Real estate euphoria premature as demand continues to be elusive

Given the deplorable base, the March quarter performance will look appealing. If at all, the financial health of firms with a higher mix of commercial assets would do better


Graphics by Subrata Jana/Mint
Graphics by Subrata Jana/Mint

On Thursday, a cursory mention in the Reserve Bank of India’s monetary policy that banks can invest in real estate investment trusts (REITs) was enough to fire realty stocks. The BSE Realty index closed 2% higher although other benchmark indices were down.

That isn’t all. Real estate stocks have been on a roll for about six months. Since January, the index representing the realty universe has returned 33%, thrice as much as the benchmark Sensex. But the concern is that the rally is yet to be backed by revenue and profit expansion.

The recent triggers have been mainly policies like the government’s initiative to boost mid-segment housing and more recently the establishment of the Real Estate Regulatory Authority (RERA) that promises a fair deal for both developers and stranded or short-changed buyers. While RERA aims to regulate the real estate sector to ensure that developers deliver projects on time and set penalties to be paid for delays, the question is if it would serve the purpose, given the time taken for settlement of disputes and grievances in the country.

However, the recent case where directors of real estate firm Unitech Ltd were arrested for cheating customers, has raised confidence in the realty segment.

Be that as it may be, the developers are still on shaky ground. A report by JLL India says that the National Capital Region, Mumbai and Bengaluru are the three biggest markets with unsold units. Worse, less than 5% units in the unsold inventory are ready for possession. That’s why most developers put new launches on hold in 2016 and the inventory overhang was reduced.

Data analysis of the BSE Realty index stocks is a dampener. The last three quarters show a year-on-year contraction in revenue and rise in interest cost as a percentage of sales. The situation was aggravated in the December quarter when the currency ban sucked out liquidity and unaccounted money, which is significant in real estate transactions. Average revenue of 12 realty firms contracted by 19% year-on-year and interest cost as a percentage of sales rose to 21%.

In fact, investors must be cautious now. Given the deplorable base, the March quarter performance will look appealing. If at all, the financial health of firms with a higher mix of commercial assets would do better. Lease rentals are rising steadily on the back of strong demand and lower supply. Stocks like Phoenix Mills Ltd and Prestige Estates Projects Ltd are better options from an investor’s perspective.

To sum up, the strong rally on the back of regulatory changes mirrors investor confidence. But then, these changes could delay recovery in the property market as developers will be forced to put their house in order. Banks and mutual funds too would look for a revival in demand before participating in the property market, be it through lending or through new instruments like REITs.

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