In a recent research note, ICICI Securities pointed out that home prices had risen by around 7% between December 2021 and December 2022, after remaining stagnant from 2017-18 to 2021-22. Along with this, home loan interest rates have risen from around 6.5% from a year back to around 9% now. One year back, the equated monthly installment (EMI ) on a home loan of ₹60 lakh—to be repaid over 20 years—would have worked out to ₹44,734. Now it works out to ₹53,984, which is more than a fifth higher. The point being that it has become more expensive to buy a home than it was a year back. This has led to real estate agents hawking pre-construction and under-construction homes much more than they did in the past. I say this from the limited evidence of seeing a lot of Instagram reels made by such agents.
These agents are very persuasive and largely offer two reasons for buying pre-construction and under-construction property. First, that they are cheaper. Second, you have more choices. The fact that they are cheaper is true. But whether they offer more choice is highly debatable given that scores of investors have bought and locked up homes over the years. Many of these homes are available for sale at the right price.
Further, there are risks that these agents conveniently don’t talk about. But before we get to that, let’s talk about a research paper titled The Market for Lemons published in 1970 and written by George Akerlof. In the US, a car which has defects is referred to as a lemon.
Now, as Akerlof wrote in the paper: “There are new cars and used cars. There are good cars and bad cars. A new car may be a good car or a lemon, and of course, the same is true of used cars [or as we call them in India, second-hand cars].”
Unless, the prospective buyer is an expert when it comes to the mechanics of a car, he or she faces a huge information asymmetry during the process of buying a second-hand car. They don’t know how good or bad the car really is. On the other hand, the seller does, and that’s why there is an information asymmetry.
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Such a market never really works well. As Nate Silver writes in The Signal and the Noise –The Art and the Science of Prediction: “In a market plagued by asymmetries of information, the quality of goods will decrease and the market will be dominated by crooked sellers and gullible and desperate buyers.”
This happens because the seller of a good second-hand car cannot prove that the car is good and, hence, does not get what he or she thinks is the right price. In this scenario, such sellers are likely to keep the car and the cars ultimately available in the market for sale are basically lemons. Given this, it’s very difficult for a prospective buyer to buy a second-hand car.
So, what has this got to do with under-construction or pre-construction homes being sold? The information asymmetry that prevails when it comes to buying a second hand car also prevails when it comes to buying an under-construction or a pre-construction home.
It’s very difficult for the buyer to know whether the builder will get around to delivering the project on time.
Between 2002 and 2013, when real estate prices rose at a fast pace, many builders simply didn’t deliver on time. This led to a situation where the buyers had to continue paying rent along with repaying the home loan.
Some builders just took the money and disappeared. Now, in 2023, with real estate regulators around, the situation is a little better. Nonetheless, real estate regulators are still work in progress and the quality of the regulators also varies from state to state.
Further, many projects now come with a delivery date of 2027 and 2028. Four years or five years is a long time and a lot can change during that period. Also, even if the builder delivers on time, you run the risk of the final flat not being similar to what was promised. What you see is not what you may get. Of course, one can take this up with a regulator, but then that will take time, money and mental space, stuff which is usually in short-supply.
So, should one really take on the risk of buying an under-construction or pre-construction property? Or does it simply make more sense to buy a ready-to-move flat, albeit slightly smaller or slightly away from the city? While the choice is clearly yours dear reader, you now know the risks involved.
Vivek Kaul is the author of Bad Money.