Ground reality

Affordable housing is the only silver lining in an otherwise lacklustre real estate market. Investors need to tread with caution



The residential property market, which was in a downturn since 2013, turned the corner in early 2016. In the first half of calendar year 2016, unit sales growth (compared to the same period the previous year) in the top eight cities became positive after a long gap.

However, then came the demonetisation in November 2016, along with the Benami property law; helping the Central government go the whole hog and crack down on cash-based transactions in the sector.

The Real Estate (Regulation and Development) Act, 2016, which became applicable from May 1 this year, gave a further blow, making builders shelve new launches and focus on RERA compliance to remain in business.

Given the uncertainty, buyers too preferred sitting on the fence and playing it safe — only buying properties that were already completed or nearing completion.

In the top eight cities of the country, unit sales were down 11 per cent in the first half of the calendar year 2017, according to data from Knight Frank, a global property consultant.

Affordable housing shines

With lack of confidence looming large in the sector, new launches dwindled during the first half of 2017; about 60,000 units were launched in the top eight cities, a multi-year low.

However, the silver lining in all this has been the mushrooming affordable housing across the country. Thanks to the Centre’s ‘Housing For all by 2022’ initiative that exempted developers from taxes on profits for affordable housing projects, about 70 per cent of the first half-year launches in 2017 were in the price bracket below ₹50 lakh.

The initiative got a further leg-up with Budget 2017 granting such projects infrastructure status as well as increasing the construction time limit from three to five years. Ever since, most builders across the country have been modifying their projects to make the most of this new opportunity.

laggard office market

Coming to the office market, slowdown in the IT and ITes sectors, triggered by cut in IT spends in Europe and the US, has affected demand for office spaces. During the first half of 2017, 18.1 msf (million square feet) of office space was transacted; it was down 13 per cent as compared to the previous year.

IT and ITes constituted 39 per cent of overall sale transaction during H1 2017 .

However, a positive trend at the national level is the consistent fall in vacancy levels since 2012. During the first half of 2017, they hit an all-time low of 12 per cent. Lack of ready-to-occupy new office spaces in the IT-dominated cities of Bengaluru, Hyderabad and Pune led to single-digit vacancy levels of 4 per cent, 9 per cent and 8 per cent, respectively.

To gauge how the residential and office market is doing, here is a low-down on major property markets in the country.

Mumbai

Mumbai residential unit sales during the first half of 2017 were down 8.3 per cent as compared to the previous year. Moreover, even the launches were lower compared to the previous year thanks to huge unsold inventory. Many launches saw a reduction in apartment sizes by the builders to make it affordable.

The proportion of new launches in the below ₹50 lakh price bracket range doubled from 33 per cent during H1 2016 to 71 per cent during H1 2017. Peripheral central and western suburbs accounted for bulk of new launches during H1 2017.

Among the listed realty players, Oberoi Realty, Indiabulls Real Estate, Godrej Properties, Mahindra Lifespaces and Sunteck Realty have significant presence in the Mumbai residential market.

And those in the luxury space — especially Sunteck Realty and Oberoi Realty —look vulnerable.

‘Signia Isles’of Sunteck at a price tag of about ₹46,000 per sq ft (psf) will find it hard to find buyers, given the current market conditions. Moreover, Oberoi’s ‘Three Sixty West’ at Worli is struggling to find buyers at a price of ₹50,000 psf. In the June quarter of 2017-18, it sold just two of its units.

Godrej Properties, with its focus on the central suburbs, is on better ground. Godrej Trees, its residential property in the central suburb (Vikhroli), has been receiving good response. This project contributed about 21 per cent of the company’s overall sales during the June quarter of 2017-18. Its recently launched projects Godrej Tranquil (Kandivili east) and Godrej Origins (Vikhroli) are also in the suburbs.

Thankfully for Indiabulls Real Estate, about 96 per cent of its luxury residential project ‘Blu Estate and Club’ at Worli has already been sold. And its forthcoming projects are coming up in the periphery of Mumbai .

Office space: About 3.1 msf of office space was transacted in H1 2017; it was down 18 per cent as compared to the previous year. Office transactions have been slowing since 2015. And the vacancy rates, which were about 20 per cent during H2 2016, increased further to 22 per cent during H1 2017 .

As against IT/ITes, it has been the ‘other services’ comprising e-commerce, consulting and media that drove the demand for office space in H1 2017.

Among the listed players, Indiabulls and Oberoi Realty have significant stakes in the Mumbai office space. Indiabulls Finance Centre and One Indiabulls Centre, put together, have about 3.3 msf of leasable area; 1.6 msf more will be added.

However, its completed properties have a high occupancy rate of 91 per cent, thanks to its locational advantages. Its management expects to clock about ₹1,360 crore in rental revenues by FY21 from ₹540 crore as of FY17; 82 per cent of its FY21 rental revenues will be from Mumbai office space. With most of its upcoming office properties located in the prime business location, it is on relatively better keel.

Godrej Properties has about 1.3 msf of saleable office space area at the prime location BKC. While it has got players like Abbott on board, it needs to ramp up sales to reduce its debt levels. However, Godrej Properties is reasonably hedged; in the first quarter of 2017-18, sales from Godrej BKC contributed to only 4 per cent to its overall revenues.

Oberoi Realty derives about a fourth of its revenues in the form of rentals, all from Mumbai city. Its office spaces, ‘Commerz’ and ‘Commerz two’ in the western suburb (Goregaon), have occupancy rate of 89 per cent and 45 per cent, respectively. ‘Commerz two’ commenced operations recently. However, the company’s rental income is diversified with presence in mall (Oberoi Mall) as well as hospitality (The Westin) that, in turn, have an occupancy rate of 99 per cent and 82 per cent, respectively.

Takeaway: In the residential space, investors are better off sticking with players that are not in the luxury segment. With huge inventory, they might find it hard to find buyers. Godrej Properties is perhaps the best poised to weather stormy times in the city. In the office segment, Indiabulls, given its presence in prime locations, is expected to maintain relatively higher occupancy rates.

Bengaluru

About 21,200 units were sold in Bengaluru during the first half of 2017, down by 19 per cent as compared to a year ago. Launches were down by 42 per cent during H1 2017 as compared to the previous year. Residential inventory is currently at its highest levels since June 14. Also a lot of launches were in the ₹25-50 lakh price bracket.

Sobha Developers, Prestige Estates, Brigade Enterprises, Puravankara and Godrej properties are among the large players in the city. About 73 percent of Sobha’s unit sales during the first quarter of 2017-18 were from Bengaluru and about 76 percent of them were in the premium price bracket of above Rs 1 crore. That makes the company vulnerable given high inventory levels, especially in the premium segment.

Puravankara earned about 48 percent of its sales from the city during the first quarter of 2017-18. However, it was better placed than Sobha with Rs 1 crore plus flat constituting only 15 percent of its sales. Prestige Estates, has about 86 per cent of its ongoing projects in the city. As of June 2017, it had 30 per cent of its inventory in premium projects.

Office space: Bengaluru constitutes one-third of overall transactions in the country during H1 2017. About 5.8 msf of office space was transacted in H1 2017, down by 5 per cent. However, given its very low vacancy levels, rental growth was stronger at 9 per cent during the first half of 2017 as compared to the previous year.

Prestige Estates has forayed into commercial projects the major way — about 10 of its 35 forthcoming projects will be commercial. In the first quarter of 2017-18, ‘Prestige Trade Tower’ was completed. In contrast, Sobha and Puravankara, largely operate in the residential space.

Takeaway: Investors are better off sticking with players who don’t have much of residential inventory in the premium market. Cut in IT spends will slowdown residential sales in the city and bring prices lower. Puravankara seems better placed to weather the residential realty downturn in the city.

With office space vacancy remaining at record low levels, rental growth is expected to be strong in the city, benefiting office players like Prestige. However, cut in spends in the IT/ITes across the US and Europe will weigh heavy on office occupancy rates over the medium term.

National Capital Region (NCR)

About 17,188 units were sold in the NCR region during the first half of 2017; it was 26 per cent lower than the previous year. During H1 2017, sales from Greater Noida constituted 43 per cent of overall sales in the NCR region, followed by Noida (19 per cent) and Gurugram (14 per cent).

The new launches in the first half of 2017 were just 4,800 units; a sharp fall of 73 per cent from that of the previous year and a new multi-year low. The share of launches in the below ₹25 lakh price bracket shot up from 2 per cent during H2 2016 to 70 per cent during the first half of 2017.

While sales in Gurugram was hit by falling consumer confidence, litigations and poor connectivity, Noida managed to prop up sales in H1 2017.

DLF and Indiabulls Real Estate are major players in the city. About half of DLF’s land bank of 203 msf is in Gurugram. During the June quarter of 2017-18, about 80 per cent of its sales were from Gurugram, projects .

Against the tide, Godrej Properties has upped the ante at Gurugram. During Q1 of FY18, it added three new properties in the region while also launching a new Noida project ‘Noida 150’. Also, Indiabulls has considerable presence in Gurugram; about one-third of its ongoing developmental projects are in the NCR region. However, its two residential projects ‘Centrum Park’ and ‘Enigma’ at Gurugram have received booking for 79 per cent and 91 per cent of its flats.

Office space: Leasing in the office space was down 9 per cent in NCR to 3.2 msf during H1 2017 as compared to the previous year. Gurugram remained the most preferred with about 55 per cent of the transactions in H1 2017 happening in the region.

DLF Cybercity, Golf Course road remained preferred office space in the NCR region. Rentals in Gurugram were up by 8-12 per cent in the last one year as against 9 per cent for Noida. DLF has significant office presence in NCR region and it will benefit from increased preference for DLF Cybercity and its expansion. The company derived 16 per cent of its revenues as lease rentals during the June quarter of 2017-18.

Takeaway: Higher inventory is expected to keep prices lower in the region. Only reputed players like DLF or Godrej Properties will be able to generate demand in this otherwise slackening residential property market. In the office segment, DLF is better placed to benefit from higher rental yields in the region.

Chennai

Chennai bucked the trend to post a positive 5 per cent growth in residential unit sales during the first half of 2017 as compared to that of the previous year. Hit by floods about two years back , it has still managed to revive. The proportion of launches in the ₹25-50 lakh price bracket was up from 21 per cent in H1 2016 to 46 per cent in the H1 2017.

Puravankara, Indiabulls Real Estate and Godrej Properties have presence in the city . Chennai is the second biggest market for Puravankara after Bengaluru. Chennai constituted 12 per cent of overall sales during Q1 FY 18. Its project at Thirumazhsai is expected to be launched along with that at Medavakkam. Moreover, its completed projects — Swanlake at OMR and another (Windmere – I) at Medavakkam have received 85 percent bookings each .

Takeaway: While Chennai market is expected to pick up, given its lower inventory levels, uncertainty hangs over the political leadership. Most builders are sitting on the fence seeking more clarity. Puravankara and Indiabulls Real Estate operate in the city; its contribution to total sales is not much.

* * *

What’s in store for realty stocks?

Investors looking to take exposure in the realty sector should tread with caution. For one, valuations are expensive for companies with sound business models. Take, for instance, Godrej Properties. The company’s stock price is up 86 per cent in the past one year, on the back of expectations that organised players will benefit, post RERA. The company is definitely well placed among its peers; it managed to grow its sales and profit at a three-year CAGR of 10 percent and 17 percent respectively. However, at a price-to-earning (PE) multiple of 73 times trailing 12-month earnings, it is quoting at a substantial premium to its 3-year average of 34 times.

Moreover, stocks of Bengaluru-based players Sobha and Prestige were up by 26-34 per cent in the last one year. Sobha witnessed a negative annualised growth of its net profit (about -11 percent) between FY 14-17 while it was a negative 5 percent for Prestige Estates. However, the stock of Sobha is quoting at a PE multiple of 23 times as against three-year average of 18. PE of Prestige was higher at 31 times as against three-year average of 22.

Running ahead

Indiabulls has been the best performer in the sector with its stock up by 209 per cent in the last one year. The company has plans to completely eliminate debt by FY 20 from its residential sales cashflows . Its sales and net profit were up by 10 percent and 20 percent respectively in the last three years. However, the upside is limited for the stock, given that much of the positives have been factored in the stock price. Its stock is currently quoting at a PE of 28 times as against its three-year average of 13. Currently its debt to equity is 2.3.

Oberoi Realty’s business model looks vulnerable on the residential side, with its higher exposure to premium priced flats. It PE multiple is at 37 times as against three-year average of 27. However, its operating margins were among the highest in the industry (55 percent in FY 17). It had negligible debt in its books.

The stocks that look reasonably priced now are Purvankara and Pune-based Kolte Patil Developers. Purvankara is quoting at a PE multiple of 14 times, which is same as its three-year average. Kolte Patil with its major exposure in the relatively better residential and office market of Pune is quoting at 16 times as against three-year average of 18. However, Kolte Patil has not been able to improve net profit; net profit was down by about 2 percent annually in the last three years.

Investment strategy

Investors should be cautious before taking fresh equity exposure in the space. Launches have hit a new low as many players are focused on completing their existing projects or become RERA compliant. This is expected to hit future sales for these companies and mar revenue visibility. While the low-ticket sales constituted bulk of recent sales, it needs to be seen if these listed players will benefit significantly from the affordable housing initiative.

Except for Godrej Properties and Mahindra Lifespaces, none have announced foray into this segment. Moreover, going ahead, slowdown in global IT spends is expected to take the sheen off Bengaluru office market which, in turn, could affect rental revenues.

Lastly, high debt levels also remain a concern for many of the realty players, including Indiabulls. Many builders took more debt to hold on to property prices. This, in turn, has affected their financials . There is bound to be a price correction, with high inventory especially in the luxury segment. Moreover, while RERA is notified in 25 States , uncertainty looms large as regards launch of further projects.

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