Debt overhang for real estate firms to continue in this year also

Debt overhang for real estate firms to continue in this year also

New Delhi: Investors in real estate stocks are in a quagmire. Even as the world around the real estate industry has moved on, the industry was still caught in the excesses committed in the previous bull run.

Over the last two hand half years (i.e. from Jan 2009 to 8 June 2011) the BSE Realty index registered a loss of 11%. While the Sensex in the same period gained more than 85%, investors had to bear a huge opportunity cost for sticking with real estate stocks.

High debts and falling sales are two issues that are plaguing the Indian real estate industry. As the economy recovered in 2009, analysts expected sales to recover in 2010. However, the recovery remained elusive as high property prices kept buyers at bay. Meanwhile, construction cost inflation and rising interest costs started to squeeze earnings of the real estate companies. While this impacted earnings in the last financial year, the situation is unlikely to change in the current year.

With developers reluctant to reduce prices and interest rates remaining high, volumes are expected to remain weak over the next few quarters. This will translate into high inventory levels and impact cash flows of the real estate companies. According to analysts, weak cash flows and sagging sales are estimated to put pressure on financials of the real estate firms, thereby reducing their ability to reduce debt.

IIFL analysts Bhaskar Chakraborty and Avi Mehta note:

We do not see these structural headwinds abating in FY12. Developers’ reluctance to offer price cuts on projects would continue to weigh on sales in FY12. Also, rising construction costs and high interest costs in the current tight liquidity environment are likely to hurt operations. As a result, reduction in net debt levels looks challenging in FY12.

Indian real estate companies are actively considering ways to generate cash. They are looking to generate money by selling land or divesting stakes in non-core businesses. For now, that seems the only way to get out of a debt trap.