In a research note published recently,Securities noted that the home price index had risen around 7% from December 2021 to December 2022 after being stagnant between 2017-2018 and 2021-22. Home loan interest rates also increased from 6.5% a year ago to around 9% today. The equated monthly payment (EMI) for a home loan worth Rs60 lakh, to be repaid in 20 years, would have been Rs44,734 a year ago. It is now Rs53,984, a five-fold increase. It is now more expensive to purchase a house than it was last year. Real estate agents are now promoting pre-construction or under-construction properties much more than in the past. This is based on the limited evidence I have seen of Instagram reels created by these agents.
They are persuasive and offer two main reasons to buy pre-construction or under-construction properties. They are firstly cheaper. You have more options. It is true that they are less expensive. It is debatable whether they provide more choice, given the fact that many investors have purchased and locked up properties over the years. These homes are often available at the right price.
These agents also conveniently do not discuss the risks. Before we go there, let’s look at a 1970 research paper by George Acerola titled The Market for Lemons. A car with defects is called a in the US.
As Akerlof said in his newspaper: “There is a difference between new and used cars.” There are bad and good cars. “A new car can be a good one or a lemon. The same goes for used cars, which we call in India second-hand vehicles.”
The process of purchasing a used car can be a very confusing one for a prospective buyer if they are not experts in the field of car mechanics. They do not know the true quality of the car. The seller, on the other hand knows, which is why there’s an information asymmetry.
A market like this never works very well. Nate Silver wrote in The Signal and the Noise: The Art and Science of Prediction that “In a marketplace plagued by information asymmetries, the quality of the goods will decline and the market will become dominated by crooked vendors and gullible and desperately desperate buyers.”
It happens when a seller cannot prove the quality of the second-hand vehicle and does not receive the price he or she believes is fair. This is because the seller will keep the car, and ultimately the cars that are available for sale on the market are lemons. Due to this, it is very difficult for a potential buyer to purchase a used car.
What does this have to do with the sale of homes that are still under construction or in pre-construction? Information asymmetry is also prevalent when buying a used car and when buying an under-construction, or pre-construction home.
The buyer has no way of knowing if the builder is going to deliver the project on schedule.
Many builders failed to deliver their projects on time between 2002 and 2013. This was during a period of rapid real estate price increases. The buyers were forced to pay rent and repay the mortgage at the same time.
Some builders took the money, and then disappeared. In 2023, real estate regulators are in place and the situation has improved. Real estate regulators still need to improve, and their quality varies by state.
Many projects have a projected delivery date in 2027 or 2028. It is difficult to predict what will happen in four or five years. Even if a builder is on time with the delivery, there’s still the possibility that the flat you receive will not be what was originally promised. You may not get what you see. You can certainly take the matter up with a regulator but that would take time, money, and mental space – all of which are usually scarce.
Should one take the risk to buy a property that is still under construction or in pre-construction? Is it better to purchase a flat that is ready for move-in, even if it’s a little smaller or a bit further away from the city centre? You are free to make your choice, but you should be aware of the risks.