A 'wild child' in corporate governance norms, the realty sector's performance, of late, has not been quite up to the mark. What has triggered the correction is a surge in borrowing costs and higher prices. The alleged involvement of some of the companies in a wave of scams has only fed to the negative sentiment. ET Intelligence Group analyse the dynamics of the Indian real estate sector.
Indian realty stocks that looked all set to fly on the wings of rising demand amid easier access to bank loans and higher purchasing power have been beaten down once again in the recent market correction. In the past one year, Bombay Stock Exchange's Realty Index has been a stark underperformer, losing half of its value when benchmark Sensex managed to churn out a 2% return.
The price-to-earnings ratio of the realty index corrected from its peak of 59 in January, 2010, to a modest 19 in March 2011. But factors such as a rise in borrowing costs and peaking asset prices - that are weighing down the residential home segment - have stopped investors from bottom fishing in the stocks.
On the flip side, increasing interest rates will hit realty firms that have high debt on books and those whose demand is typically affected by higher borrowing costs for end consumers. But the impact will not be uniform on all builders with varied exposure to residential, commercial, and retail sectors. So, is it a good time to buy into the sector? ET Intelligence Group looks at the sector dynamics and its impact on the players.
On the flip side, increasing interest rates will hit realty firms that have high debt on books and those whose demand is typically affected by higher borrowing costs for end consumers. But the impact will not be uniform on all builders with varied exposure to residential, commercial, and retail sectors. So, is it a good time to buy into the sector? ET Intelligence Group looks at the sector dynamics and its impact on the players.
A squeeze on credit flow and slowdown in demand as job growth in the country came to a standstill led to a sharp fall in asset prices and many new projects were held back. This also pushed up inventory or vacant and unsold space across cities, resulting in high working capital pressure for the real estate companies. But in mid-2009, signs of revival in domestic economy, correction in asset prices, and lower interest rates led to a pick-up in realty demand.
Indian property prices are moderating
However, the expected fall in demand for residential housing is likely to be offset by the recovery seen in commercial realty segment over the past six months. The overall revival in economy and improving business sentiment is prompting companies to expand operations and set up new branches, thus leading to a rise in demand for commercial property.
While smaller realty firms are solely residential housing developers whose fortunes are directly linked to any change in property prices, interest rates, and absorption, the integrated players whose businesses are spread evenly between commercial and residential housing are less risk prone in a growing economy.
The company is partly insulated from high costs of purchasing land that eats into margins as interest rates go up, but its business is affected by a slowdown in demand either due to rising cost of home loans or unaffordable property prices. HDIL, the leading slum developer, derives close to half its business by selling transfer development rights (TDR), where a portion of land can be sold by a company undertaking redevelopment projects. So, any movement in TDR price determines its revenue on a sequential basis.
As all realty companies are not comparable on the same plank due to different revenue models and risks, investors need to pick their stock based on some other parameters that are comparable at par. While selecting a stock, an investor could thus consider the operating cash flow of the company as it is not impacted by any revenue recognisation schemes and gives the cash position, which is critical for realty firms exposed to high debt. Potential investors should also watch out for disclosure standards of companies, as it is necessary to make informed decisions.
Indian realty stocks that looked all set to fly on the wings of rising demand amid easier access to bank loans and higher purchasing power have been beaten down once again in the recent market correction. In the past one year, Bombay Stock Exchange's Realty Index has been a stark underperformer, losing half of its value when benchmark Sensex managed to churn out a 2% return.
The reality of residential home segment
The price-to-earnings ratio of the realty index corrected from its peak of 59 in January, 2010, to a modest 19 in March 2011. But factors such as a rise in borrowing costs and peaking asset prices - that are weighing down the residential home segment - have stopped investors from bottom fishing in the stocks.
Already considered a wild child in corporate governance norms, the sector was also hit by revelations of some firms being allegedly tainted by scams that fed into the negative sentiment. On the valuations side, the sector is attractive as the price-to-book value currently is at the same level as it was when both realty and stock markets had crashed in 2008, despite better fundamentals.
Fundamentals of the sector
On the flip side, increasing interest rates will hit realty firms that have high debt on books and those whose demand is typically affected by higher borrowing costs for end consumers. But the impact will not be uniform on all builders with varied exposure to residential, commercial, and retail sectors. So, is it a good time to buy into the sector? ET Intelligence Group looks at the sector dynamics and its impact on the players.
The real estate market can be broadly divided into three sectors - residential, commercial, and retail. Residential housing is the biggest driver of demand in the sector. In commercial realty business, nearly two-thirds demand come from office space and the rest from leased retail space. The demand for office space in the country has improved on the back of growth in information technology and banking sectors, which account for a big chunk of demand in the category. The Indian realty market went through a downturn following the global economic meltdown in 2008.
Fundamentals of the sector
On the flip side, increasing interest rates will hit realty firms that have high debt on books and those whose demand is typically affected by higher borrowing costs for end consumers. But the impact will not be uniform on all builders with varied exposure to residential, commercial, and retail sectors. So, is it a good time to buy into the sector? ET Intelligence Group looks at the sector dynamics and its impact on the players.
The real estate market can be broadly divided into three sectors - residential, commercial, and retail. Residential housing is the biggest driver of demand in the sector. In commercial realty business, nearly two-thirds demand come from office space and the rest from leased retail space. The demand for office space in the country has improved on the back of growth in information technology and banking sectors, which account for a big chunk of demand in the category. The Indian realty market went through a downturn following the global economic meltdown in 2008.
A squeeze on credit flow and slowdown in demand as job growth in the country came to a standstill led to a sharp fall in asset prices and many new projects were held back. This also pushed up inventory or vacant and unsold space across cities, resulting in high working capital pressure for the real estate companies. But in mid-2009, signs of revival in domestic economy, correction in asset prices, and lower interest rates led to a pick-up in realty demand.
The aggregate inventory nearly halved from mid 2009 to the quarter ended March 2010, according to a Credit Suisse report. As a result, residential property prices hit all-time highs in major markets. Going forward, Indian property prices are seen moderating as an increase in borrowing costs and record high asset prices will dissuade residential home buyers from buying new properties in coming quarters, say analysts and industry experts.
Indian property prices are moderatingRealty companies expanding operations
However, the expected fall in demand for residential housing is likely to be offset by the recovery seen in commercial realty segment over the past six months. The overall revival in economy and improving business sentiment is prompting companies to expand operations and set up new branches, thus leading to a rise in demand for commercial property.
Realty firms that derive a major chunk of their revenue from commercial property space have witnessed a significant rise in volumes and could be less impacted by the expected slower growth in housing demand. However, the commercial retail leasing market in India still remains under pressure as lack of government reforms in allowing foreign retailers to set up shop in the country has restricted volume growth.
Financial performance and stock selection
While smaller realty firms are solely residential housing developers whose fortunes are directly linked to any change in property prices, interest rates, and absorption, the integrated players whose businesses are spread evenly between commercial and residential housing are less risk prone in a growing economy.
DLF, Unitech, and Anant Raj Industries derive a significant chunk of revenue from commercial leasing, besides residential properties. As a result, they have more recurring rental incomes that support operating cash flows and their revenues are not just dependent on launch of a new housing project.
Realty companies are prone to high risks
On the flip side, these companies generally have high debt due to huge asset class, which makes them prone to high risks during a downturn. Among companies that primarily depend on residential properties, Godrej Properties - unlike most other realty firms - has an asset-light business model with most of its portfolio skewed towards joint development projects.The company is partly insulated from high costs of purchasing land that eats into margins as interest rates go up, but its business is affected by a slowdown in demand either due to rising cost of home loans or unaffordable property prices. HDIL, the leading slum developer, derives close to half its business by selling transfer development rights (TDR), where a portion of land can be sold by a company undertaking redevelopment projects. So, any movement in TDR price determines its revenue on a sequential basis.
No comments:
Post a Comment