First Cut | GST on real estate slashed – will there be any impact on prices?

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In a move to cheer homebuyers, the government has doled out one more pre-election sop by slashing the Goods & Services Tax (GST) rate on properties under construction from 18 percent (effective GST of 12 percent and 6 percent abatement for land) to 5 percent. The Council also cut GST rate on affordable housing to a percent  from the current 8 percent and expanded the scope of affordable housing to units costing up to Rs 45 lakh and measuring 60 square metres (earlier 30 sq m) in metros and 90 sq m (earlier 60 sq m) in non-metro locations.

However, builders will not be able to claim input tax credit. This is interesting as the final benefit depends on whether the benefit of GST rate cut outweighs the negative of no input tax credit as builders were rarely passing on the benefit of input tax credit to homebuyers.

Take an example of the Mumbai market, where construction cost is typically around 40 percent. Input tax credit claimable was 7.2 percent and GST rate on the project was 12 percent, resulting in a positive spread of 4.8 percent. With the abolition of input tax credit, tax paid on inputs is still 7.2 percent and GST rate is 5 percent, resulting in a negative spread. So, it remains to be seen if the benefits are passed on or the builder resorts to a small price hike. In view of the oversupply in the market, hiking prices may not be an option, resulting in a squeezing of margins for developers.

In a market where the construction cost is a higher share of project cost, the economics is worse. For instance, if the construction cost was 80 percent of project cost, the input tax credit was 14.4 percent, and with a GST of 12 percent, there was a negative spread of 2.4 percent. With the slashing of GST rate to 5 percent, the spread is significantly negative.

Homebuyers, therefore, should expect no relief on final prices although they will now pay an effectively lower GST, since in the earlier regime the benefit of input tax credit was not passed on.

For affordable housing, the earlier input tax credit was 8 percent and the GST rate was also 8 percent. With the abolition of input tax credit, the benefit of 8 percent is gone, and the new GST rate is a percent, again resulting in a negative spread for the developer and could lead to a small price hike.

It remains to be seen, in the face of the oversupply in the market, how developers react to the announcement. Given that availability of credit is increasingly becoming an issue for the real estate sector, resorting to price hike while clearing unsold inventory may not be an option. We do not see this as fundamentally altering the stressed scenario of the real estate market and therefore the linkage to the rest of the economy would be at most limited.