Impact of macroeconomic factors on the growth of the real estate sector in India

Macroeconomic factors influence a country’s economic outcome on national and regional level. Gross domestic product (GDP), employment rate, inflation rate, interest rate, Foreign Direct Investment (FDI), stock performance, government policies, and production cost are the major economic factors which affect economic growth. In India, the construction business in the real estate sector is the second largest in terms of employment generation. It is next only to the agriculture sector. As an economic activity construction provides employment to approximately 33 million people in India (Nithyamanohari & Ambika, 2014). It is also ranked as fourth largest industry generating FDI in India. During 2015-2028, the sector is estimated to grow at Compound Annual Growth Rate (CAGR) of 15.85%, 7 times of the current CAGR (IBEF, 2016).  The growth of Indian real estate industry is also subject to changes in the macroeconomic factors. Effect of each macroeconomic factor on growth of Indian Real estate sector is explained in this article.

GDP affecting India real estate market

GDP and real estate sector of India are interlinked with each other. With a rise in GDP, employment increases due to investment in infrastructure and business. This leads to increase in income and purchasing power of people. As purchasing power increases, demand for housing (rental and purchase) also rises. Therefore the prices of property also increase in that region (Singh, 2017).

On the other hand, real estate growth also contributes to GDP growth. Secure and affordable housing increases employment and educational opportunities for individuals. It also enriches communities leading to a better civil society and quality of life. According to  IBEF (2017), India’s real estate sector contributes to 5-6% GDP growth. The sector’s capital to output ratio is 0.61 which means that 0.61 units of capital produces 100 units of output. Its labour to output ratio, i.e. number of persons employed to produce a lakh unit of output, is 2.34 and is the highest among all the sectors.

Population and unemployment affecting real estate demand

With a population of 1.34 billion, India is ranked as second largest populated country all around the world. Due to the presence of such a huge population the country is witnessing to an acute shortage of housing. Increase in population gives rise to the demand of house for dwelling. There is also increasing migration from rural to urban areas of India for employment. The migrating population also gives rise to demand for housing (Raghavan, 2016).

The unemployment rate is the percentage of the total labor force that is unemployed, but actively seeking employment and willing to work. Unemployment results in lack of income, thus affecting the demand for property (Rogers & Winkler, 2013). Also the longer the people remain jobless, the more they start feeling de-motivated towards any investment. In countries with high unemployment, companies do not tend to demand bigger office spaces (Gan & Zhang, 2013). Therefore unemployment is a critical factor in real estate performance. According to The Economics Times (2017), unemployment in India is estimated to rise to 17.8 million in 2018, which may directly affect the purchasing power of people and thereby decreasing the demand for real estate.

Change in inflation rate majorly affects the real estate market

Inflation rate is determined by fluctuations in the price of goods and services in an economy. Inflation is dictated by cost of credit.  Due to this the cost of goods such as food items, fuels, and others increase, leading to higher inflation rate (Jain, 2017). Higher inflation rate leads to decrease in purchasing power of people. As their disposable income decreases the demand for real estate too decreases, bringing down property prices. For instance, for the period January to June 2014, the sale of properties in Delhi-NCR were down 50% due to recession and high inflation (Datta, 2015).

Construction cost of a building affects the real estate prices directly and indirectly (Zainal, Teng, & Mohamed, 2016). Prices of materials such as wood, concrete, and steel directly affects the prices of a property. Increment in the prices of these materials is directly proportional to the increased prices of real estate. In India, with the recent implementation of the GST, construction prices are expected to fall. It has been perceived as a positive step towards revival of the real estate industry.

Interest rate plays an important role in the performance of any type of investment as their present value affects the future cash flow. If the interest rate rises, cost of borrowing increases, resulting in its devaluation (Razin, 2017). This applies to real estate too. Also high interest rates signifies the less return on the borrowings, which makes a property less valuable with time. Interest rate on housing loan has been on a downward trend in past few years in India. This is a measure to boost the demand for property (Sharma, 2017).

FDI is a major source of funds in the real estate sector

Real estate of India is second largest sector generating FDI inflows. Higher FDI inflow leads to the higher construction and development of new properties. Also, drop in FDI results into lower private equity which is a major source of funding in real estate sector of India. Any change in FDI inflows subsequently affects the funding capability in the sector (The Economic Times, 2015). Too boost foreign investment in the sector, the Indian government in 2015 announced decision to allow 100 % FDI inflow through automatic route in construction and development projects. Also, the Indian government has banned External Commercial Borrowings (ECBs) and Foreign Currency Convertible Bonds (FCCBs) routes for raising funds for investment into real estate which will enhance the importance of FDI in real estate sector.

Stock Market and Government policies directly affects the the real estate market

The stock market of a country has a significant impact on its real estate. Stock market majorly works on credit. When stock markets are bullish, investors look for alternative investment instruments and real estate is a lucrative option. Moreover, bullish markets also lead to lower interest rates on account of a positive market outlook (Merill, 2015). A lower interest rates prompts more demand for home loans, boosting real estate. The 2008 recession was a landmark event in this case. As stocks across the globe crashed, the real estate markets was one of the first to take a hit. Thus, stock market directly affects the demand and growth of real estate market.

Legislation of a country plays a major role in the real estate demand and prices. Policies related to tax rates, subsidies, deductions and rebates, etc. are directly responsible for the fluctuations in demand for real estate market (Puri, 2014). For example to improve the housing market, the Indian Government has announced several measures such as:

These government policies have transformed the unorganized real estate sector towards dynamic growth by recognizing the requirement of infrastructure development for economic growth of country.

Macroeconomic factors affecting India's Real Estate Sector

Macroeconomic factors affecting India’s Real Estate Sector

In case of India’s high unemployment, comparatively high interest rates and government policies such as GST are the most crucial factors which affect the growth of the Indian real estate market as these factors affect the demand and supply of launches. In order to foster healthy real estate growth, the Indian government needs to address critical issues. The most critical issues today are job losses and high interest rates. The effect of macroeconomic factors on real estate is examined further empirically in the following articles.

References

Anita Tomer

Anita Tomer

Research Analyst at Project Guru
Anita is a post graduate in applied operational research and a graduate in mathematics (hons.)from University of Delhi. As a part of her association with Project Guru, she is working in the direction of developing strong statistical concept. Apart from data analytics, she loves adventures and loves to explore places.
Anita Tomer

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