Dreams: At What Price ?

Understanding the Rise & Rise of Real Estate Prices In India - Part I

High prices are keeping buyers out of the market, making it harder for firms to attract workers in pricey markets and breeding high consumer debt and speculative buying. Potential buyers see warning signs of a speculative market but worry they run a bigger risk if they wait and prices jump still higher. But it also has economic pitfalls.

If the reason the price is high today is only because investors believe that the selling price will be high tomorrow—when “fundamental” factors do not seem to justify such a price—then a bubble exists. The price per unit of the existing stock is determined in the demand side of the model, making the difference between the actual home price and the estimated price of particular interest in assessing the existence of a bubble. A positive difference would imply that current prices are higher than what the fundamentals can support over the long run, thus suggesting a bubble.

Few fundamental factors that influence the demand for housing over longer horizons include growth in household disposable income, gradual shifts in demographics (such as the relative size of older and younger generations), permanent features of the tax system that might encourage home ownership as opposed to other forms of wealth accumulation, and the average level of interest rates (possibly related to the long-run behaviour of inflation). The availability and cost of land, the cost of construction and investments in the improvement of the quality of the existing housing stock are longer-term determinants of housing supply.

Another factor affecting the liquidity of the housing market is the specific transaction cost framework such as the level of VAT, stamp and registration duties and inheritance taxes. Finally, the uncertainty about future prospects that follows periods of heightened volatility in housing prices tends to lead to a more cautious response of housing construction to shifts in demand because of the inherent irreversibility of this type of investment.