City property is expensive and unaffordable. But prices are being held up more by bad policy and self-created myths than real pressures of demand and supply

Why has city realty become so unaffordable to almost everyone but the rich and super-rich in India? Is there any chance that prices will come down significantly?

Ask realtors, builders, home lending agencies, bankers and people who already own homes, and the answer to the second question will always be: no, barring short-term minor corrections, prices can only go up and up. Ask them a follow-up question - who will buy such high-priced real estate if incomes are not rising even half as fast - and they will talk about mysterious "investors". One presumes they are talking about speculators.

Barring homeowners, who are obviously not real estate experts and hence may be mouthing only what they hear and see, the rest are all speaking half-truths, if not outright lies. These half-truths are believed because of two other intuitive beliefs we all tend to nurture: that land is scarce, and relative to availability, a growing population will always ensure rising demand, whatever the price of land. That's why prices can only go up.

Sorry, but this is a voodoo belief, and not based on sensible economics. No theory in economics tells us that demand will always outstrip supply, even given a finite resource like land. The fact is: when prices rise too much, demand will either fall or shift to substitutes.

Aha! But land has no substitutes, you will say. After all, the basis for this touching faith in voodoo non-economics is this quote: "Buy land. They ain't making any more of it." Attributed variously to many people, from Mark Twain to Will Rogers, this quote forms the basis for all myths about real estate. In India we believe more in this notion than in god because, over the last two decades, we have not seen real estate really crash or fall dramatically. At worst, we have seen small corrections.

Let me try and dispel this myth. Neither is land supply limited, nor is population growth a continuous given.

Start with the world. Current population is around 7.1 billion. The estimates are that this population will peak around 2050 in the range of 8.7-9.5 billion. In short, the overall population of the world will rise by only 20-30 percent from now. So if we are talking demand for houses, the net additional demand over and above what exists now is just 20-30 percent based on population growth.

I am oversimplifying to make the reasoning clear - not to hide reality. The flaw in the above argument is clear: the bulk of the land may be available in North America, Africa, Russia, etc, not in India, South and West Asia, where most of this population growth is going to come from. So, you may ask, is it not fair to assume that land prices in India must keep rising continuously?

Not quite. There is a reason why prices keep rising, but it's not about India's population, which is expected to peak in 2060 at around 1.7 billion (from 1.2 billion now). That's another 500 million to go in five decades. Put another way, even assuming land supply remains the same, the additional population demanding houses - assuming everyone is earning an income - will be up by only 50 percent.

Okay, let me grant you another flaw in the argument. The problem is with urban land availability. India is urbanising rapidly, and we will probably have an urban population of around 600 million by 2031 - about 17 years from now, up from 300-and-odd million. So, even in urban India, we are talking about a doubling of population by 2013. Not exactly something that should drive land prices 10- or 20-fold, as they have done over the last decade or more.

If we have capped the population/demand issue, let's now nail the supply side argument - that land is scarce and supply won't increase.

But is it? If your city allows an FSI (floor space index) of 1:1 - that is you can build an area equal to the size of the land you hold - land will be scarce. If the FSI is doubled, land supply will double - since you can build higher. In places like New York and Singapore, FSIs range upwards of 10. In India, we can double or triple land even in urban areas simply by tinkering with FSI and redeveloping old property even in city centres.

Urban land is not scarce, urban infrastructure is. It is the lack of fast, cheap public transport - and lack of social infrastructure like schools and hospitals - that makes the pockets where such infrastructure is available horribly expensive.

The real issue in urban property prices thus boils down to location. Land is available in plenty where the infrastructure is weak. The solution to the problem of land is thus infrastructure and FSI.

But, you may ask, if this is so easy - why isn't it happening?

The answer: in India, real estate is a malfunctioning market. Only one side of the demand-supply equation works: demand. The supply side is bottled up by vested interests and systems that constrict availability.

Here's why.

If you expand the supply of land by FSI or infrastructure, the wealth and profits of all those who currently hold land will crash. This is why realtors, builders, home lending agencies, bankers and people who already own homes prefer to believe that prices will keep rising even as new buyers hope it will fall and correct.

Real estate prices are being propped up by high expectations.

Many builders would be ruined if prices crash. Banks would have to put in enormous amounts of capital in case realtors go belly-up and default (many have begun to default anyway). State governments will lose revenue in the short-run if prices crash. Home loan companies will have to demand part repayment of loans in case the value of the mortgaged property falls drastically.

This is why these vested interests prefer to assume that prices will always rise - and keep talking the market up.

But, surely, there are lots of people (including investors and speculators) who still buy property? Sure, but many of them may merely be flipping higher-value property to buy lower-value ones, or parking the huge hoards of black money created in the boom years of 2003-08. When black money quantum soars in the economy, there are only three likely places to park them anonymously: real estate, offshore tax havens or gold. The threat to offshore tax havens - from the US tax authorities - has probably pushed some of the Indian loot held abroad into real estate.

Why only real estate, and not gold or shares or other assets? Simple: the markets for gold and shares cannot be rigged, not even in India, for such large sums of money. That leaves only real estate, where politicians, builders and crooks can band together to artificially constrict the supply of land and keep prices high even though nobody is buying.

A case in point: lots of land would be available near Mumbai in the trans-harbour area if only there is a road/rail link across the sea from south Mumbai. But for 10 years now, vested interests have stalled the building of this bridge to prevent a crash in south Mumbai realty prices.

This is why city property prices are high.

This begs the question: can they ever fall significantly? Yes, in Nariman Point in south Mumbai, property prices are 25 percent down from their peak. Commercial property prices have taken a beating regularly. It is only residential property prices that have held up - and that too has a reason.

Those who have only one home can't sell as they may be staying in it. Those who are willing to move out to cheaper places do sell, but the expectation that property prices can rise further dies a hard death. Thus, they take their time in deciding to sell and cash out. The laborious process of buying and selling property in most urban centres adds another crimp in the supply pipeline.

If you believe that you cannot ultimately defy the laws of economics, and that irrational laws that artificially restrict supply cannot forever be allowed to remain on the statute books, city realty prices have to fall. Not unless you irrationally believe that people will buy overvalued property even when their incomes are not rising as fast. Or that investors can hold on forever. It needs only some significant story of huge losses to get them to sell and book profits (or but losses).

Of course, we don't know when that will happen. Just that it will.

Here's one piece of statistic to tell you the larger reality.

Ajay Shah of the National Institute of Public Finance and Policy wrote last year in The Economic Times, there is no real shortage of land in India. "If you place 1.2 billion people in four-person homes of 1,000 square feet each, and two workers of the family into office/factory space of 400 square feet, this requires roughly 1 percent of India's land area assuming an FSI (floor space index) of 1. There is absolutely no shortage of land to house the great Indian population."

Now, or in the future, one may add.