CATCH 22 – Rising CRUDE Prices – Inflation in Indian Economy & Real Estate Prices

There is a strange CATCH 22 situation which is developing in India for the Real Estate Market. Due to the increase in the CRUDE Oil prices there is an overall increase in the input cost of production of Cement and Steel. With the increase in Cement and Steel prices, the cost of real estate development is increasing. Due to the increasing prices the cost of real estate is rising, however, due to the increasing inflation rate in India, the money in a common man’s hand is depleting, so they can not afford to buy costlier real estate. This means on one side the increase in real estate prices is becoming inevitable, and on the other hand the decreasing liquidity is making people unable to buy real estate at the increasing costs.

Rising CRUDE Oil Prices
There are difficult days ahead in 2008 for worldwide markets. With the continuous rise in CRUDE oil prices, the worldwide economy is being affected. The recent price hike in Fuel prices across India is the LIVE example where there will be an additional burden on common man:
Petrol prices increased by Rs. 5 / Liter
Diesel prices increased by Rs. 3 / Liter
LPG prices increased by Rs. 50 / Liter

This price hike was inevitable as the Oil marketing companies were facing the liquidity crunch because of global Crude oil price increase taking the price to $125/barrel.

So what does this mean for us now? More Inflation in Indian Economy?
For starters, it means prices for daily use commodities going up, prices for daily commutation going up, prices for raw material for manufacturing going up. In brief, inflation going up and as predicted reaching approx 9.5%. It means everything is going to get more expensive for a common man. So FMCG, Electronics, Automobiles, Aviation etc would be seeing cost hikes and then price hikes.

Real Estate Prices
The real estate prices saw a boom in 2007. However, the steady rise in inflation and probably recessionary trends in US led the Indian economy to see escalating prices of two essential commodities - Steel and Cement. Unfortunately we have not been able to find any substitute for the same. For some mysterious reasons, the government didn’t do much about increasing cement and Steel prices and the Real Estate developers had to bear the brunt of the same.

The increased input costs led to increase in real estate prices coupled with Investors investing in real estate to create a fake increase in prices.

However, now considering the inflation will lead to depletion of household income on a regular basis, the demand for real estate would go down and the only option left with the real estate developers would be to take a hit on the prices of the properties. However, if the real estate developers choose to hold on to the properties, it would affect the new project completions. Also, the developers are holding onto the properties for a future price rise which may or may not happen in the immediate future. A marginal price rise in the apartment price in one years time will have the same NPV as the price today, with the additional impact of affecting present cash-flows.

Therefore, unless a price rise is indicated by strong economic indicators, I believe the prices are being sustained at the current levels purely by the developers holding power (the larger the developer, the longer he can sustain in a falling market) and are soon to be southward bound if the economic conditions persist.