The Indian economy is expected to generate a sustainable 6.0-6.5 per cent real gross domestic product growth rate over the next two to three years. The service sector is expected to lead this growth rate and contribute largest to the employment growth in the country.

This trend could have a positive impact on the property markets. However, there are a number of risks that could adversely affect the outlook for a strong and sustainable growth rate.

First, an increase in oil prices and commodity prices could lead to increase in inflation resulting in tightening of interest rate by the Reserve Bank of India [Get Quote].

Second, as the Indian economy gets aligned with the world markets it will be more exposed to geopolitical and world markets, and to the risks associated with the same.

With various property types (office, housing, retail, industrial, warehousing, hotel, etc.); come different property cycles. Economic dynamics directly affect each of the property types differently.

Real estate is relatively slower to respond to changes in the economy as compared to many other asset classes. Knowing the background of a market and property type within the market can help determine the risks and cycle length of a market.

The fundamentals for investing in property markets remain strong in India -- relatively low interest rates, strong capital flows, high employment growth, abundant liquidity, attractive demographics (young population and migration from West), increase in affordability, and a large supply of stock to keep up with demand and focus on quality.

Housing sector

India joined the global housing boom driven largely by low interest rates and rising incomes. Never before have house prices risen simultaneously in most parts of the world. The question that always comes up is -- when is the housing boom bubble going to burst.

The housing boom in India continued its fourth successive year of price rises. Year 2004 witnessed the sharpest price increase as compared to the last few years with price rises ranging from 12% to 50% in some regions.

Further the rise in prices has not been widespread but in selected locations within the city -- basically in centres of growth.

The supply of residential stock remains strong. In Mumbai itself, a record 30 million square feet will be added in next two to three years. The yields of residential properties are now in the range of 4% to 6%.

Investors need to be cautious in locations where rents have not moved in line with the sharp increase in property prices.

There has been a significant improvement in the quality of residential stock now being introduced in the market. This has widened the price gap between new and old properties.

The residential sector will continue to outperform other segments for next two to three years. But in order to enjoy benefits, it is necessary to invest in regions with high growth potential and diversify across metro areas with different economic structures and cycles, and not just by region.

Office sector

Year 2004 marked the revival of office sector with steady rise in capital values and rental values. This was due to strong business confidence, expansion announcement by companies, relocation to new business districts, growth in IT and ITES related activities and opening of new business sectors to private companies (banking, insurance, etc.).

The capital appreciation recorded ranged from 10% to 20% with rental yields now quoting in the range of 9% to 11%.

As large and small scale industries shift from cities, the office sector in such cities is predominantly driven by the service sector. The supply of quality office space has also reduced. New projects are now being announced which should be available for occupation by 2006 and 2007.

Investment in office sector now requires large capital outlay due to growing demands of international tenants (both in terms of large space requirement, infrastructure and interiors support). This has dissuaded individual investors from participating in this sector.

As interest rates rise there could be pressure on yields to rise. But the strong capital flows and demand for quality investments could add pressure on yields further.

Hence, gains in this sector are expected from identifying new business districts, new regions and new cities that offer investors not only rental returns but solid capital appreciation.

Retail sector

Supply situation in retail sector continues to remain strong with various formats being introduced in the markets. It is too early to comment on the performance of this sector as the 'mall mania' is only 5 years old and with not many reports of secondary sales in the market.

With the opening of foreign direct investment in retail, this sector could gather further steam. But again the investment outlays will remain large. Further the retail sector is characterised by high maintenance costs and refurbishment costs which could eat away the returns.

Also the bond-like nature of retail leases and high pricing relative to reproduction costs will make the returns unsustainable in near future.

New class: Mutual Funds

Year 2005 could witness opening of mutual funds to invest in real estate. This would provide investors all the advantages of diversification, exposure to real estate sector with limited capital, liquidity, greater transparency and exposure to various sectors, different markets and regions.

Real estate is by far the world's biggest single asset class. Investors have much more money tied up in property than in shares or bonds.

Real estate is just as prone to irrational exuberance as is the stock market. It should not be reviewed as an easy way to make money. People buy property with the expectation that its price will continue to rise strongly over time (property is known to be an inflation hedge).

Such expectations lie at the core of all bubbles formation. Bubbles form when the price of an asset gets out of line with its underlying value.

The price you pay for a property should reflect the future rent/income at which you let it. As in the stock market, the prices in real estate are also driven by sentiments. All that is required to reverse a price movement is a change in sentiment. Wish you all happy investing in year 2005.

The author is Director, Mymakaan.com. The view expressed here are personal.

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