Price Is A Random Walk

Price Is A Random Walk

The new Nobel Laureates for Economics 2013 just announced; the prize is shared by three American professors, two from Chicago University and one from Yale. They think variously on economic theory and on the co-relationship between Price and Assets, but together, over 50 years, have contributed much to the world’s understanding of how prices of assets behave. This includes stocks and real estate.  The only thing to remember is that time seems to be accelerating and breaking free of its contexts, and what is probably most relevant is the last five  or seven years.

Two out of the three, Chicago University professors Eugene Fama  who distinguishes between unpredictable short term price movements and a more rational long term, and Lars Hansen,  have done extensive work predicting price-asset movements over the long-term, and believe there is a workable pattern that led to much indexing of mutual funds etc.

But the third winner, Robert Schiller from Yale, thinks there is an embedded wild card, that the stock market is no ‘weather’ indicator, and coined the famous term “irrational exuberance”.

 Robert Schiller of Yale thinks Real Estate is amongst the worst possible investments if one is expecting it to turn into a cash cow, with say, importantly this is in the American context, a 10% increase in value every year. He thinks this is illogical, because eventually all property would become unaffordable if this were to happen year on year.  He is obviously not familiar with 20% Indian inflation year on most years!

Schiller also thinks the property price increases, a doubling, between 2000 and 2006 brought on by very low mortgage interest rates are not coming back till the 2030s in the US.

This, as the doubling went down by 35% after the ‘bubble’ burst post 2006, and is now at some 22% down from that all-time high. Schiller thinks that property prices don’t really go up but just keep pace with inflation and here he might well be making the bleakest point in economics.

Schiller thinks property prices in the US are being supported still by low interest rates. He does not think interest rates will rise very much and cannot predict what would happen if they did. He also thinks land in America, with some down-town exceptions, only accounts for some 30% of the price of property, and that new property using new technology in its construction, is favoured over older construction.  He has even devised a Property Index, the Case-Schiller Index put out by S&P and conducts regular polls and surveys on real estate.

Much of this excellent Nobel quality international economic logic does not seem to apply in India. Property prices here keep going up relentlessly despite high interest rates and difficult borrowing terms for loans, both short and long- term. Our land prices are the main thing. We see old houses being knocked down all the time in very expensive prestige locations down town in our Tier One cities to make way for swanky and pricey flats.

The situation eases in the distant suburbs and in the Tier Two and Three cities and towns but the broad principles of Indian real estate apply there as well. And no ‘bubble’ or crash in prices is expected to last because of the pent up demand at least for residential accommodation. The international logic does however seem to apply to the sharp rise in supply of commercial property but there again it is seen as a possible lag before demand catches up with supply.

The RBI has been worrying about a property bubble for quite some time now and has made it tough for the real estate sector to borrow. This has certainly restrained the speculative element in the market though without seriously denting the prices. The sentiment  is too strong to be affected by doomsday logic and our demographics provide a very real demand scenario as does the fact that everyone now, each unit member of a family almost, wants to personally own the roof over his head.

Indians believe deeply in property and gold. No Nobel laureate from a country far far away is going to change their minds.

So it came to pass, in malodorous Mumbai, equal parts slum and El Dorado, billionaire investor Rakesh Jhunjhunwala has just bought six sea- facing flats from Standard Chartered Bank for a total of Rs. 176 crore. Five of them are about 2,500 sq.ft. each, and the sixth is a duplex at nearly 5,000 sq.ft. and together constitute half the building, half its underlying land and 7 garages.

Rana Talwar of Yes Bank bought a single flat in Mumbai’s Altamount Road for 128 crores a little while ago, and there have been several other high value deals, mostly between corporate honchos in Mumbai, even as the average rate of appreciation of well- located real estate there has declined from 30% per annum over the last three years, to just 10% now.

Gross rentals are returning a mere 3% of property value in a soft market but that is no longer material given the capital appreciation game afoot.  Nevertheless, the estimated net worth of notables that live in the Malabar Hill area, where these stellar transactions are going on, is about $30 billion, and that too provides a certain bouquet to the new entrants.

This dollar figure may not impress the Americans but let’s face it, it does impress us. But everyone, the above notables beyond being buffeted by market swings amongst them, expect things to get better soon. We are a country on a leash, and the recent inflow of FII investment into the stock markets seems to acknowledge this. The locals are despondent still, and are net sellers. Morgan Stanley expects this pessimism to lift shortly.  

When the rich buy real estate at these astronomical prices, they are also saying they expect a decent return on investment within a reasonable period of time. So there is an up and up expected and never mind Schiller. And so, the real estate juggernaut goes on, with the full range of wares from affordable housing in the sticks to the astoundingly luxurious in the centre of Malabar Hill.

Much quality and iconic real estate in Mumbai is coming on stream from the old premium companies and banks that used to provide their executives excellent housing as a perk in the 1960s and Seventies. Now, the same companies and banks are busy monetising their assets which have grown thousands of times in value. We cannot represent the rise in percentage terms, and the thousands by way of multiples is not an exaggeration. So it’s no wonder the relatively new billionaires like Jhunjhunwala are not shy to step up to the plate.

Perhaps Mr. Schiller needs to study the Mumbai market for its ‘irrational exuberance’ too, but like many things Indian, it may force him to re-evaluate his fundamental beliefs!

The mantra goes that property price surges are cyclic in India, and when they eventually start lifting they make up for all the waiting time very handsomely. One can’t really go wrong, and anytime at all is a good time to invest in  Indian real estate.

(1,195 words)

October 17^th, 2013

Gautam Mukherjee