India’s real estate sector, which accounts for about 7% of the country’s GDP (pdf), has seen demand dry up drastically following Narendra Modi’s decision to demonetise the Rs500 and Rs1,000 notes.

Much of that is because a significant part of the transactions in the sector is cash-based.

“In the real estate development cycle, black money is utilised mostly at the land acquisition stage and also during secondary sale of residential units and strata sale of commercial units,” real estate research firm Colliers International said in a report. “This quantum varies and is higher in business community-dominated cities as compared to cities dominated by the salaried class.”

Realtors hurting

For decades, Indian real estate has been an attractive investment option for businessmen and politicians to park black money.

In most transactions in the sector, sale documents don’t reveal the actual property price. Sometimes, sellers receive up to 60% of payment in cash, which remains unaccounted for. Cash deals help avoid stamp duty and registration charges, which add over 5% to the price.

The primary market usually involves only the property buyer and developer, and so doesn’t quite dictate pricing. It is the cash-rich secondary market, where investors engage in sale and resale, that plays a crucial role in fixing prices.

Before demonetisation, the Indian real estate sector was poised to touch $180 billion by 2020, growing at 30% annually for the next 10 years. Things have changed dramatically since then.

“We expect little or no transactions in land, commercial strata sale and secondary sale of residential units at least for the next three months,” the Colliers report added. “The primary reason for this lull in the market is that majority of the players will get busy in figuring out how to account the black money and reduce their losses. At the same time, investors with white money will also adopt a wait and watch approach in expectation of a decrease in prices.”

Already, some firms have begun fire-fighting. Developers are cutting costs through layoffs and cuts in marketing budgets. Others are holding off purchase of new land. Property enquiries, too, have fallen sharply between 50% and 80% across India, according to various estimates.

Since demonetisation, share prices of listed developers have taken a beating. Shares of DLF, India’s largest realty firm, have fallen 19%, while those of Housing Development & Infrastructure lost 15% and Indiabulls Real Estate 14%.

State-wise impact

Consumers in the Delhi National Capital Region (NCR), Mumbai Metropolitan Region, and some tier II geographies like Surat and Vadodara would feel the pain severely, Narasimha Jayakumar, COO of 99acres, an online real estate sales platform, wrote on Moneycontrol.

“Minimal impact of demonetisation has been felt in markets such as Bangalore, Pune and Chennai, which are primarily end-user driven and rely on bank funding,” he wrote.

In the meantime, affordable housing could get a significant boost. “Confined to the fringe areas of metros, this segment is expected to get a boost as land prices will plummet in the next few years, especially in far-flung areas around Indian metros, and the tier-II, III cities” Anuj Puri, chairman and India head at real estate consultancy firm JLL, said.

Recovery

Realtors are betting on the Reserve Bank of India (RBI) to cut key rates, helping increase consumer spending.

“We expect a fall in inflation rates in the next three to 12 months,” Colliers said. “This should trigger RBI to reduce interest rates in the next cycle by about 50 basis points. The reduction in bank rate will put pressure on the banks to reduce home loan and construction financing rates.”

Even the CREDAI, the apex body of real estate developers agrees. “CREDAI expects the mop up of black money to also lead to higher tax collection and a lower rate of personal and corporate income tax from the next financial year onwards,” the organisation said in a statement (pdf). “In other words, demonetisation would put more money into the pockets of home purchasers through lower tax burden and incentives for home ownership.”

In the long term, the source of funds in India’s real estate sector could see increased transparency, and, hence, instill trust among consumers. “This will lead to an economy that is more aligned to global compliance standards and an industry with high levels of corporate governance making it easier for foreign entities to invest in India,” Colliers said.