Up ahead, the real test for real estate

1. Near-term hiccups

Residential sales had been recovering over the past year on the back of cheaper home loans and stamp duties. Property prices also stayed stable as developers held back price increases. All that may be up for a short disruption now, evident in some cities in June-quarter data.

“Due to the rise in input costs and interest rates, the sector is pressured indeed, and it may hurt short-term demand for homebuyers," said Harsh Vardhan Patodia, president, CREDAI. However, he hopes that repo rate hikes are for the short term, and that the sector will return to a robust recovery in the long run. Historical evidence also points against any startling long-term impact.

“Given the strong demand in the housing market, developers are able to gradually pass on the increased construction cost," said Vivek Rathi, director (research), Knight Frank India. “The deleveraging the sector underwent over the last few years has also provided a cushion."

2. Margin pressures

The industry was in troubled waters even before covid. Grappling with weak demand, developers had to absorb cost pressures to stay afloat. In the eight years after the housing crash of 2008-09, profit margins of real estate companies shrank almost 700 basis points (bps). But as things stand now, the segment may avert a fall through the cracks.

Recent government measures to reduce import duties on steel products, iron ore, and steel intermediaries will bolster the local availability of raw materials, cool off the prices of steel products, and help check the rise in prices of projects, Patodia said.

Rising interest rates may not materially impact home loan growth and housing finance companies (HFCs). Home loans had grown at an average 17% annually between 2014-15 and 2018-19 when interest rates were higher than now. “As long as housing demand is strong enough and rate hikes can be passed on to borrowers, material negative impact is not expected," Rathi said.

3. Muted investments

Past episodes of rate hikes have also had a bearing on completions of ongoing projects and announcements of new ones. The value of projects completed declined 12% between 2004-05 and 2007-08, when the central bank raised the repo rate by 300 bps. Both new investments and completions declined in 2013-14 when rates rose 75 bps.

For now, rate hikes do not set the alarm bells ringing due to strong domestic demand, experts argue. However, Murtuza Arsiwalla, director at Kotak Institutional Equities, said launches were expected to stay modest due to formalization in the sector and as several small or unorganized developers are finding it hard to sustain operations due to the pandemic.

Launches had already been declining over the past five years, “absorbing the excesses of the preceding periods", he added.

Some signs of slowdown are already present, as new investments plunged around 90% in the June-ended quarter, while the overall capex slumped nearly 37% sequentially.

4. Dearer loans

For home loan borrowers, it would result in an uptick in equated monthly instalments (EMIs). With a cumulative 90-bps repo rate hike since May, EMIs have risen 7.2%. If the repo rate is hiked by 85 basis points more, as some market observers expect, EMIs would have risen 14.2% from March 2022 levels.

However, analysts are positive. “The increase in loan rates usually translates to an increase in tenure rather than an increase in EMI, effectively subduing its impact to some extent," Rathi pointed out.

Meanwhile, Ravi Subramanian, chief executive officer of Shriram Housing Finance, expects demand to be resilient at least until rates rise beyond 150 bps. “As the rates increase, we expect banks to become more picky about whom they lend to, and to offer higher credit at reasonable costs to well-managed non-financed companies and HFCs," he said. The change in cost of funds is expected to play out differently across the spectrum of lenders.

5. Investors in lurch

However, stock market investors are left in the lurch in the prevailing uncertainty. In the current market turmoil, when the Sensex has fallen nearly 6% in the last four months, the realty index is down over 10%, marking an incessant underperformance since the sub-prime crisis.

“If you break it down into shorter time periods, you realize that every economic shock or disruption has had a high initial reaction in real estate stocks," said Arsiwalla. However, each such event further drives formalization and shifts market share towards the larger, listed players, leading to stronger stock performance, he said.

Between 2020-21 and 2021-22, the market share for the top 10 players rose from 17% to 18% in volume terms and from 20% to 22% in value terms, said a Motilal Oswal report in June, adding that cost inflation and interest rate hikes were likely to only accelerate the consolidation.