Taking Stock of Ground Realty

The contrast is stark. While there is high chance that the house you bought last year has risen in value, the shares of your oncefavourite real estate company are going only one way – down.

The Bombay Stock Exchange(BSE) Realty index has fallen 37% between March 2, 2010, and July 29, 2011. The BSE Sensex, in contrast, has risen 8.49% during the period.

DB Realty has seen the steepest fall of 83% to Rs 78 during the peri- od. DLF, India’s largest property developer, has fallen 21% to Rs 230.

The sector’s prospects are looking bleak due to a series of interest rate increases since March 2010 affecting demand for real estate, along with rising input costs and mounting debt.

So, as you wonder whether to buy, hold or sell real estate stocks, market experts advise caution.

Mehul Ashar, president and head, wealth management, Inventure Growth and Securities, says, “Investors should check the fundamentals of the company. If the fundamentals are looking weak, it is better to book losses and exit at the present levels.”

RATE PAIN

What has hurt real estate companies the most is the Reserve Bank of India’s (RBI’s) war on inflation. On July 26, the RBI increased the repo rate, at which lends to banks, by 50 basis points (bps) to 8%. It has increased rates 11 times since March 2010, making loans costlier and keeping buyers at bay.

Manish Sinha, head, consumer assets, HSBC Bank, says, “The 50 bps increase is significant. From the perspective of retail lending, it will definitely slow borrowing, especially in investment and buy-to-let mortgages.”

Ashutosh Datar, an economist at IIFL, a brokerage, says, “The latest increase was against the market expectation of a 25 bps rise. We expect another 25 bps increase and a pause thereafter. There is a possibility that inflation will ease in the second half of 2011-12.”

Teena Virmani, vice president(Private Client Group Research), Kotak Securities, agrees. “By the end of 2011-12, interest rates may start coming down. Also, some issues in the real estate sector are expected to be addressed. Investors should then focus on companies with good governance norms and attractive valuations,” she says.

Increase in interest rates affects demand for homes by making loans expensive. “For a 20-year loan, we have estimated that EMIs, or equated monthly instalments, have risen 20-23% because of the rate increases since March 2010,”says HSBC’s Sinha.

ALL-ROUND PRESSURE

Prop-equity, a research firm, says there has been an 18% increase in construction cost over the last two years due to higher prices of steel, cement and bricks, along with rising labour costs.

This, along with tight liquidity and rising interest rates, led to a surge in debt of real estate companies in 2010-11. For instance, debt of DLF and Godrej Properties rose 19% and 79% to Rs 15,060 crore and Rs 816 crore, respectively, in 2010-11, as against 2009-10.

The Confederation of Real Estate Developers’ Association of India has estimated that the sector will face a funding gap of $70 billion(Rs 3,15,000 crore) over the next five years.

To make matters worse, the RBI has asked banks to be cautious on lending to real estate companies. It has been increasing provisioning—the capital banks have to set aside—for loans to the sector.

According to RBI data, bank funding to commercial real estate grew 20% in the year ended May 30, 2011, as compared to 1.2% in the corresponding period a year ago.

Real Estate Sensitivity Index data from Liases Foras, a Mumbaibased real estate research firm, show that in March 2011, the unsold inventory in six major markets—Mumbai Metropolitan Region, Delhi, Bangalore, Chennai, Kolkata and Pune—was 471.91 million square feet, or 4,06,000 housing units. Market experts say rising interest rates have made potential buyers defer purchases.

INVESTMENT OPTIONS

That the sector is going through a tough phase is a given. However, if you still want to invest in some real estate companies, you can choose the ones with low debt, say market experts. Virmani of Kotak Securties says, “You can invest in companies which are either debt-free or have low debt on their books.”

Parikshit D Kandpal, senior research analyst, Karvy Stock Broking, says, “The holding should be limited to companies with minimal debt-to-equity ratio, strong cash flows, no share pledges and high governance standards.”

Incidentally, the shares of companies such as Sobha Developers and Ashiana Housing rose after they reported a fall in debt during the financial year ended March 2011. Sobha’s total debt fell 17% to Rs 1,211 crore, while Ashiana Housing reported a 60% fall to Rs 3.10 crore. Between March 2010 and July 2011, Sobha Developers and Ashiana Housing stocks have risen 4% to Rs 259.75 and 59% to Rs 152.35, respectively.

Suman Memani, research analyst, PINC Research, says,“Following the recent fall in stock prices, valuations are attractive from a long-term perspective. We are positively biased towards the sector as we are likely to see inflation cool off from the fourth quarter of 2011-12 or from the beginning of the next financial year.”

“Among large-caps, one can consider DLF and HDIL. Phoenix Mills is looking attractive in the mid-cap space,” says Memani.

A Motilal Oswal Securities report says Indiabulls Real Estate and Mahindra Lifespace Developers can touch Rs 190 and Rs 480 in the next few months. This will mean an increase of 64% and 26% from the July 25 levels of Rs 115 and Rs 370, respectively.

PRIMARY OPTIONS (IPO)

Out of the 132 initial public offerings (IPOs) lined up, the largest number —15 —are from the real estate sector. Real estate companies are facing liquidity crunch and are looking to raise money.

A number of unlisted developers plan to finance projects and repay debt by raising money from the stock market. These include Raheja Universal, Lodha Developers, BPTP, Lavasa and Kumar Urban Development and Emaar MGF. However, Kandpal of Karvy is not expecting any real estate IPO this year due to subdued market conditions.

While the primary market option might not be available to those wanting to invest in real estate companies, one should exercise caution while investing in these stocks in the secondary market as well.