Shares of property developers have bounced back sharply in the past fortnight. The Bombay Stock Exchange’s realty index has risen 7.76%, beating the bellwether Sensex’s 4.75% gain. However, the bounce back may not be sustainable as concerns that led to their fall in the first place haven’t gone away.

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Customers are deferring buying homes due to a combination of high property prices and rising mortgage rates. Housing Development Finance Corp. Ltd hiked lending rates by 25 basis points (bps) at the beginning of this month and ICICI Bank Ltd by 50 bps a week prior to that. Now, rising interest rates will not only bite home sales, it will also attack profits through higher debt refinance costs. One basis point is one-hundredth of a percentage point.

As it is, banks are wary of lending to property developers after the recent spate of scams. A look at the Reserve Bank of India (RBI) data for the week ended 28 January shows outstanding loans to commercial real estate declined marginally from two months ago, the last time RBI disclosed sectoral data.

Besides, property prices continue to remain high, especially in metros such as Mumbai. Equated monthly instalments as a percentage of monthly household income are close to the peak levels seen in 2008, according to PINC Research. In Mumbai and Delhi, this ratio stands at about 50%, putting further pressure on home sales.

With developers generally reluctant to cut prices, the broker consensus is that it could take up to six months for houses to become affordable again. This would be partly due to rising incomes and partly because rising cash flow problems will spur some of the weaker firms to sell inventory at lower prices, sparking a round of price cuts. True, there are not many concerns on execution, despite many companies missing sales guidance. But construction costs are rising, with labour shortage pushing up wages, and margins are getting tighter.

So what prompted the recent round of buying?

Of course, this bounce back has been led by rate-sensitive sectors, which had also taken the worst beating since the market attained its high in November. But one must also note that banking and auto had other things going for them such as decent credit growth and strong sales.

In the case of real estate stocks, valuations had become extremely cheap. To cite just two instances, valuations had slipped to 4.8 times in fiscal 2012 for Housing Development and Infrastructure Ltd and 8.3 times for Unitech Ltd.

But with earnings downgrades and rate hikes looming large, even that argument might peter out in some time.

Graphic by Sandeep Bhatnagar/Mint

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