Mid-sized developers with high exposure to residential assets have unsold inventory amid a liquidity crisis
Much of the recent recovery is largely linked to office space, where the demand-supply dynamics has been turning favourable
On Tuesday, Japan’s Sumitomo Corporation Group bid a record ₹2,238 crore for a three-acre commercial plot in Mumbai’s Bandra-Kurla Complex (BKC). This is not a one-off deal. Recently, Blackstone Group bought the fully occupied One BKC office complex for ₹2,500 crore. And earlier, Godrej Properties bought a two-acre property in Chembur for around ₹200 crore.
To be sure, there is traction in large property deals. Much of the recent recovery is largely linked to office space, where the demand-supply dynamics has been turning favourable. “Going by office transactions in the top seven cities, the market recorded the highest transaction volumes in CY2018. The new office completions in 2018 were recorded at 37 million sq. ft. The vacancy level has reduced from 20% in 2012 to 12% in 2018," says Vivek Rathi, senior vice president (research) at property consultant Knight Frank India. What followed is a steady increase in office space rentals, which have been northbound for the last five years.
However, this must not be mistaken for a sustained and uniform recovery across the real estate market. Mid-sized developers with high exposure to residential assets are in a rut, with unsold inventory amid a liquidity crisis.
Firms with a portfolio of annuity assets are leading the sector recovery. For instance, the largest realty developer in the listed universe, DLF Ltd, is still languishing with completed but unsold housing inventory that could take another three years to get off its books. However, its rental assets are helping offset this pain. Analysts estimate a 10% increase in rental income over the next few years for DLF. Another reason investors have turned positive on the firm is that its stand-alone net debt-to-equity ratio is likely to be at a comfortable 0.1 by FY20.
Companies are therefore increasing their exposure to annuity portfolios. “Oberoi Realty has changed its upcoming project mix to include 50% of annuity/hotel assets versus a 24% share in its ongoing projects," ICICI Securities Ltd said in a report on the commercial property market.
“Prestige Estates should reach a rental EBITDA of over ₹1,100 crore by FY21 from ₹730 crore in FY18 while Brigade Enterprises should see its rental EBITDA rising to ₹530 crore by FY22 from ₹240 crore in FY18," added ICICI as examples of firms raising exposure to commercial property. Ebitda is earnings before interest, tax, depreciation and amortization.
Note that commercial rental properties and large malls are capital-intensive and require developers with balance-sheet strength. The turnaround in this segment is also underscored by the host of private equity and real estate investment trusts that are pouring money into commercial property.
But note that the recovery is specific to commercial and large A-grade annuity assets. Investors shouldn’t assume a recovery across cities and segments, which is necessary to pull the sector out of its woes. Like builders, they too need to be selective about their portfolio additions in this space.