After much dilly-dallying, the GST Council has decided to cut GST rates on under construction homes. The new rates are 1% for affordable housing projects and 5% for others —a significant reduction from the current 8% and 12% respectively. The council has also redefined affordable housing. Units should cost less than Rs 45 lakh and should be less than 60 sq m in size in metros and smaller than 90 sq m in other places.

How would these decisions impact real estate companies? First, the price gap between under-construction and completed projects will come down. This in turn will revive demand for under-construction projects, especially from builders concentrating on lower income groups because the GST gap between under-construction and ready possession is just 1% now.

“Redefining affordable housing and cutting the GST are big positive moves and will help builders who have inventory that fits into the segment,” says Sharad Mittal, Director & Head, Real Estate Fund, Motilal Oswal Real Estate. Rahul Prithiani, Director, CRISIL Research, concurs. “End-user interest towards under-construction properties will improve. Since 40-45% of ongoing supply in six cities fall below the Rs 45 lakh ticket size, the effective 1% GST rate should stoke demand. This should gradually improve liquidity of developers,” he says.

The GST cut was expected. As home buyers kept postponing their purchases, most real estate developers suffered lower sales in the third quarter of 2018-19. A GST savings of 7% works out to be Rs 7 lakh for a home buyer who buys a house worth Rs 1 crore, a sum that makes waiting worth it.

Will there now be a rush to buy under-construction properties? No, because the new GST rates will become effective only from 1 April. “Home buyers may wait for a few more months. Builders are reworking their pricing strategy, so the sales of under construction properties may get impacted in the fourth quarter as well,” says Abhishek Anand, VP, JM Financial Research.

Input tax credit impact
While this GST rate cut will improve customer sentiments, pricing issues remain. This is because the new reduced GST rates do not include input tax credit (ITC) benefits (see table). “Since input tax credit benefits will not be allowed on products like cement, steel, etc, the net impact on the final price will not be significant”, says Dharmesh Kant, Head Retail research, India Nivesh. In other words, the net gain is expected to be only around 4-5% of the house cost.

Builders who were not passing on the ITC of GST earlier would be in a better position now because there would be no impact on their margins, However, this cut will impact margins of builders who were passing on the benefit to their customers. They now have to increase their ‘base price’ to compensate for the loss of input tax credit. “Builders who were passing on the input tax credit benefit earlier will have to hike prices by 2%-4% to maintain margins. This seems difficult in the current market scenario,” says Rahul Prithiani, Director, CRISIL Research.

Location and last cost
While the number of homes costing below Rs 45 lakh will be small in big metros, that number will be high in smaller metros. For instance, Bengaluru has a large number of such projects and players like Prestige Estates and Sobha would benefit there.

Land cost is another important factor. “Since the share of land cost in Mumbai is significantly higher (between 50%-60% of the total), this change will benefit Mumbai based builders,” says Deepak Jasani, Head of Research, HDFC Sec. While Godrej Properties and Oberoi Realty are already fully priced, Sunteck Realty is the only one worth considering from this segment now. Sunteck has now got into the affordable housing segment witnthe launch of low cost projects in Naigaon.

However, the condition is different in other cities where land cost is equal or lower than 1/3 of project costs. For instance, Bengaluru builders may have to increase prices to maintain margins. “ Cost of land in smaller metros are less and therefore, their costs may go up because of the withdrawal of ITC and developers like Sobha, Prestige Estates, etc will either have to raise prices or maintain prices,” says Anand of JM Financial Research.

In addition to developers, companies that help developers by taking contract works will also benefit from the expected pickup in under-construction real estate volume.