Explained: Why the trend of higher demand for urban housing and energy is here to stay

With the rapid urbanisation and growing energy consumption in India, the trend of higher demand for urban housing and energy is here to stay. While urban residential real estate has seen a slight improvement of late and commodity prices have subsided from the highs of 2018, both housing and energy sectors will need renewed attention going forward especially to avoid future market failures.

In a recent article for the World Economic Forum titled "Why the world should be watching India's fast-growing cities", author Sangeeta Prasad points out an interesting statistic that "70 per cent of India's built environment for 2030 yet to take shape". The biggest takeaway is that with the rapidly growing urban population, necessary infrastructure such as housing will be in demand. Therefore, it is essential that the residential real estate ecosystem is well equipped to cater to the increased demand.

The current scenario of unfinished residential projects and inventory of unsold properties points towards both overall market failure and financial indiscipline on the part of the various players in the market.

The slowdown in residential real estate over the last few years has been a dampener to both formalising the real estate sector through more efficient balance sheets and allowing increased access to housing for home buyers. Residential real estate needs a refocus on tax policies that can boost sales and create market-clearing prices.

Policies that can help significantly boost sales in residential real estate will have two distinct advantages. Firstly, greater sales help expand the tax kitty even in a lower tax regime, whereby the significant increase in volumes would more than compensate for a lower tax rate. Secondly, the sales of the inventory of residential real estate held by the financial ecosystem will help boost the flow of credit within the economy and increase the investment multiplier.

The eventual sale of residential real estate will help clean up the balance sheets of developers, banks, non-banking financial institutions and homebuyers. This credit release from the clearing up of inventories will help boost both private capital formation and consumption, thereby creating new business opportunities in the economy.

The distressed residential real estate sector and the impending urban housing demand also presents large institutional investors an opportunity to generate significant returns. Partnering with local operators to access residential real estate at attractive discounts can help the entire ecosystem.

Given the relatively low-yield on residential real estate in Indian cities (at 2-3 per cent annually on average), investors need to view the residential segment more as a zero-coupon bond structure, where buying the asset at a relative discount to intrinsic value can eventually create returns when the asset is sold off. While we have seen some of these strategies being implemented, given the scale of the residential real estate sector a lot more can potentially be done.

It is crucial to note that tax policies that can set clearing prices for the residential real estate assets and increased interest from institutional investors in the sector go hand in hand. The former is essential to boost the latter. A solution that can address the residential real estate glut will help increase tax collections, relieve the pressure of real estate developers, allow consumers access to housing, provide investment returns and create a regulatory environment more conducive for business.

The second area that needs continued attention in India to avoid market failures is progressing towards an independent energy ecosystem. Lower commodity prices must not distract Indian policymakers and the energy ecosystem from the task of continually building energy self-sufficiency.

As the composition of energy production changes over the years with renewable energy becoming a more significant part of the energy matrix, long-term energy demand will still be met through a three-pronged approach involving thermal, renewable and natural gas-based energy systems.

Lessons from the past suggest that regardless of the energy source, policies must look to avoid market failures, especially by being aware of creating efficient interlinkages in the energy ecosystem. At its core, energy production has an input cost (raw material and initial capital expenditure) that generates energy.

The energy needs to be transmitted and distributed at a price as per the agreed contract or market tariff (as per the business model). Market failures generally occur when inefficiencies occur in input costs, production set-up, transmission issues or contract enforcement of payment mechanisms. Regardless of the source of energy, policies must ensure that this value-chain functions smoothly.

In summary, avoiding market failures in essential sectors requires consistent policy-making across the supply chain. While creating the requisite infrastructure will take decades, periods of demand pickups and lower volatility lend themselves to assist us to accelerate the much-needed infrastructure creation.