Prof. Jayanth R. Varma's Financial Markets Blog

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Prof. Jayanth R. Varma's Financial Markets Blog, A Blog on Financial Markets and Their Regulation. This blog is currently suspended.

© Prof. Jayanth R. Varma
jrvarma@iima.ac.in

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Fri, 07 Nov 2008

Land as an asset

The doyen of Indian housing finance, Deepak Parekh is today quoted as saying that land is no longer an asset (“There is no need for irrational pessimism”, Business Standard, November 7, 2008). Parekh says “Land prices have collapsed, land is no longer an asset – people don’t want land as a security. Today, there is surplus land, low demand ... the value of land is probably half of what it was ...”

This explains why real estate companies reportedly have to pay 35% interest after providing collateral (land) notionally equal to three times the value of the loan.

Another interesting statement in this context is in a speech by Fed Governor Kevin Warsh (hat tip Calculated Risk) “We are witnessing a fundamental reassessment of the value of virtually every asset everywhere in the world.”

Posted at 14:58 on Fri, 07 Nov 2008     6 comments     permanent link

Comments...

Gaurav wrote on Sun, 09 Nov 2008 00:08

Re: Land as an asset

Prof, This is a fascinating paper by Gary Gorton titled "Panic of 2007" (https://www.kansascityfed.org/publicat/sympos/2008/Gorton.08.04.08.pdf). He is a prof at Yale and was the brains behind the risk models of AIG.

What Gorton says is that there were some unique design features in subprime mortgages that caused the crises, which are not there in other mortgages. We might criticize subprime mortgages for their high LTV's and their option ARM features today. But lets step back to figure out why they came in the first place.

In late 1990's, US legislators wanted banks to make housing loans widely available - even to the poorest people. Now these people can neither put down a downpayment, nor can they pay a high interest rate - commensurate with their risk profile. So the only possible way to design these subprime mortgages was to have high LTVs (close to 100%), and low risk-adjusted interest rates. To make money on these mortgages, banks thus put an optionality in these mortgages (the option ARMs) - whereby the bank stood to benefit if house prices appreciated. Effectively, the subprime borrowers sold call options on their homes to the banks to get attractive mortgages. This feature is not present in prime mortgages.

The implication of this is huge - for Indian real estate market. We might not see massive mortgage defaults because of negative home equity here - there are no option features in mortgages. Defaults would be driven by traditional factors - overleveraging, job loss, health problems, divorce etc. The problems will be more on developer side - as we are already witnessing.

Would appreciate your comments, considering you are very negative on Indian real estate market.

Madhu wrote on Mon, 10 Nov 2008 10:27

Re: Land as an asset

Prof are we seeing drastic reduction in prices in India?. I've been planning to purchase a house but i dont see BIG price cuts by developers. There is a cut in built up area which makes the flat affordable and stimulates demand. But per sq ft prices remain almost the same (atleast in chennai).

Are you foreseeing deeper price cuts in India going forward? Is 35% reduction imaginable?

BizBlogged1 wrote on Tue, 25 Nov 2008 05:58

Re: Land as an asset

Real estate has been there. In India, it's been red hot since tech boom. Now is the time to evaluate if it is a bubble or not? The share prices go up and down. But real estate values come down in very very rare circumstance.

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