Budget 2017 has rolled out measures to encourage first-time home buyers, but by tweaking select provisions on tax reliefs, finance minister Arun Jaitley has ensured that real estate may no longer be an option to invest in.

The Narendra Modi government is set to club tax incentives for self-occupied properties by bringing them on par with rental houses. Under the new regime, the deduction limit on interest paid for home loans taken for houses that a buyer is already occupying, will be the same as for those bought with the intention of earning rental income.

Earlier, you could claim tax exemption on the interest paid, up to a limit of Rs2 lakh for self-occupying houses, while there was no such ceiling for houses bought for rental income. People who invested in real estate could book the loss they suffered on lower rent, which helped in reducing their overall taxable income.

The math goes like this: rental yield today is about 2-3% of the actual value of houses. Pitch this with the average home loan interest rate of 10-11%, and you have a loss of 8-9 percentage points, which investors made good till now by claiming tax deductions to that extent. With the budget looking to limit the tax exemption on interest for even rental homes to just Rs2 lakh, it will keep investors off the sector.

“The new budget provision is a game changer for the worse.”

This will in turn push up supplies of homes in the secondary real estate market, the segment that includes resale units. A rise in the number of houses on sale will bring down prices that have already fallen by 30% post-demonetisation.

“I would call the new budget provision a game-changer for the worse,” says Pankaj Kapoor, founder director of Liases Foras, an independent property research firm. “The primary market is already seeing huge inventory thanks to the slowdown; now the secondary market too will join this list. All regions which typically see large investments—the NCR and nearby areas in the north, to some pockets in Mumbai—will see a sharp fall in prices.”

This drop will compound the situation, as, according to real estate consultant Knight Frank, housing sales in the October-December 2016 period in India’s eight big cities, fell by 44% from 72,933 units to 40,936 units.

Ailing companies and a cash crunch

While the fall in prices may not immediately help users, it will further delay the revival of real estate companies that have been defaulting on high-interest loans sourced from the market, as traditional banking routes are still closed to them.

Such developers are expected to get some relief as the budget has brought affordable housing under the infrastructure sector. This categorisation will ensure cheaper loans for real estate companies. However, while demonetisation hit the sector by reducing the cash components of transactions, the further capping of cash deals will only worsen the impact. The budget proposes to limit cash transactions to Rs3 lakh. But as builders have always preferred a mix of cash and cheque bookings for their projects, such a clampdown will not only turn away investors, but will also close down one source of funding for developers.

Most real estate companies have always priced their projects such that an investor paid some part in cash and the rest through bank loans. If the cash component was higher, the actual cost of the project was lowered by that amount, which in turn reduced the stamp duty payable to the government.

Such an arrangement helped both investors and the builders. The buyer paid less stamp duty and the builder got a ready amount in cash. But the Rs3 lakh cap stipulated in the budget being very small, people will be less inclined to invest.

“The intent of the government, through the tax exemption limit, is to dissuade people from using bank-financed deals in real estate,” says Amit Bhagat, managing director with ASK Property Investment Advisors. “The budget proposal will definitely impact real estate investments but the sops announced for affordable housing will more than make up for that.”

A sector abandoned

A shift away from real estate towards equities is reflected in the steadily rising domestic mutual funds inflow tally, already at a 16-month high by December. People looking to invest surplus money have traditionally opted for real estate and gold. However, recent economic trends and an ongoing slowdown has led to returns from these two options falling sharply, prompting most to put money in mutual funds or directly into equity stocks.

The trend gets more visible in the investing patterns of mid to senior managerial professionals in IT, ITeS, and pharmaceutical companies, who typically have investible surplus of between Rs20 lakh and Rs30 lakh a year, says N Arunagiri, founder of Trustline Holdings, a Chennai-based equity research and business analytics firm.

“Real estate as an asset class is losing its appeal. Such measures (the latest provision in the budget) will speed that up. Most of our clients who had invested in real estate are selling off their investments at a loss, as they see no immediate recovery in prices. Our leads in portfolio management services (PMS) are seeing a sharp rise with investor interest turning entirely toward equities,” Arunagiri said.

People have seen returns of 20-25% from equities via PMS, through which a firm invests on behalf of clients who put in a fixed amount. Compare this with the less than 8-9% earned in real estate and it’s not hard to understand the shift.

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