Realty faces reality: 15-20% correction by Q1 2009
The Economic Times
31 Oct, 2008, 1725 hrs IST,Surya R Kannoth
MUMBAI: The real estate bubble has finally burst! The sector that was in the limelight a year ago is simply coming apart. Severe cash crunch with bank loans drying up, sales plunging, demand falling and stock market crashing have compounded the worries for real estate companies.
The real estate sector in India has grown 30-35 per cent in the last five years, reflecting the rapidly-increasing demand for office, commercial and industrial space, as well as bigger homes now considered within the range of India's prospering working class.
But the economic juggernaut has been slowing since earlier this year due to double-digit inflation, a severe liquidity crunch as fallout of the US sub-prime crisis, and now, the possibility of economic activity shrinking as part of a global slowdown. The country's growth estimates of 9 per cent at the beginning of the year have been revised to well below 7 per cent, and the effect is directly visible on the realty sector. The BSE Realty Index has already witnessed 82 per cent fall from October 2007.
“People are concerned about cash provisions and where real estate companies will get money from. People are exiting at any price because there are no buyers for realty stocks. Investors are now shifting from net asset value-based valuation to cash flows of the company. Real estate stocks have been correcting mainly because developers have not reduced home prices despite a slowdown in sales,” said Sandeep Acharya, analyst with Spark Advisory. Developers are now hitting upon novel marketing strategies, absolutely unheard of in the sector, to woo reluctant flat buyers. Offers ranging from 'Buy 1 flat, get another free', 'Drive to your new dream home in your dream car' clearly show the desperation among real estate players.
A clear move to shore up the sagging morale of prospective buyers, property developers have even come forward to pay pre-EMI interest on part-money disbursed on the housing loan taken by a flat buyer. Local builders such as Mantri Synergy, Jains Sunderbans, ETA Rosedale and Hirco Palace Gardens have come out with such schemes to attract buyers.
Most of the real estate companies take debt at project level, which typically range from 2-4 years. This implies that every year, close to 30-40 per cent of the total debt becomes due for repayment. Hence, real estate companies need to monetize the project timely to be able to repay the debt on time.
“Due to the slowdown in the sector, this cycle has come under pressure, as property transactions have dried up considerably - delaying the monetization of assets. Due to the ongoing credit tightness, banks are unwilling to extend or refinance old loans and are imposing several new covenants on the developers. At the same time, financing for new projects is becoming more stringent with clauses for exclusive use for stated projects as a result, servicing of bullet repayments falling due in 2008 remains a key challenge,” said Motilal Oswal Securities in a report.
The credit crisis across the globe has taken the sheen off large property firms, with DLF and Unitech, two of India's leading real estate companies, seeing their market cap eroding almost completely and their fund raising plans being hit.
Recent developments - particularly with respect to Lehman Bros and Merrill Lynch that have been amongst the large investors in the domestic real estate market--have created concerns over the fate of their key investments. Lehman has investments of $165 million in one key Mumbai project (that of Unitech) and $200 million in DAL (a promoter group company of DLF), while Merrill has invested $370 million in seven of DLF's township projects.
Struggling under depressed sentiments and falling prices during the last few months, the sector has seen a substantial erosion of value and wealth in the market mayhem, with most speculators running for cover. The impact is clearly visible in raising funds for projects and meeting deadlines.
“To unlock the liquidity crunch across the globe, major central banks lowered their key rates. Reserve Bank of India has, in tandem with the global banks, cut key rates few days back. However, despite the rate cuts, banks are not likely to cut the rates on home loans and other loans. So unless realty firms unlock the liquidity problems by selling homes at lower prices, they may continue to be hammered along with markets," Spark Advisory's Sandeep Acharya said.
Even as real estate players pin hopes on the RBI to reduce repo rates further, banks are in no mood to revise their home loan rates. The country's largest bank, State Bank of India, on Monday said it would keep its lending rates, including home loan rates, unaltered. Smaller banks, like Karnataka Bank, Canara Bank and Vijaya Bank, have also indicated that lending rates are likely to stabilise at current levels.
“Home loan rates staying firm could lead to postponement of housing demand. Mortgage firms like HDFC and LIC HFL are witnessing lower sanctions and disbursements in the high rate scenario. This could continue as high rate structure could stay for couple of quarters and availability of credit becomes dearer of mortgage firms. As for mortgage business, better indicators could be housing finance companies rather than banks, as for later housing finance is one of the businesses and the mortgage portfolio could be smaller part of the entire business,” said Sandeep Shenoy, strategist at PINC Research.
Realty stocks are expected to see a further slide and sector analysts predict that it could realty prices could go down to 2002-03 levels. Untech, DLF and the likes were responsible for galloping real estate prices.
Sector analysts at Enam pointed out that aggressive land acquisition at peak prices through short-term high cost debt and huge working capital mismanagement (short-term debt used for long-term projects) were some of the ills that plagued the industry. Moreover, developers had stubbornly held on to selling prices and high-cost inventories, hoping for a renewal of demand and hike in prices.
The realty business model consists of three stages of value creation--land acquisition / aggregation and conversion, construction and development, and the lease/sale of the property.
The whole business model depended on the ability to infuse cheap monies at the earliest stages, including additional infusion through exits at the end of each stage, to be able to funnel monies back to stage one-- land acquisition. Further, as each project funds another in this working-cap intensive business, liquidity is the key driver of the business. With decreasing options, distress-sale of land parcels was the only option for some.
“We see the discount on offer as the last attempt of developers to hold on to current prices with a marginal discount of 5-8%, before they are forced to adjust property prices taking into account the challenging macro economic realities. We do not expect volumes to recover in the current economic uncertainty which would worsen the cash flow problems for the sector. We expect sharp and visible correction in prices by developers from early next year,” said a report of JM Financial.
In most cases, we observed that property prices were maintained or increased from the level they were about six months back. Taking into consideration the slowdown that capital market related activities have seen, we feel that the current prices are not in line with the affordability of buyers.
The government, in March 2005, amended existing norms to allow 100 per cent FDI in the construction business. This liberalization act cleared the path for foreign investment to meet the demand into development of the commercial and residential real estate sectors. It has also encouraged several large financial firms and private equity funds to launch exclusive funds targeting the Indian real estate sector.
“With debt market getting dried up, developers facing the heat of liquidity crunch and PE funds shying away from real estate investments and speculative investments at an all time low, we can expect a 15-20 per cent correction by the first quarter of 2009,” said Anuj Puri, managing director, Jones Lang LaSalle.
Moreover, private equity investors who had been picking realty deals earlier this year appear to have tightened their purse strings now. September month has witnessed only two transactions worth just $12 million.
According to real estate consultants, seven major Indian cities including Delhi, Mumbai, Kolkata and Bangalore showed a marked decline in demands during the quarter ending September. Leasing of office space had also slowed down significantly.
Only those players who have achieved substantial revenues from past deals could expect to rise against the tide. “Rationalise costs, move to affordable housing and be realistic in pricing; those who cannot do that would be in danger of being pushed to bankruptcy,” warns PINC Research's Shenoy.