(Senior Manager, Research, Jones Lang LaSalle India)In 1959, Charles E Lindblom, the American political scientist, published
a paper in the Public Administration Review – The Science of ‘Muddling Through’.
In this, he contrasted what he called the ‘root method’ of decision-making with
the ‘branch approach’.
The root method involves comprehensive evaluation
of options in the light of defined objectives; whereas the branch method
involves building up, step-by-step and by small degrees, from the current
situation. Lindblom claimed that the root method was, in fact, not usable for
complex policy questions. His verdict was that the practical individual must
follow the branch approach – applying the science of muddling through.
The residential property
market in India, particularly in the Tier I cities, has remained sluggish
for the past 12 months, with significantly lower sale volumes when compared to
the high absorption rates of 2010. Home loan interest rates now seem to
be at their cyclical highs (but should soon decline) and unforeseen tax levies
have come at a time when the industry is facing its moment of reckoning.
In these uncertain times, the question arises whether strategic
decision-making for residential property developers to improve sales should
follow the root method – a comprehensive evaluation of options, or the branch
approach – a process of muddling through. In a multiple stakeholder environment
with several large uncertainty input parameters, the branch approach seems to be
the instrument of choice.
In adverse market conditions, developers want
to ascertain facts on some key issues. They consider whether they should:
Lower prices in on-going projects
Proceed with construction
Launch new projects at lower prices
Sell non-performing assets
such as land
THE ‘LOGIC’ OF RESIDENTIAL PROPERTY
PRICING
While others require comprehensive evaluation,
determining residential property prices usually entails a trial-and-error
approach. During good times, prices are invented. When the going gets tough,
prices are discovered (hence the term ‘price discovery’). Developers continually
assess the market with trial price levels to increase sales in on-going
projects. To avoid adversely signaling the market (which could lead to a
downward spiral) prices in on-going projects are kept ‘sticky-upward’.
In the first phase, negotiations are held behind closed doors to test
the market’s appetite. If sales do not recover, discounts are offered up-front
on the table. If there is still no perceived recovery, discounts are advertised
to increase visitors to the sales office. At this stage, the market is said to
have witnessed a correction. This is fundamentally a process of ‘muddling
through’, in which residential prices offered by developers in on-going projects
rise like rockets but fall like feathers.
projects which are different from the on-going projects – and priced much lower
than the market average (the price levels being decided by the root method of
decision making). Since new projects have a high construction risk, the lower
price is somewhat justified and avoids the signaling effect to the market.TROUBLE AHEAD?
Is the Indian residential property market headed for a hard landing? During the slowdown in 2009, prices
in some on-going projects witnessed corrections while a large number of projects
maintained stable prices. New launches were made at highly-discounted prices;
subsequently, a significant rise in absorption was observed as prices were
termed ‘affordable’. Prices then increased rapidly by as much as 30-40% (mostly
in newlylaunched projects) across Indian Tier I cities until end-2010, followed
by slower growth in 2011.
However, all predictions of a hard landing for the residential property market in 2011 have failed to come true. Despite slow sales, highly leveraged balance sheets, expensive finance in a high interest
rate environment and rising input costs, developers have been able to avoid a
market-wide crash. They have been able to generate sufficient cash flows through
the gradual process of price discovery, and several factors are in their favour
in the near term.
Over 60% of residential launches in the top seven cities (other than NCR and Mumbai) are priced in the range of Rs 2,000-4,000 per sq ft, which meets the demand of the middle-income buyers
The Reserve Bank of India has given sufficient indications of probable cuts in key rates
during the second half of the year, which will improve affordability for home
buyers and provide lower interest costs for developers
The prevailing absorption rates at nearly 10-12% translate into an average absorption period of
8-10 quarters for a residential project. This implies that at average prices,
any average residential project should be sold out before construction is complete
New project launches, slow in Mumbai and NCR during the first
half of 2011 due to approval and land acquisition issues, have started to pick
up and should improve cash flows for developers with land banks during 2012
With rising input costs, developers do not want to sell below a
threshold which does not justify their minimum replacement returns
This leaves home buyers with a small window of opportunity – the next six months,
when home prices should witness marginal appreciation. After six months, a
second wave of high appreciation is predicted. Are you geared for it?