Once the bubble is burst, the property is worth a fraction of its purchase price and people get left behind with a negative asset, where the EMI is higher than what the asset can earn in a month. In such a situation, the balance outstanding loan cannot be paid off even if the asset is sold.
Japan is an excellent example of a housing bubble that went horribly wrong, and it has a glaring similarity to what is happening in India.
Read on and identify the similarities:
The Japanese real estate market boomed from 1985 to its peak sometime in early 1991.
During this time, Japan’s property prices rose much faster and more steeply as speculators used paper profits from a booming stock market to invest in property, insupportably leveraging the prices of both higher and higher.
The biggest speculators in Japan's frenzy were deep-pocketed corporations, and they pumped up the commercial property market at the same time that home prices were inflating.
Japan suffered one of the biggest property market collapses in modern history. At the market’s peak in 1991, all the land in Japan, a country the size of California, was worth about $18 trillion, or almost four times the value of all property in the United States at the time. A commonly-quoted claim was that the land beneath the Imperial Palace in Tokyo was worth more than the entire state of California.
Then came the crashes in both stocks and property, after the Japanese central bank moved too aggressively to raise interest rates. Both markets spiraled downward as investors sold stocks to cover losses in the land market, and vice versa, plunging prices into a 14-year trough. In 2005, the land in Japan was worth less than half its 1991 peak, while property in the United States has more than tripled in value, to about $17 trillion.
Homeowners were among the biggest victims of the Japanese real estate bubble. In Japan’s six largest cities, residential prices dropped 64 percent from 1991 to 2004. By most estimates, millions of homebuyers took substantial losses on the largest purchase of their lives.
By 2004, a prime “A” property in Tokyo's financial districts were less than 1/100th of their peak, and Tokyo’'s residential homes were 1/10th of their peak, and even at this time they were considered to be listed as the most expensive real estate in the world. At the end of the Japanese housing bubble, some $20 trillion (1999 dollars) was wiped out with the combined collapse of the real estate market and the Tokyo stock market.
Read next story in this series: Myth: Prices Will Keep Rising Forever
This article has been developed from the October 2005 issues of the New York Times. You can read it here
Property Trouble? ARCHIVES | EQUITYMASTER HOMEPAGE 24TH APRIL 2008 In July 2006 I made a prediction: property prices in India will decline by 25% to 40% over the next 9 months. By July 2007, property prices had increased somewhere in the region of 20% to 30%. So much for my prediction. So much for sensible analysis. The property markets were in frenzy in 2006 and 2007. Large developers were listing their stocks via IPO’s and they were all lapped up. Well-paid analysts were talking about the embedded Net Asset Value in the stocks of these property developers and the land bank they all owned. The SEZ policy is the equivalent of the industrial license raj that ruled - and ruined -India’s economy till 1991. Land was acquired at maybe Rs. 10 per square foot. A few approvals later, the land was re-zoned and re-born as a pretty garden villa real estate project selling at Rs. 4,000 per square foot. The magic of the Indian rope trick. The magic of an opaque approval process. Land barons were born. They made it to the mega rich league of the market cap charts. Investing in India: real estate is overpriced? Sam Zell, the legendary real estate developer and investor from USA, gave a talk at a conference in Bombay in December 2006. Not more than 5 feet 6 inches in height, he stood above the frenzy of the crowd. Sam Zell had just sold his company, Equity Office, to the private equity firm, Blackstone, for some USD 35 billion in November 2006. Why are you selling Sam? - all the commentators seemed to be asking him - the US economy has a long way to run. I can picture Mr. Zell smiling in silence as he collected his cash. He sold out at a level that - in hindsight - was the peak of the US property market cycle. ADVERTISEMENT Your Family’s Future Depends On This. Read Now "There is no shortage of land in India", declared Sam Zell, "there is only a shortage of zoned land". Read that statement carefully. Read it again. And think of the SEZ policies and the land grab. Sure, India has a demand for some 20 million homes and some 5 million office units and some 200,000 hotel rooms. And schools and colleges to educate the one hundred million young children. And hospitals to take care of the 100 million elderly people in the country as they age in a changing society where the children don’t live with them anymore. And we need many more cricket stadiums to watch overpaid cricketers sell you some TV sets, washing machines, and mobile phones. A back of the envelope estimate indicates that India needs to build some 3 billion square feet of property in the next 5 years to partially meet some of this demand. How much is that? Well, visualise Nariman Point. And now imagine that we have to build a string of Nariman Points from Bombay to Bangalore. There is enough land to construct all of that. The shortage is in the zoned land. This is a man-made shortage. A shortage created by policy. Just as India had to suffer for 20 years with a regime that forced us to buy the Premier Padmini and the Ambassador - and we had to wait 3 years to get the cars delivered. At the end of the wait, we got a useless product for a lot of money. And Premier and Ambassador were profitable companies - whether their profits were declared in cash or cheque. Just like the sheltered real estate developers. Land is in abundant supply. There is some special mechanism to convert this useless land to useful, zoned land. My colleagues in our real estate arm tell me that there are 62 approvals required to get useless, un-zoned land converted into an end product that we can live on. Artificial barriers have created an artificial price of the end product. And this leads to a strange end market at today’s prices. The very rich can buy any property anywhere in the world - or any city in India. The rich can afford to buy one nice home in any one city. The middle class cannot really afford to buy in many cities. The poor have no hope of buying anything. ADVERTISEMENT