How Macroeconomic Factors Influence Real Estate

Even though global financial markets has been experiencing a slump, Reserve Bank of India (RBI) Governor Raghuram Rajan is of the opinion that India's macroeconomic fundamentals are strong. In June, Rajan had said that though India's gross domestic product (GDP) growth had improved, this could largely be attributed to the change in methodology according to which growth was calculated. Macroeconomic performance deeply influences the performance of real estate assets.

Here are the reasons why Rajan thinks that the India's macroeconomic fundamentals are strong.

India is the fastest growing major economy. In the fourth quarter of the previous financial year, India's GDP growth rate was 7.5 per cent. Rajan points out that no major economy is growing at the same pace. Even though India has the potential to grow at a much faster pace, its recent performance has been satisfactory. The Indian economy was growing slowly for years; it is performing far better now when compared to other economies in GDP growth rate.

Even though India was, a few years ago, the only large nation with an unusually high rate of inflation, this is not true today. Now, India's performance is better than countries such as Brazil, Russia and Indonesia. Two years back, India was facing double- digit inflation when many countries witnessed falling prices. The reason is, of course, that the RBI Governor is an eminent economist, who understands the importance of inflation targeting. As, inflation erodes the value of savings of people, this is a great achievement. In July, Consumer Price Index-based inflation was 3.78 per cent.

The RBI has started slashing interest rates. In 2015, the central bank cut the repurchase rate thrice, by 75 basis points in total, over three monetary policy reviews. Rajan thinks that as inflation has fallen, the RBI is happy to deliver low interest rates. Home loan interest rates have fallen too.

Commodity prices are low now, and this would be so for a while. As the Indian economy is more prosperous, greater domestic and foreign investments are likely to happen in the next few years.

But, Rajan thinks that there are three reasons why we should be apprehensive.

A) Inflationary expectations are still high.

B) India's GDP growth rate is still below its potential.

C) Non-performing assets in the financial system are still high.

How would strong macroeconomic fundamentals influence the real estate sector?

When macroeconomic performance is better, real estate assets are likely to perform better. In countries in which real estate markets perform more efficiently, appreciation in real estate prices are even used to predict the GDP growth rate. This means that GDP growth rate and real estate prices are closely linked to each other.

When interest rates fall, there will be greater demand for real estate, and this will drive up real estate prices. The price of apartments in India would rise too.This is quite likely to happen because inflation and interest rates may fall further. 

When there is high residential property prices to GDP ratio, it means that that future productivity of a nation is high. Otherwise, people would not spend so much of homes in an area where GDP growth is relatively low. So, the ratio of home prices and GDP growth would tell us a lot about the future economic performance of India. In India, the ratio is much higher than that of other countries because apartments in Delhi and Mumbai are far more expensive than apartments in comparable cities in China and other countries.