Wednesday, December 29, 2010

Sector Review - Realty 2010

Vidya Bala

BL Research Bureau

The stalled township project of Lavasa Corporation over alleged flouting of green laws and the resultant delay in the company's IPO is just one among the many snags that real estate players in the country struggle to cope with.

The real estate sector may have braved the crisis of 2008 and 2009 and managed to reduce borrowings and renew construction activity in 2010; but not too many factors are in its favour to aid a bounce back to the heydays of 2007.

That the earnings of companies in the listed realty space in the first half of FY-11 were still a good 67 per cent below earnings in the April–September half year of 2007, suggest that the climb back is quite a while away.

What 2011 holds

2011 could see the sector earnestly build on volumes, with residential sales remaining healthy and commercial space absorbed picking up. Even so, modest profit margins compared with earlier years and rising interest costs could continue to act as a drag on the sector's prospects.

If the recent trend is anything to go by, it is the mid-sized players that are likely to shake off the slowdown faster than their larger peers.

Residential demand

Residential demand can be expected to be the key revenue driver for developers, thanks to supply not keeping pace with demand as a result of slowdown in execution in 2008 and 2009.

According to a Cushman & Wakefield report, cumulative residential demand could be well over four million units by 2011. About 1.7 million units may be met in 2011, says the report, with the mid-sized housing segment seeing the maximum deficit (around three times).

Players in the listed space such as Sobha Developers, Peninsula Land, Puravankara Projects, who are focussed on the residential space, capitalised on this deficit by coming up with timely launches at a time when interest rates were slashed.

While the commercial space pick-up towards the end of 2010 has been encouraging, estimates suggest that only two-third of the 55 million sq. ft of supply coming in 2011 may be absorbed.

Inability to hike capital values and rentals at a desired pace, even as vacant office spaces are occupied are likely to keep margins depressed.

Modest profit margins

In all, operating profit margins of developers may only continue at more sustainable levels of 20-25 per cent (as against 30-45 per cent in 2007-08) for most mid-sized players for two reasons. One, most of them have altered their strategy from selling high-end homes and instead shifted focus to mid-sized housing, which offers lower margins, albeit with potential for high volumes.

Two, even as capital values of residential properties have risen, the inability to hike prices steeply in the middle-income segment in the face of higher input costs and interest costs could also mean settling for lower returns on projects.

Interest costs, in particular, may see some uptick this year. While most listed realty players have deleveraged their balance sheets, net credit by banks to the realty sector as a whole has risen five-fold to Rs 9,604 crore for the half year ending September 2010 compared with a year ago. Equity raising too, has slowed and may get tougher going forward.

According to data from Venture Intelligence, a research service focused on Private Equity & M&A, private equity investments in the realty sector in 2010 was $1,736 million against the high levels of $6,686 million seen in 2008.

Larger players languish

Overall, mid-sized regional players' focussed approach to select market segments may help outperform a DLF, still struggling to raise funds through divestment of non-core assets, or a Unitech embroiled in the telecom mess or an HDIL which deals with price-sensitive transferable development rights (TDR) market in Mumbai.

Traversing the coming year without being caught on the wrong foot on corporate governance issues also remains a big challenge for most players in this space.


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