Minor correction likely in real estate

Minor correction likely in real estate

Iwas speaking with a builder friend the other day about the real estate scenario in Mumbai. He said that he has been looking for a penthouse close to his daughter’s school in Juhu. “I am from this industry and that makes it even more difficult for me to buy considering the kind of loading and prices one has to pay. It’s ridiculous and I know that I will not be able to buy for myself. Hence I have outsourced this activity to my wife. Prices must correct by 20-30% at in most places," this friend said.

I told him that prices should have corrected long time ago but they haven’t, even though negligible buying has been happening. He said, “Yes, I agree. But the point is that many projects today are stuck for lack of approvals and hence there is dearth of new supply. Hence, most builders are taking advantage of this situation and holding on to prices." Additionally, the constant flow of unaccounted money continues to support a lot of real estate activities (and prices) and hence many people lose their patience and eventually give in to high prices.

The roadblocks

The industry: Most real estate companies have huge levels of debt on their books. As interest rates have gone up, so has the interest burden for these companies (to as high as 15-18%). Private funding has gone up to 20-30%. This increased interest cost combined with higher prices for materials and labour is likely to depress margins of most real estate companies. Obviously the exceptions would be ones with zero or negligible debt and they will hold on to prices. Many are planning to launch projects due in 2016-2018 and use funds raised to stay afloat till they can tap the primary markets or till conditions improve.

The investors: A lot of smart investors are exiting at a 10-12% discount (as they have been unable to get the rates they want). Interest rates, which were around 8% a year ago, are now 10.75%. High interest rates coupled with soaring prices have made a lot of middle class consumers defer their purchases . On the other hand in the high-end segment (luxury homes and big-ticket projects), wealthy consumers seem to be buying as they do not want to miss the yacht.

However, the number of transactions is very low and hence real estate companies have seen their inventories on the rise. This has led to a severe cash crunch for many companies.

What can companies do?

Real estate companies now have three choices. The first is to raise funds through private equity, non-banking financial companies or qualified institutional placements. Since the short-term outlook of this sector looks gloomy, investors are also very sceptical. However, the time is right for institutional and high net worth investors to strike interesting deals with builders and we are already witnessing debt deals happening for 20-24%. Second is to sell non-core assets to generate funds, which can be limited. The final option available to realty companies will be to cut down prices.

What should you do?

Individual investors should exercise patience as the noise is getting louder and every stakeholder, including real estate consulting firms and rational builders, are expecting a correction. A minor correction of 10-20% can also mean substantial saving.

When you are negotiating, consider the loading. For example, if you have been quoted a rate of 20,000 per sq. ft for 1,000 sq. ft, whereas the actual carpet area is 800 sq. ft (20% loading), then essentially you are paying 2 crore for 800 sq. ft. Similarly, if you have been quoted 18,000 per sq. ft, whereas the actual carpet area on a 1,000 sq. ft flat is 700 sq. ft (30% loading), then you are paying more per carpet area.

There is a lot to look at beyond the price and location. Make sure that all approvals and clearances are in place. Just because there is a home loan offered on a project does not make it safe or indicate its quality. You must consult and hire a good lawyer to do all legal due diligence of approvals, land titles and other requirements.

Start educating yourself on the nuances of real estate transactions as there is a lot to learn. For example, when you go to buy an apartment in the secondary market, measure the size of the premises wall to wall. Most of the times you will see a discrepancy in the actual carpet area mentioned.

Amar Pandit is CEO, My Financial Advisor, a financial planning firm.

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