The latest housing price data released by the National Housing Bank (NHB) last week suggests that home prices have begun to correct. India has traditionally suffered from the lack of a proper gauge of housing prices, with most of the public information based on reports by real estate brokers who have few incentives to publicize price decreases. The NHB index does not suffer from that problem. Its latest release shows that housing prices slipped in 22 cities between April and June. Other data shows that the inventory of unsold housing stock in the major cities continues to climb, and is now as high as 700 million sq. ft.

There is a carefree belief that housing prices can never decline in India—given rising incomes, rapid urbanization, rent control laws and development rules that restrict housing supply in the large cities. Such a confident assumption flies in the face of evidence. Housing prices had dropped sharply in 2010 after the global financial crisis, only to bounce back in tandem with the V-shaped economic recovery. A more lasting decline was seen between 1998 and 2002.

Reality check: Indian housing prices are not immune to the laws of gravity.

There are also anecdotal hints that the property market is losing steam. A drive past the outskirts of any major Indian city will take you down roads flanked by massive housing projects that seem to be unoccupied, either because the flats are unsold or have been bought by investors who hope to flip them for a handsome profit later. A few places like the town of Ulwe outside Mumbai are enveloped in the eerie silence of the notorious Chinese ghost cities. There are also signs that builders are now more ready to negotiate lower rates with prospective clients, although they are holding the official price line.

There are two broad rules for asset prices. One, they move in tandem with the growth in nominal incomes over the medium term. Two, they are volatile because of the tendency to overshoot fair values. Like any other asset, real estate is not immune to such economic logic. India already has some of the priciest real estate in the world, especially when compared with relative income levels. It is also worth noting that Indian real estate prices have grown faster than nominal incomes. Data on the rental yield on homes also suggests that the market is overheated.

There are three reasons why Indians have continued to buy real estate despite the stratospheric prices. First, there are the traditional social norms that encourage home ownership. Second, high inflation has made physical assets such as real estate and gold more attractive relative to financial assets. Third, the momentum of real estate prices has attracted speculators who seek to flip homes for easy profit.

These factors may yet combine to keep real estate around their current high levels, but that seems increasingly unlikely. Most real estate developers are battling financial stress, as a look at their share prices shows. Economic growth is also slowing, and the expectations of wage growth in the urban economy are rapidly being reset downwards. And commercial real estate prices have been sliding for quite some time now; residential real estate could be next.

Lower real estate prices should be welcome because it will make housing more affordable. But policymakers should also use the opportunity to address some of the underlying structural issues as well. Most cities need more housing stock, and given the current difficulties in acquiring land, it stands to reason that cities need to grow to the skies. Rent control and tenancy laws should be drastically reformed so that more houses are available to stay in. Indian cities also need better infrastructure to make lives more tolerable.

In other words, the government should not try to prop-up real estate prices in a bid to bail out developers and financiers (though the involvement of politicians in this market muddies the waters). India needs more supplies of liveable homes at lower prices. There is one blue-sky option: new cities that will ease the pressure on the existing cities.

Too much of urban policy is hostage of the powerful builder-politician nexus that has an interest in high prices. The coming fall in home prices could offer an opportunity to radically change the way our cities are managed.

Is the property market losing steam? Tell us at views@livemint.com

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