After eight years in the Indian real estate under multiple roles (investment banker, consultant, fund manager, and business development) and across major participants (property consulting firm, investment bank, private equity, and real estate developer), I was always intrigued by the lack of major corrections of prices in the industry.

I was in the US during the subprime crash. From early 2008 to early 2010, the ”for sale” sign was simply unmissable across that country. Prices crashed by 60-70% on the east coast as well as the west coast. I was told the scenario was not very different in parts of Europe either.

So, why didn’t India witness a similar crash?

In the last two years, we have seen inventory levels rise across metros. Bengaluru, the country’s “best performing” market, has over 27 months of inventory. With sales at an all-time low, developers are under stress. Key markets such as the National Capital Region, Bengaluru, and Chennai are depressed. A few top builders even told me that quarter-on-quarter and year-on-year sales are down by up to 50%, depending on product category. Yet, as usual, prices haven’t come down. Why?

Easy access to liquidity

Even in this gloom, private equity (PE) players have invested a record $3 billion in Indian realty in fiscal 2014-15. All the big boys—Piramal Group, Edelweiss and ASK Group and others—have raised and/or deployed over $1 billion each in the top metros. With easy availability of cash to refinance loans, why reduce prices? Besides, almost all PE investments in the residential sector were debt deals. In most, the cost of funds is between 17% and 30%. So, why exactly do developers pay lenders so much, but don’t reduce prices to improve sales?

The answer lies in the following four points:

Buying land

Land is the most important raw material, and accounts for almost 30% of total project cost. Developers either buy land (a practice more prevalent in northern India), or they sign joint development agreements (JDAs) with landowners (mostly in the south). If they buy land, they need to pay the money upfront. In JDAs, they build specific areas for landowners within the project at their own cost.

For funds to buy land, developers usually raise money from PE investors or private individuals.

For funds to buy land, developers usually raise money from PE investors or private individuals. The cost of borrowing for land acquisition is upwards of 20%, and can be as high as 30%. The time lag between the day the developer buys land to the day the project is launched could be up to two years.

However, the investors’ interest or return “metre” starts ticking from the day they dole out the cheque to the developer. To pay out investors over the project tenure from the cash flows would be extremely challenging if prices do not keep going up from quarter to quarter. Therefore, there is hardly any room to reduce prices.

Black money

Real estate is the biggest recipient of black money in India because of the possibility of utilising “cash.” Developers need “cash” to bribe government officials for approvals or land-related matters, and to pay landowners who need it to avoid or reduce capital gains tax on land transactions.

So, even if sales are poor, developers are not cash-starved as the system is flush with black money. Hence, unlike developers in the West, they don’t go bust in India during a crunch.

Lack of understanding of cash flows

Remember finance 101? “A dollar today is worth more than a dollar tomorrow.”

Unfortunately, developers either do not understand or choose to ignore this simple concept. In a weak market, they prefer to hold on to inventory. The logic is: “Pay extra to lenders now and realise more when the market improves.” In the process, they sacrifice cash flows seeking higher realisations.

Raw materials

Developers have no control over commodity prices. Steel, cement, labour, and other components form the bulk of a project’s cost. With steel and cement sectors going through consolidation, prices may rise.

Now, a typical project tenure is between three and five years. Imagine that a developer sells the bulk of units at a fixed price on launch day. The company is then exposed to cost uncertainty for almost five years, which it may not be able to pass on to existing buyers. The only way to neutralise this cost is to pass it on to new buyers. This, in turn, means prices have to go up if the developer has to manage project costs.

The result of all this is that real estate has become unaffordable for most Indians, which isn’t a particularly good thing for the industry. However, some measure could help reduce prices:

1. Reduce approval timeline: The government must enable single-window clearance. If the time to obtain approvals reduces by 50%, there will be a correction of between 5% and 10%—that is if developers pass on the savings to end buyers.

2. Reduce endless refinance options: This will force developers to reduce prices to some extent. By diluting restrictions such as minimum amount and areas open to FDI, the government has provided developers no motivation to reduce prices as they now have more partners to manage cash flows. Some restrictions on both non-banking financial companies and debt funds are needed.

3. Land banks: The government of India is the biggest hoarder of land, with large tracts left utilised. If the government can auction land parcels in metros, private landowners would be forced to pare down their unreasonable demands over land prices.

4. Technology: Lastly, utilising technologies such as pre-cast methods have reduced construction timeline globally by over 50%. (Pre-cast is an industrialised method of building. It means transfer of work from sites to factories. This improves productivity and quality and shortens construction time). This can reduce interest outflow on borrowings, which in turn can be passed on to buyers.