Real estate developers’ fixation with prices

Real estate developers’ fixation with prices

The moot point is how would real estate companies generate enough cash to pay back lenders if they choose to just hold on to their land holdings and hope that demand recovers. It is becoming increasingly evident that demand won’t recover in a hurry. Yet, the economic slowdown will lead to a further slowdown in demand for commercial property, and the possibility of job losses and salary cuts should curb demand for residential property.

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Why, then, are real estate developers reluctant to cut prices to spur demand? One hypothesis is that the real estate industry has a longer business cycle than most other asset classes. Once prices drop, they stay there for a longer period and the recovery normally takes longer than other asset classes. Hence the hesitancy in letting go of current price levels.

Whatever the reasoning, the wait-and-watch approach isn’t working. Demand didn’t recover meaningfully even during the Diwali season. Holding on to prices at the cost of not launching new projects essentially means that developers would have to rely on other sources for their cash flow requirements. Many of them have loan repayments due in the near future as well as payments for land purchases. In most cases, the only meaningful resource held is land, which now cannot be converted into cash easily. The other recourse, which most developers are now betting on, is to get lenders to refinance or restructure loans.

It is to be hoped that lenders will ensure real estate companies take adequate steps to generate cash flows internally, even if it requires lowering prices, before agreeing to any terms on refinancing or restructuring loans.

Solvency’s the issue

Although developers have preferred to hold on to property prices, the stock markets have concluded long ago that property prices are bound to fall sharply across the country. At current levels, though, not only is price correction in property a given, but in the case of some real estate stocks, even their very solvency is being questioned.

Unitech Ltd, for instance, has dropped 93% from its 52-week high. One view is that short-sellers are responsible for this, but the markets’ worry is not without reason. According to a recent report by India Infoline’s institutional equities research desk, “The debt maturing over the next 12 months for Unitech Ltd, Sobha Developers Ltd and Puravankara Projects Ltd is higher than our estimate of these companies’ revenues over the corresponding period. The situation with Omaxe Ltd, Parsvnath Developers Ltd and the Ansals also remains precarious, owing to large land advances and high receivables." Each of the stocks mentioned above trade at less than 10% of their value based on their 52-week highs.

India Infoline’s analysts Bhaskar Chakraborty and Param Desai say reduced credit flows and approaching debt repayments could threaten the solvency of weaker players who are likely to offer steep discounts to offload inventories. In the case of Puravankara, the analysts estimate that debt repayments and unpaid land costs in the next 12 months would amount to Rs740 crore, nearly double the revenue of Rs390 crore projected for the period.

Similarly, Unitech and Sobha Developers are estimated to have higher payouts in the year ahead compared with estimated revenues for the period.

As pointed out earlier, the main assets developers hold are either land or developed property. Since land is an extremely illiquid asset currently, developers have no choice but to sell developed property at a discount to current prices.

The weaker players may well get crushed under the weight of falling prices and the unwillingness of financial institutions in refinancing/restructuring loans.

Graphics by Ahmed Raza Khan / Mint

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