Outlook on Indian real estate sector

�� We attended day-1 of the ‘Real estate Investment Forum’ held in Mumbai
yesterday. In this note (first of a series), we focus on the four sources of cash
flows for developers. The points below are based on views expressed by
participants in various panel discussions and one-on-one conversations.
Impact
�� Debt – expensive and scarce: There is no doubt that rate hikes are hurting.
“Developers get debt funding on a ‘Last In - First Out’ basis”. Many
developers mentioned that the bigger problem is in fact availability. This is
forcing many developers to borrow from NBFCs and HNIs at an unusually
high 20–36%. One banker confirmed that the slowdown in residential sales
has led to delays in scheduled payments. He said that “many developers are
making payments late… but so far before the extended 90-day deadline”. This
is a big concern.
�� Equity markets (listed and unlisted) seem frozen. There is no appetite for
fresh equity in the stock market. No surprise here! We had seen a pick-up in
small- and mid-sized private equity transactions in January–June 2011. This
has slowed down considerably as well. Two private equity fund managers
mentioned that the fluid scenario of regulations and their interpretation has led
to an elevated risk profile. This is most notable in the state of Maharashtra
(and city of Mumbai). They mentioned that the consistent news flow on the
anti-corruption protests and “policy inaction” had led to foreign investors
starting to re-consider their intention of deploying money in India. Typically, a
private equity investor would be very active in the prevailing stress. But the
environment is making it tough for them to pull the trigger.
�� Residential sales and collection slowing: With the exception of Bangalore
and some tier-2 cities, the run rate of primary sales volumes across India has
fallen in the last 3–4 quarters. Mumbai has seen the biggest impact, followed
by the NCR. Importantly, pending collections from pre-sales have started to
slow. Our conversations with some industry consultants and brokers
confirmed this. We believe this is because speculators (and some end-users)
who bought units during 2009–2010 are delaying payments. This is due to
tight liquidity and lack of confidence on developers meeting delivery
deadlines. This phenomenon is most prevalent in the NCR and Mumbai.
�� Rentals stable due to commercial demand: Rental income has been the
only source of income, which has been resilient. Developers with occupied
yielding assets and good tenants are in a good position. Fresh leasing has
also been strong. While there are no signs of a slowdown so far, there are
some concerns that demand for IT space may slow due to global factors.
Outlook
�� Avoid high leverage and weak free cash flows: These are two of the most
important parameters when we pick stocks by elimination (refer to Selection
via elimination, 13 May 2011). Prestige, Sobha, Phoenix and HDIL are wellplaced.
DLF is a story of de-leveraging – with asset sales as triggers in the
next six months. We would avoid Indiabulls Real Estate, Unitech and Omaxe