Indexation removed from real estate profits: Is property investment still worth it?

For context, it's the economic policy designed by the Reserve Bank of India that governs the majority of the national economy; while the union budget, recently released by Finance Minister Nirmala Sitharaman, deals with taxation and next-generation reforms.

From a real estate point of view, the first thing that stands out in this budget is the continued focus on infrastructure with an allocation of over INR 11.11 lakh crore, nearly 3.4 percent of India's Gross Domestic Product (GDP). Experts agree that improved infrastructure is set to drive real estate growth, yet there rises is a looming threat for developers with new reforms.

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City-based investment banker and financial strategist Rajeev Kashikar remarks that "the new budget has ripped the real estate industry. The removal of indexation in calculating profits from real estate sales is a significant setback."

To dig deeper into the impact of Union Budget 2024 on the real estate industry, Midday.com sought advice from Mumbai-based realty experts who offer a deeper insight into the effects of the Union Budget 2024 on the industry and what the new reforms entail for them.

End of indexation: Pain for homebuyers

When it comes to Mumbai, Kashikar explains that indexation is the most important tool. The Brihanmumbai Municipal Corporation (BMC) introduced it in 1973, while other cities adopted it around 10-15 years ago.

The end of indexation will lead to higher real estate prices, making properties more expensive for buyers. This change comes as the government closely monitors the real estate markets, seeking to benefit from their growth. As developers pass the tax burden onto buyers, it will also affect the property loan industry, creating a ripple effect.

"We refer to this as the ‘domino effect.' Property prices will rise, particularly affecting the middle class. By removing indexation, the government increases taxes on real estate transactions, thereby generating more revenue from the sector," outlines Kashikar.

Further elucidating the math behind it, here is an example: Let's say the original cost of a property is 1 lakh, and it sells for 10 lakhs. Under the new rules, the profit to the seller would be 9 lakhs."

Previously, the indexed price, which is specific to a location, was used to determine the cost. In the same example, let's assume the property's indexed price is 5 lakhs (regardless of the original price). If it sells for 10 lakhs, under the old method, the gain would be calculated as 10 lakhs (selling price) minus 5 lakhs (indexed price), resulting in a net gain of 5 lakhs. Taxes would then be paid on this 5-lakh gain.

As evident, the new reforms in the budget pose a bigger sum to be paid taxed on as the indexation has been eliminated. In this example, the gain for the same transaction will be determined to be 9 lakh, and tax will be paid on this 9 lakh gain. However, experts opine that developers will find a way to extract this taxed amount from homebuyers.

Relief for homebuyers, if any?

To balance rising property taxes, Anuj Puri, Chairman of Anarock Group shares that, the focus on rural and urban job creation, if effective, may provide some boost to affordable housing, which has given a tepid performance since the pandemic. The move can help stir up housing demand in not just the top 7 cities but also the tier 2 and 3 cities.

With an eye on the housing needs of the urban poor and the middle class, the government has announced that it intends to construct an additional one crore homes under Pradhan Mantri Awas Yojana (PMAY) Urban 2.0 with an outlay of INR 10 lakh crore.

He stresses that mega allocation for the Hyderabad-Bengaluru industrial corridor and Vizag-Chennai corridor will boost growth along these corridors and consequently boost real estate growth there. The FM also tried to rejuvenate the MSME sector, which does have a multiplier effect on overall economic growth - with the implied positives for real estate as a collateral beneficiary.

The credit guarantee scheme for the MSMEs will help provide impetus to overall industrial development, and this can have a rub-off effect on the real estate sector. The pandemic had a catastrophic impact on the MSME sector, which slowed down the demand for affordable housing since 2020. Affordable housing demand may gain momentum once the economic impact of the pandemic subsides for this target audience.

The affordable homes category (<INR 40 lakh), Puri points out, has been seeing a decline in overall sales since the pandemic, to approx. 19% in H1 2024 from over 38% in the period before the pandemic in 2019. Consequently, this segment's percentage share of the total housing supply in the top 7 cities also fell to 18% in H1 2024 from nearly 40% in 2019. Any boost to this vital segment is therefore welcome.

For individual taxpayers taxpayers under the new tax regime, the increased standard deduction limit to INR 75,000 from the previous INR 50,000 along with the new income tax slabs implies savings - but hardly enough to boost housing demand.

Heeralal Doshi, founder and chairman at Kinjal Group adds that Infrastructure investments will be facilitated via Viability Gap Funding, and Phase IV of the PM Gram Sadak Yojana will connect 25,000 rural habitations. Dormitory-type rental housing for industrial workers in PPP mode will also be facilitated. The government plans to develop corridors in Gaya modeled after the Kashi Vishwanath corridor, ensuring strong fiscal support for infrastructure projects over the next five years."

How will developers recoup

"Mumbai will be affected the maximum as the developers will rework their economics. Industry may lobby for some concession," predicts Kashikar.

It will be interesting to observe the reactions of real estate-focused private equity funds to this taxation method, as it will affect the post-tax internal rate of return (IRR) on their investments. IRR, which measures the internal rate of return both pre-tax and post-tax, is a crucial metric for investors.

This change could impact private equity funding for the real estate industry, particularly when comparing post-tax IRR across emerging markets such as India, the Philippines, Vietnam, Thailand, Indonesia and others. If the risk-adjusted IRR from other markets is higher than the average risk-adjusted IRR in India, investors are likely to shift their funds from India to those markets. This could be the most significant impact, adds.

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