Over the medium term of a few years, real estate prices in Mumbai should become competitive against other cities.

Real estate prices in Mumbai, and most cities around the country, have skyrocketed in the past one year. Since Mumbai still remains the price-setter for the rest of the country, let us understand the dynamics of real estate prices in this city.

The market is rife with razor-sharp speculations on the expected direction of property prices, with almost an equal probability of prices staying at current levels, or going up even further, or coming down. Is there any methodical conclusion we can reach on the future direction of realty prices?

Several factors have combined to push prices up in Mumbai. For the past four years --backed by soft real estate prices, easy availability of finance, lower interest rates, liberalising construction rules, and better houses being constructed -- there was a sustained buying trend that kept growing steadily.

The wealth effect of rising income levels due to better wages, combined with the relentless growth of services (financial services, technology, BPO, retail, etc.), spawned a huge unmet demand for quality office space.

Additionally, continued buoyancy in the stock markets diverted a lot of funds to the real estate markets. Private equity and venture funds also started taking strong positions on real estate, which infused large fresh funds into real estate.

Then came the conjecture about the large-scale rollout plans by Indian and global retail Goliaths, which gripped the market in a frenzy of speculation.

During all this time, the retail homeowner's demand continued unabated, given the easy availability of home loans, and perhaps even spurred by the fear that if they did not buy they might miss the bus. The high prices are also a result of the failure of developers to bring new areas under development fast enough to counter this price hike.

The factors that can moderate prices are obviously the opposite of what have been identified as the drivers above. Most importantly, prices are completely out of whack with global trends, and have now reached a level where services are no longer competitive and have begun seeking alternative locations.

Further, the high prices have attracted a new frenzy of construction, which on completion over the next few months will exert pressure on prices.

The Bandra-Worli sea link, which is going full steam ahead, is expected to open up more areas on the Western corridor to access downtown Mumbai faster, thereby increasing supply. But the real benefit of this project is the encouraging prospects for the Trans-Harbour link, which will vastly increase the supply from the mainland to the hitherto land-locked paradigm of Mumbai.

The provisions in the latest Budget proposals to withdraw Section 801b from March, service tax of 12.5 per cent on lease rentals, and rising costs will dampen demand for residential property.

The floor space index too impacts real estates prices. The higher the FSI, the larger the floor space that can be constructed per square foot of ground area, and therefore the lower the real estate prices.

Currently the average FSI for Mumbai is less than 2. To put this in perspective, Hong Kong is now running well above 14! Admittedly Mumbai's infrastructure, as it stands now, does not give much scope for increase in the FSI.

But large integrated developments, which have become the trend, are now able to achieve a considerably higher FSI. This gives rise to the hope that the pressure on the land area and, effectively, prices will ease progressively as the FSI gets liberated in tandem with improvements in road infrastructure.

Ultimately market forces will prevail. Sensible businesses will look for alternative locations. Any major ITeS or IT company now operates with big delivery centre operations somewhere else in the world other than in India.

While India is still the fountainhead of talent, companies are not going to find homes and offices at viable prices in India at these levels. Unless prices moderate, the trend to set up delivery and off-shore centres in faraway locations such as South America and East Europe will gather momentum. Retail demand will sag if prices do not ease.

Overseas markets such as Singapore and Dubai have become favoured destinations for Indian investors in real estate, because those are more attractively priced and the quality of those properties and the environment are also far superior.

Interest rates on mortgages will move up significantly, choking off the smaller home buyers. Government policies on FDI on real estate are likely to be delayed, and probably be incremental, given the political sensitivities. Given the high prices, it will really be a brave foreign heart who will now bet billions on Indian realty! These are fundamental reasons why I believe prices will moderate.

However, I do expect continued buoyancy in the economic growth of both India and Mumbai. Thus, the salary push and attraction of foreigners to invest in India will continue.

Indeed, buying continues till now unabated. Funds are still being generated in sumptuous measures in the overseas market, targeting real estate investments in India. Surely this inflow will keep the prices up, at least in the short term. I also believe that the developers and land ownership have a strong influence on the market, which is yet to get the full effect of the buyer's power.

We are far from the perfect market; so leaving the prices of real estate entirely to the market is not going to moderate the prices quickly. However, over the medium term of a few years, I expect real estate prices in Mumbai to become competitive against other cities, which are vying for businesses to shift to their cities. The prices in these cities are at considerable lower level than in Mumbai today.

This slow moderation could be accelerated if the government decides to step in and step up city development plans, which is good, or if the money supply growth is sharply yanked, giving rise to deflationary expectations, which might be ill-advised, as it can potentially choke off the larger economy itself. The scope for any further sharp increase in real estate prices appears limited, with no further good news left for the market to rise up on.

The author is managing director and CEO, Crisil, a Standard and Poor's company

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