The valuation of real estate companies with large land banks is loaded with uncertainties, as few details of the land reserves and management capabilities to scale up production have emerged, three analysts following the equity market said.
Among the valuation methods, net asset value (NAV), which is the total value of assets less liabilities and divided by the total number of shares, has emerged as a popular choice. The basic building block is the cost of land reserves and their location, which is not disclosed fully, they said.
“We are unclear as to the value of the properties, their location and their values,” said Alex K. Mathew, chief analyst at Geojit Financial Services Ltd. “This is the main reason for volatile movements in realty sector stock prices.”
Based on the land banks, realty companies broadly have two business models. The first is to develop and sell, where a plot of land is developed as an office complex or residential apartments and then sold. In the second, the company develops the property but rents or leases it out to clients instead of selling.
“Land bank is the raw material for real estate companies,” said Shyam Sekhar, an independent equity analyst. “Real estate companies have to create revenues through value addition (developing the property) from the land they hold. Their core activity is to add value to the property.”
“What we are concerned with is how the valuations of the listed stocks we cover measure up,” wrote Matt Nacard and Siddhartha Gupta, analysts at Australian advisory firm Macquaire, in their report on Indian property.
“A detailed assessment of each company’s land bank is required for us to be confident of our NAVs. There clearly is substance behind the hype,” they said.
Macquaire uses “sum of the parts” valuation, which means different businesses within a company are valued underdifferent methods and then added.
For the ‘develop and sell’ part of business, they use the discounted cash-flow method, which discounts future earnings of the business to today’s value. Here, too, the details of the land are essential to ascertain the viability and determine the business potential from a particular location.
Sekhar said capital required and cash flows from the property depend on the type of land ownership. He classifies these into three groups: presumptive ownership (where lands are shown under sole development rights), absolute ownership (where the company owns the land) and vested ownership (there is no land bank, only a letter from a government agency).
“It is unfortunate that the same premium is attached to all the three types of lands owned. It should change as the capital requirements and cash flows arising out of the projects vary,” he said.
To remove the uncertainty over land ownership and other details, Geojit’s Mathew said rating agencies could rate the land reserves held by the realty companies so that “investors can have a criterion to value the company”.
Already, Icra Ltd, a credit rating agency and an associate of Moody’s Investors Service, has developed a rating methodology for the construction and real estate sector. It has developed ratings criteria for both real estate projects and real estate developers.
Yet, another uncertainty in estimating the value for a company is the non-availability of long-term demand and supply forecasts. Companies are claiming that their existing land reserves are sufficient to meet their demand for between seven years and 10 years.
For example, DLF Ltd, whose initial public offering opens next week, said its land reserves are sufficient to meet its development needs for another 10 years.