollars. Great odds. When things are too good to be true, they almost always are. The lottery fine print stipulated a payout of a dollar a year for a hundred thousand years. However lame this joke may be, there is a real lottery joke being played in the Indian real estate market and the end result may not be funny for many who fall for it.

image credit:
http://www.zerohedge.com/contributed/2013-08-15/housing-bubble-bungle

A wealth manager who hasn't done much in years to make any wealth for me (maybe for himself - yes) called me to say he had a great wealth creating idea that would yield a 100% IRR in less than 18 months. I am always a sucker for such great ideas. Intrigued, I asked him to tell me more.

He said that there was a real estate project in an up coming area of a growth city in India being developed by a very reputed developer, and that there were just a few apartments left for sale, being made available at exclusive and below than market rates to exclusive buyers like me. Wow! I did not know I still qualified for that title. I asked him why the favour and his response was that the developer was not interested in tapping the local market and were looking at gentry from out of town as the development would be marketed to upmarket transient communities (meaning foreigners domestic and international). He explained the growth dynamics of the place and why it would make a great rental market in the future. Okay, I bought all he said, but did not understand how I would fund the Rs. 6 million apartment and get a 100% IRR at least in the next 18 months.

He look surprised at how ignorant I was on the way the financial markets worked. "Just pay 5% of the 6 million now and the stamp duty and registration charges. At the end of 18 months, pay just 15%, and that too if you wish to keep the apartment. If you sell on completion which will happen in 12 months, your IRR on cash flow can be as high as 500%, and if you cannot sell, then the builder will take it off your hands by giving you a 100% return on the 20% you invested. Mind well the developer will service the interest on the 80% borrowing until completion or 18 months whichever comes later" he said with a grin that would have done a Cheshire cat proud.

I asked if the entire arrangement would be documented and was told that the buy back could only be covered by a comfort letter from the honourable developer.

I told him to give me a couple of days to think about it. I did it and thought that the risk reward situation may be worth it and decided to meet the developer. At that meeting, I was told that there were only 2 apartments left at the Rs 6 million price point and maybe I should look at the larger and better Rs 8 million apartment that would be completed in 24 to 30 months as they were yet to break ground. I told the developer that I may not be eligible for the higher quantum loan based on current commitments. I was told not to worry and that it had a tie up with a NBFC (Non Banking Financial Corporation) that would fund me. I once again went into think mode.

I called up a few friends in the City and asked them about the project. "Don't even think of that area for now. No water, no infrastructure, its a development in the middle of the corn field, and the construction is not the greatest." I was told. Now I understood why the same was not making the local rounds. But, the market would surely change after 24 months, I felt. I did my math and realized that in the event I was unable to sell myself or the builder failed to keep his commitment (which was quite likely) then I would be left with an asset that would not return more than a 3% yield on my buying price. There was a very low probability of a 100%+ IRR and more a chance of me being stuck with a lemon that no actual user may want. I laid these arguments with the wealth manager who had slipped into a RE broker avatar realized that his commission was slipping away fast.

Right or wrong decision; I don't know. But I do know that the developer was playing with what was potentially my balance sheet and my asset as collateral to secure a cheap retail housing loan for himself which for all practical purposes was my liability as well. Servicing interest of 10% on a housing loan is certainly much cheaper than servicing a 24%+ interest on a commercial paper secured by direct collateral and personal guarantees. I also see that the morning newspaper is full of such schemes from cheap to expensive and exclusive houses that make people believe that all investors will win the real estate lottery based on the potential good days for the Indian economy.

image credit:
http://amazingstuff.co.uk/other-amazing-stuff/flying-balloon-house/#.VeGnySWqqko

All I can see through such schemes is that the development community is hurting across the board, and this is one more technique of trying to market goods at unrealistic rates to gullible investors looking for returns rather than real buyers. Sooner rather than later, irrespective of the way the Indian economy moves, the RE market will crash and will burn scores of well meaning middle class investors like those burned in the Chinese stock market crash. I don't have to say it but a lottery works on the principle of a few winners and many losers. Question is which side of the equation do you think you will end up should you decide to subscribe to the Great Indian Real Estate Lottery?