How do the falling circle rates affect you?

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In the last week of June, Haryana government’s revenue department decreased the circle rates in Gurgaon. The new rates are now 15% lower in almost all areas of the city. This has been done for residential as well as commercial properties.

In January, the Uttarakhand government had reduced circle rates in various parts of Dehradun. In a few localities, the circle rates were almost halved.

Usually, circle rates only go up. Rarely do we see any reduction in them. However, almost all real estate markets across the country have been stagnant for the past few years and have been facing price depreciation. Experts believe that the decrease in Gurgaon’s circle rates is in keeping with the market needs. They also believe that some other states and cities could follow suit soon.

But how does a change in circle rates affect property prices? Let’s find out.

What is circle rate?

Circle rate is the minimum value at which a property can be registered in a new owner’s name. This rate is administered by state governments and is revised periodically. “Increasing or decreasing the circle rates is an administrative play to improve revenue collections from property registrations, or to give a boost to under-performing property markets,” said Anuj Puri, chairman and country head, JLL India.

Circle rates can differ among cities in the same state, and even among different areas of a city.

In ideal conditions, it serves the purpose of curtailing black money. A property can no longer be drastically under-valued simply to avoid higher taxes. Circle rate usually indicates the fair property prices in an area.

Its big role comes in while transferring a property from one owner to another. For the purposes of registration, every property in a ‘circle’ has to be valued on the actual transaction value. However, even if the transaction value is lower than the circle rate, the levies on it will be calculated on the circle rate value, not the actual transaction value.

This can place extra burden on buyers if the actual value of a property is less than the circle rate. Buyers then have to pay higher stamp duty and registration fee, which is calculated on the more expensive circle rate.

For instance, stamp duty for registration of properties in Gurgaon is 8% of property value in urban areas and 6% in rural areas. If the sale deed is executed in favour of a woman, then there is a rebate of 2%. Similarly, properties located within the limits of Municipal Corporation of Mumbai attract a stamp duty of 5%. So, for a Rs.1 crore property, a man in Gurgaon will have to pay Rs.8 lakh as stamp duty, while in Mumbai only Rs.5 lakh.

The need for circle rates

In the days when real estate market was booming, the gap between circle rates and market rates had widened because market rates grew much faster than the pace at which government could revise the circle rates.

It was observed for long that while the market rates were high, properties were being transferred and registered consistently at the low circle rates, primarily to save on levies like stamp duty.

However, as the real estate market stagnated, in many cities the gap between actual rates and circle rate shrunk. In some of the other areas, circle rates were regularly revised upwards despite low demand. Here the circle rate overtook the market rate. This happened in Gurgaon too.

“As we have seen, market rates in Gurgaon have decreased over the years but the collector (or circle) rates continued to be high, leading to reduced interest from buyers,” said Vineet Relia, managing director, SARE Homes, a Gurgaon-based developer.

Even in Delhi, some localities are facing a similar situation. For example, in Maharani Bagh (an A category location with the highest circle rate), market rates are about 20% less than the circle rate, based on property prices of the area available on several property portals.

This gap between circle and market rates has adversely affected both sellers and buyers. The buyer now has to pay higher stamp duty, and sellers have to pay more capital gains tax.

Let’s take an investor who had bought a property for Rs.2 crore and wants to sell it now. Its current market value is Rs.4 crore but according to the circle rate it can only be valued at Rs.5 crore or higher. If a sale is made, the buyer will have to pay stamp duty on Rs.5 crore, even if she pays Rs.4 crore for the house. And the seller too would have to calculate the capital gain on Rs.5 crore, even if she received only Rs.4 crore.

Effect of circle rates

A change in circle rates may not immediately impact the market prices, which are driven by demand and supply in each area. “Usually, circle rates are a reference point for property transaction prices. They do not seem to bring about any direct impact on property prices,” said Puri.

However, it has been observed in the past that when circle rates rose, property prices also went up marginally. And when market rates went up, government increased the circle rates to keep pace with the upward movement. This became a vicious cycle in many areas and developers and property owners regularly cited the circle rate to demand more for their property.

This cycle seems to have run its course now. In sluggish markets where demand is low, increase in circle rates no longer has any impact on the market rate, as sellers can no longer absorb the increased price.

In the current market conditions, where property prices are already under pressure because of low demand, a decrease in circle rate could trigger a price drop. “It will not have a direct impact on prices, but clubbed with other factors such as implementation of the real estate regulation Act, drying organic funding and low demand may result in bringing down the prices further,” said Rajeev Bairathi, executive director and head-capital markets, Knight Frank India.

While a change in circle rates will not have much effect on the price of ongoing or under-construction properties, it could affect upcoming projects because many of the charges that developers pay are linked to the circle rate. A lower circle rate will bring down the developers’ costs, which it may pass on to the customers.

“It has a direct impact on the land premium payable, rates of purchasable floor area ratio (FAR), stamp duty for execution of lease deed, and other transactions, all of which will have a bearing on the project cost,” said R.K. Arora, chairman, Supertech Ltd, a Noida-based real estate developer.

Rahul Purohit, principal partner at real estate aggregator squareyards.com, agreed. “Upcoming and new property launches would see a positive impact as market sentiment will improve towards these properties,” he said.

The relationship between market rates and circle rates can differ across cities. In places where prevailing market rates are lower, a decrease in circle rates may not impact prices in the secondary market. The revised rates will surely reduce the gap between the market and circle rates and keep them in sync, thus helping the buyer and the seller to execute fairer deals.

However, one must remember that a downward revision of circle rates can also reduce the government’s collection of stamp duty and registration fee.