Friday, September 02, 2011: 12:18:01 PM

TJCD Case Study

Realty financing and investments - predictions for next 1 year

Rising interest rates, increase in vacancy and demand slowdown will impact the earnings of developers, resulting in slowdown of construction activity; the property sector would have fewer new launches and delayed project delivery

The only constant is change. This has been an axiomatic truth for the Indian real estate market over the last 24 months, with volatility having become a byword to describe it. There has been little or no respite from this state of flux.

 
The US and European debt worries have added to the uncertainty. Over the last 2 months, the domestic real estate market has been beset by reduced growth expectations a potential tightening of the liquidity squeeze. This is an unsettling time for the market and obviously for real estate investors as well. Are we looking at 2008 all over again?
 
With the escalating global liquidity issues, these are challenging times. Over the next 12 months, we definitely expect these sentiments to reflect in the financial profile of the Indian real estate sector. It is a certainty that banks will enforce selective lending with stricter verifications. Interest rates will stabilise, but liquidity will continue to be tight and the disbursal rate of home loans is bound to reduce.
 
Developers will be under pressure to reduce their debt-to-equity ratios. Fundraising through the qualified institutional placement (QIP) route will reduce, and we are going to see a decrease in real estate IPOs. Considering the current liquidity crunch, the proceeds from existing IPOs will be fully utilised for the completion of projects and repayment of debt.
 
Listed developers to gain
 
These dynamics are going to lead to a very clear segregation of the sheep from the goats. In other words, listed developers with better disclosure standards, good corporate governance, better speed of project delivery and records of consistent dividend payments will see better share price performance. Simultaneously, the distressed projects of smaller developers will be acquired by medium-to-large players at prices that will be significantly lower than their original valuations.
 
With banks and institutional lenders becoming more cautious about lending to the real estate sector, demand for capital from private equity funds and NBFCs will increase. Meanwhile, the risk appetite of private equity investors will reduce further. Those that will continue to invest will display a preference for core and core-plus type investments, and smaller residential projects within and in close proximity to the city limits of our metros. Realty funds are expected to focus more on HNIs and family offices in domestic markets for fund raising.
 
The high interest rates, increase in vacancy and demand slowdown will impact the earnings of developers. A natural consequence will be a slowdown of construction activity, leading to fewer new launches, and also delayed project delivery. Once again, we are going to see developers resorting to the volume-led strategy rather than focusing on margins. In this respect, at least, the scenario that is strongly reminiscent of is 2008-09.
 
Margins will in any case be squeezed by the increased construction costs brought on by inflation. This means that a number of developers will miss their pre-launch targets. We are likely to see pre-launch projects coming with at 10-15% discount over the pricing of other projects in the same areas.
 
Nevertheless, unsold residential stock will increase further. Many developers will sell their non-core land and divest their stakes in non-core businesses such as hospitality and retail. Given the proposed land acquisition bill and impacted funding scenario, developers will go slow on land banking and focus on the joint development route.
 
Significantly, SEBI is expected to come out with a separate set of guidelines to regulate real estate private equity and FDI into the real estate market. The objective of this increased scrutiny is obviously to reduce the incidences of real estate being used as a tax haven. The RBI is also expected to review its standpoint on standard provisioning and risk weightages for loans to the real estate sector, and lay out tougher due diligence standards for banks with regards to sanctioning loans to the sector.
 
The report was prepared by Ramesh Nair, managing director (West India) at Jones Lang LaSalle India, a property advisory firm

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