Affordability on Mumbai's Central Railway Corridor

Residential Apartment Affordability on Mumbai's Central Railway Corridor between 2008 vs 2014 is as shown below.

Rise in property prices has forced home buyers to move to suburbs which fits their income profile.

• A budget of Rs.132 laths could buy property in Sion(E) in 2008, but only in Bhandup(W) in 2014
• Family with pre-tax income of Rs 8 lakh can buy a house in suburbs like Ambarnath /Badlapur and Titwala
• Ambivali has seen the highest Rise while Kurla (W) has registered the Lowest.

Affordability On Mumbai's Western Railway Corridor

Residential Apartment Affordability in the Western Railway Corridor in Mumbai Metropolitan Area between 2008 Vs 2014 is as shown below.

Rise in property prices has forced home buyers to move to suburbs which fits their income profile, For Example, a budget of Rs.66 lakhs could buy property in Malad (W) in 2008, but only in Vasai (W) in 2014 • Family with pre-tax income of Rs 10 lakh can buy a house in suburbs like Vasai-Virar
• Bandra (W) has seen the highest price rise while Jogeshwari (W) has seen the lowest rise

Affordable housing norms eased significantly

The Government of India headed by the most able Prime Minister of Independent India, Shri Narendra Modi notified amendments to “Consolidated FDI Policy Circular 2014” inline with announcement made in Oct’14. Key revision from the Oct’14 announcement lies in the Affordable housing (AH) qualification criteria which has been eased significantly.

The amended norms provide for no restriction on capital and size if a project has 30% of cost in AH segment. Projects which have to qualify for AH have to use 1) at least 40% (reduced from 60% in Oct’14 announcement) of the FSI for dwelling units of Floor Area <140 sq mts (increased from 60 sq mts carpet area); and 2) 25% of the total number of dwelling units (reduced from 35%) constructed should be of floor area <60 sq mts (increased from 21-27 sq mts in Oct announcement).
The relaxation of qualification norms for AH significantly increases the ambit of FDI investment in the sector. Removal of FDI restriction, in addition to RBI incentives for AH segment (allowing banks to raise long term bonds); will reduce the cost of funding for developers undertaking affordable housing projects

However for AH concept to become a reality across country we need to see improvement in clearance process (reduce timeline of approvals), incentives to builders (extra FSI, higher low cost land availability), and incentives to customers (interest rate, stamp duty subsidy) inorder to improve the viability of the projects.

GoI has clarified that 100% FDI under automatic route is permitted in projects for operations and maintenance of townships, malls/shopping complexes and business centers. However we have limited clarity if this can be interpreted as FDI investment in completed assets or just for undertaking operations and maintenance activities in these projects

GoI has removed the condition of minimum 3 years lock-in (subject to completion of trunk infrastructure) while allowing the exit after completion of project. Inclusion of exit on completion clause helps shorter execution tenure projects (affordable housing projects).

Residential Sales Bottom Out India

Gurgaon broke the eight-quarter declining trend on sales while Bangalore and Mumbai maintained their steady run-rate. Launches slowed down further in 1HFY15, owing to high inventory in most markets. With
launches slowing down and sales marginally showing some pick-up, inventory months (months to sell unsold area in under-construction projects based on the current pace of sales) have now stabilized across the key markets in India. 2QFY15 was the first quarter since 3QFY10 in which sales in the top seven metros were more than launches, mainly on contribution from MMR (Mumbai Metropolitan Region) and a strong Pune market.

The National Capital Region (NCR) continues its weak performance, as all markets in the region remain weak. Among the major markets within NCR, Gurgaon ducked the trend with more sales then launches in 2QFY15. We believe that in Mumbai and Gurgaon, volumes will increase with price rationalizations. We see Gurgaon volumes picking up gradually over the next four quarters, as we expect developers to launch projects at rationalized prices (some signs in 1HFY15). Similarly, prices will stabilize in most markets of Mumbai due to high supply. Bangalore and Pune continue to sell well (below `6 mn/unit ticket size) and remain the largest markets in India.

Bangalore recorded lower launches for the fifth quarter now (delays on changes in some committees as well as large launches in the past) and Mumbai (fewer launches before elections) during 1HFY15. Gurgaon continued its low run-rate of launches due to the high near-completion and under-construction unsold areas. Mumbai continued its steady but low-volume run-rate of sales while mid-income sales in Bangalore and Pune remained strong.

Bangalore Vs Gurgaon Vs Noida - Apartment Sales Trend

Absorption rate in Bangalore stooped starting in 1QCY14 on the back of aggressive launches and stable sales in CY14. Despite weakening, absorption rate in Bangalore remained the strongest among all cities discussed in this report, primarily due to its affordability ensuring high end-user demand. Once again,
most new project launches in 3QCY14 were by the top 10 developers. We expect CY14 to witness quality launches (similar to 2013) at attractive prices (under Rs6,000 per sq ft) to sustain current absorption run-rate of ~10%.

We continue to reiterate our belief that Bangalore residential market’s robustness is primarily due to its affordability attracting end-users and investors. The majority of areas in Bangalore are priced at ~Rs4,500 - 5,500 per sq ft equating to USD90k- 175k per unit. We strongly reiterate our view that residential products within the sweet spot of USD75k-200k sell the most in India.

We believe the two key risks we have been highlighting for Gurgaon have played out – 1) rising prices amidst slowing income growth and 2) stock dump by investors in projects nearing completion (launched in 2009-10). We foresee the following events to occur before any meaningful resurrection in sales and cash
flows – 1) a notable rise in new launches with freebies and discount schemes and 2) a reduction in investor inventory in the secondary market. Although developers hinted at a notable pick-up in enquiries in 3QCY14, our channel checks confirmed no positive trends in conversions or sales.

Although Gurgaon’s unsold inventory (in absolute terms) is the lowest in the country, it has seen an exponential rise over the last 3 quarters indicating a significant slowdown in sales. Quarterly sales (demand) have fallen from an average of ~6,000 units in CY12 to ~2,000 units in CY14. Consensus strategy
among developers seems to be slowdown launches against price moderation

Looking at the recent trend of a slowdown in launches in Noida, we believe unsold inventory has peaked at ~100,000 units. Although this sounds positive, the absolute number of 100,000 unsold units is huge. Also, the # of qtrs required to exhaust this unsold inventory has been rising since last 5 qtrs adding to the worry. This has applied pressure on any further price revision upwards. Our onthe- ground sources say end-user demand remains weak in Noida whereas investor demand has picked up given attractive prices / discounts / freebies offered by well-known developers to clear unsold inventory/

REIT IPO - Listing in India

Issue and Listing of REIT Units in India - SEBI Rules & Regulations

Atleast 25% of the units outstanding are offered to the public provided that for initial offer greater that Rs5bn, if units are held by the public prior to initial offer, such existing units will be counted in calculation of 25%

Value of all the assets held by REIT greater than Rs5bn

The draft and final offer document shall be accompanied by a due diligence certificate signed by the Manager and lead merchant banker.

Under both the initial offer and follow-on public offer, the REIT shall not accept subscription of an amount less than Rs0.2mn from an applicant.

Units may be offered for sale to public if such units have been held by the existing unitholders for a period of at least one year prior to the filing of draft offer document with the Board (Provided that the holding period for the equity shares or partnership interest in the SPV against which such units have been received shall be considered for the purpose of calculation of one year period)

If the REIT fails to make its initial offer within three years (increased from 18months in draft guidelines) from the date of registration with the Board, it shall surrender its certificate of registration to the Board and cease to operate as a REIT (provided that the Board, if it deems fit, may extend the period by another one year)

The units of REIT will be listed on recognized stock exchange

Any person other than the sponsor(s) holding units of the REIT prior to initial offer shall hold the units for a period of not less than one year from the date of listing of the units subject to circulars or guidelines as may be specified by the Board.

Final Regulations Indian REIT

SEBI announced India Real Estate Investment Trust Regulations, 2014. It has made key changes in terms of investment required in completed assets, minimum size of REIT, limit on number of sponsors, and minimum number of assets requirement, in-line with the announcement in Aug’14

Key changes announced in final regulations vs. draft regulations are on minimum asset value of REIT (Rs 5bn vis a vis Rs 10bn in draft), minimum project requirement (atleast 2 projects vs. 1 in draft), limit on number of sponsors (3 sponsors vs. no cap in draft) and value required in completed projects (80% vs. 90% in draft). In addition REITs will be required to make 90% of net distributable profits on a half yearly basis.

Special purpose vehicle is defined as corporate or LLP: a) in which the REIT holds or proposes to hold controlling interest and not less than 50% of the equity share capital or interest; b) which holds not less than 80% of its assets directly in properties and does not invest in other SPVs; and c) which is not engaged in any activity other than holding and developing property. In the SPV no other shareholder/partner shall have any rights that prevent the compliance from REIT regulations. In addition SPV is required to distribute not less than 90% of distributable cash flows. There is no borrowing limit at SPV level.

While REITs have been given a pass-through status, taxes (corporate and dividend distribution) will be applicable at the SPVs controlled by REITs. In a scenario of all equity REIT investment in SPV, limited benefit of tax pass through will be available to investors as all taxes will be applicable at the SPV level. A structured investment in SPVs (Debt/Equity mix) will improve return profile by 80bps. However the yield profile is likely to be below 10 year Gsec for both domestic and foreign investors.

Key monitorable remains the expectations gap between sponsors and investors. While sponsors look to factor in the benefits of capital appreciation in the valuation of assets, investors are still skeptical on building in significant capital appreciation and would keep appreciation as option value for their investments. Lower interest rate scenario is necessary to bridge the gap.

While SEBI has largely addressed regulatory issues, certain tax related issues still need to be clarified by Ministry of Finance inorder to improve viability of REITs in India. MAT arising on revaluation during swap of units and SPV shareholding will lead to cash flow mismatch for sponsors (while actual capital gains matches realisation). In addition capital gains tax imposed on sale of assets by REITs (vs internationally exempted if gains distributed) will lead to a listing discount on NAV. Any clarity on these aspects will improve attractiveness of I-REITs for both sponsors and investors.

Inventory pile-up continues at NCR / Mumbai

The inventory buildup is continuing as evidenced by low absorption rates; and there is a deterioration in the mid- to high-end segment with inventory months of 48 (36 in FY13). NCR and Mumbai stand out with
average inventory months of 56 for unit sizes of >INR 3 Crore. NCR and Mumbai have 45-50 months of
unsold stock. This is mainly due to lower absorption rates and higher project launches in the past two years. For Bengaluru, inventory months are not as high as those at NCR and Mumbai, but they are still much higher than the historical average.

In some segments (at current offtake rates), we believe it may take as much as >5 years to offload the current unsold inventory. Most real-estate developers have a large portion of their portfolio in these segments, implying their absorption/operational data is unlikely to improve until they cut prices and / or launch projects in the mid-end segment

The sector’s contingent liabilities now total 43% of net worth, vs 22% in FY09. Also, gearing (including off-balance sheet risks) has increased in the past five years. We believe the increase in contingent liabilities for some companies can be justified by the potential increase in revenue (SOBHA Developers), but for others it should continue to weigh high in the daily operation of the company.

For now, we do not expect REIT listing to be a big game changer, as clarity on regulations and unattractive yields could dampen investor appetite. Also, the proposed real estate regulatory bill could further elongate the execution cycle, leading to lower ROEs and stretched cashflows.

Residential Demand Weak - No Acche Din Yet

Residential prices have been increasing despite weak volumes over the past 3-4 years. However, now different data points are suggesting some decline in prices in a few areas. At least the sharp price rise has moderated over the past few months. In key cities, the residential prices grew 7% YoY in 1QFY15 – deceleration from 12%-16% YoY increase seen over 2QFY12 - 4QFY13. NHB Residex for 4QFY14 shows significant deceleration in prices with 13 cities (out of 26) showing YoY decline in prices and average (unweighted) price increase of just 0.3% YoY across 26 cities

Residential absorption (area sold) in key cities of India fell 44%YoY/ 13%QoQ in 1QFY15 (Prop Equity
data). The pace of demand destruction has continued unabated. Residential absorption fell 27% YoY in FY14 with 0%/ 25%/ 36%/ 45%YoY decline in absorption in 1Q/ 2Q/ 3Q/ 4QFY14. All these data point to very weak demand environment and it appears that up-tick in GDP growth in 1QFY15 has not impacted demand yet

Commercial absorption in key cities fell 19%YoY/ 29% QoQ in 1QFY15 on an already weak base of FY13 / FY14 which had a decline of 16%YoY/ 12%YoY. High inventory (~60 months of available supply) has kept rentals in check. Rentals are flat to down (~-2%) YoY despite continuing high inflation.

FSI increase in suburban Mumbai

In a major policy move, the Maharashtra government has allowed an increase in Floor Space Index (FSI) from 1 to 3x in suburban township projects. Under this policy, if developers construct affordable housing stock of 0.75x FSI and hand it over to the government, they can avail of higher FSI on their plots. The move is aimed at improving the affordability of suburban residential development and the low cost housing stock with the government. The policy, in our view, is a major positive for suburban township developers in Mumbai like IBREL/ HDIL that have large land parcels for township development in the suburbs.

IBREL (+20msf) / HDIL (50msf) and Godrej (4 msf) have large suburban township projects in Panvel and Virar regions and hence stand to benefit in the longer term from this policy. The additional FSI comes in lieu of additional construction done for providing housing stock to the government and as such is not free. Nonetheless, it still is accretive for value on a marginal cost basis. FSI increase additionally should keep longer term price inflation in check in these areas allowing for more sustainable demand.

As with other major cities in India, Mumbai’s population growth is now concentrated in the suburbs. As per the last census (2011), population growth over a 10-year period in suburbs like Navi Mumbai (+56%), Virar (221%), Panvel (113%), and Thane (44%) have outgrown the city center (-5%) or main city (only 5%) growth.

FSI levels (1-2x) in most Indian cities are way below most global city standards despite each individual city (NCR/ Mumbai 20MM+) having populations to rival small countries. FSI increase, in our view, is the only possible way to reduce pressure on land & infrastructure rollout costs. Some cities have at the margin started to increase such levels (i.e., Noida, and now Mumbai) but this still is yet to become a more generalized trend across major cities.

REIT Regulations in India for Dummies

SEBI has approved the SEBI (Real Estate Investments Trusts) Regulations. In its Finance Bill 2014,
the Government cleared a majority of tax regulations for the eventual listing of the REITs in India.
SEBI is yet to release a detailed notification, which is expected in the next two months. Most
regulations from the proposed draft (REIT regulations 2013) were passed, with a few relaxations.

• 80% should be invested in rent yielding projects versus 90% mentioned in the drafts
• Value of the REIT for an IPO has been reduced to Rs 5 bn from Rs 10 bn.
• Multiple sponsors are permitted with a maximum of three.
• Borrowings shall not exceed 49% of the value of the REIT assets, versus 50% in the draft
• Minimum size of the IPO shall be 25% of post issue share capital or `2.5 bn whichever is higher,
  versus Rs 2.5 bn in the draft
• REIT shall have at least two assets with a maximum 60% investment in one asset; versus REIT can invest 100% in one asset.

We await clarity from detailed notifications over the next one-two months. The Finance Act 2014
has already specified tax related incentives proposed by the Government. We wait further/changes
if any in the tax structure for the eventual listing of REIT instruments.

#NaMo Government Pushed for Affordable Housing

Under the directions from Finance Ministry, the RBI, in a notification today, eased credit availability for the affordable housing sector in India. We believe the central bank’s fresh measures will enhance availability of funds to the sector, while not having material impact on affordability. The above measures along with key
announcements in Budget 2015 highlight the government’s intent to give impetus to the real estate sector.

Banks can issue long-term bonds with a minimum maturity of seven years to raise resources for lending to affordable housing (defined as housing loans eligible under priority sector lending by RBI and also housing loans to individuals upto INR5mn for property valued up to INR6.5mn in Mumbai (clarity awaited whether intent is Greater Mumbai or MMR), New Delhi, Chennai, Kolkata, Bengaluru and Hyderabad, and INR4mn for property valued up to INR5mn in other cities.

The above measures will enhance availability of funds to the affordable housing sector. The measures will not significantly impact interest rates and accordingly affordability, as current home loan rates (~10.25%) are already near base rates (10%) but in the Medium Term will help Small & Genuine Home BUYERS across India as Interest Rates Will begin to Fall in the next 24 months.

Residential Demand / Launches Dull - Price Stable

Residential absorption (area sold) in key cities of India fell 31%YoY/ 51%YoY in FY14/ 4QFY14 (Prop Equity data). The pace of demand destruction has accelerated through FY14 with 3%/ 27%/ 39% 51%YoY decline in absorption in 1Q/ 2Q/ 3Q/ 4QFY14. Absorption fell 19%QoQ in 4QFY14. Though the monthly numbers are volatile, April 2014 (1MFY15) saw an absorption decline of 53%YoY in key cities tracked. All these data point to sharp deterioration in residential demand due to ongoing economic slowdown and stubbornly high prices.

 Residential Property Prices in India have been increasing despite weak volumes over the past 3-4 years. However, now different data points are suggesting some decline in prices in a few areas. At least the sharp price rises have moderated over the past few months.

REIT in India Could be Simple With Taxation / Rules

The very act of setting up a REIT requires a sponsor to contribute assets (either directly to the REIT or shares of an SPV that owns immovable property into the REIT). Any such contribution, under the current law, will mean a capital gains tax incidence of at least 20% on the difference in value between the holding cost and the transacted fair market value in terms of contribution to the REIT. The industry has lobbied hard to the Finance Ministry that such a tax incidence on contribution will be a non-starter, as it would entail a 20% outflow in order to do an IPO and a liquidity element of at least 20% will be required just to pay taxes. Experts on our call opined that the Finance Ministry is coming around to the view that the contribution of assets or contribution of SPV shares into a REIT should be treated as restructuring and hence, should be tax exempt.

Secondly, any income generated at the SPV level or property income at a trust level is subject to corporate tax and a dividend distribution tax in order to upstream income and be distributable to unitholders.
The industry is seeking a zero-tax regime on the grounds that: (a) income stands distributed to unitholders and unitholders, depending on their character, may or may not be taxed; and (b) being a new investment product, the REIT, as an investment instrument, needs a fiscal impetus. Whilst zero-taxation is the ask, our
experts felt that the Finance Ministry may agree to a single point of taxation but it may not be in a position to provide complete exemption.

Whilst these tax concessions impose a minimal cost on the exchequer, our experts opined that the benefits to the Government and the economy, in the form of foreign inflows, comfortably outweigh the implicit costs. REITs will not only attract foreign inflows that positively impact the economy’s current account deficit but also channel household savings towards investment in REITs (as against the current habit of Black Money Investment in Physical Gold and Real Estate Assets)

How Real Estate Developers Model Changed in India ?

We'd liek to Present you on How the Indian Real Estate Developers Model has changed from Greed Towards being Industry Oriented on various factors such as Land Bank, Fund Diversion, new Project Launch, etc

There have been numerous lessons learnt from the mistakes of 2008, recovery of 2009/10 and the slowdown of 2010 onwards. The last three-plus year slowdown may well have been a blessing in disguise, in our view, as it has shaken out the industry and forced a re-think of a lot of practices (as detailed below) which, in our view, are key to the longer-term health of the business. Some of the main areas of change
which, in our view, are under-appreciated as of now are:

NRI Investors Must Avoid Real Estate With Modi Win

Given the baggage of political uncertainty that impacted buyer confidence and Investor sentiments during the past few quarters, experts on the panel unanimously welcomed the strong political mandate at the Centre. However, with key areas such as land and labour being state government subjects, experts opined that a stronger government at the Centre, by itself, will have a limited role to play in ironing out key ground-level issues that the real estate sector currently grapples with, especially around ease of transactions and approval timelines.

Real Estate developers are likely to identify geographies witnessing healthy job creation and employment generation as key growth corridors of relevance. Demand for housing, in geographies driven by healthy job creation, is largely end-user driven, reasonably stable and relatively more immune to demand-side shocks.

As a result, residential demand in cities such as Bangalore, Chennai, Hyderabad and Pune remained reasonably stable through FY14 with a healthy run rate of launches coupled with steady absorption. On the contrary, residential demand in NCR and Mumbai continued to be investor-driven, resulting in significantly higher volatility in underlying demand. In fact, most developers, according to the experts on the panel, make the mistake of deploying excessive amounts of short-term capital in land, which deters on-time project completion and affordable pricing of completed units.

Problems for Realty Developers
The panel of experts unanimously opined that although capital is available to highest quality developers, the cost of capital gets prohibitively expensive when developers are unable to demonstrate their ability to convert inventory (land) into cash flows in a time-bound manner.

Real Estate Regulation Bill penalises developers for undue delay in project completion, developers on the panel highlighted the exogenous factors in the local government agency domain that often delay the approval process and hence, the project completion lifecycle. The experts on the panel believed that these legislative and regulatory moves will be rendered toothless unless proportionate accountability is fixed on the state, in terms of time-bound approvals and clearances for projects.

In this backdrop, Historical Performance of Indian Equities in 10 Years with ZERO Long Term Capital Gains Tax and total White Money in the hands of Investors which they are FREE to encash.

Bangalore shines, Gurgaon slumps

Launches in Bangalore bounced back to 10,000-11,000 units/qtr after a slowdown in 4Q CY13, aided by faster approvals. Our recent meetings with Puravankara and Nitesh had highlighted the same. Absorption remains strong in the affordable category (Rs7.5- 15mn/unit, +8% YoY). Inventory levels remain steady around 8 qtrs of sales. Sobha has already reported 25% growth (QoQ) in Bangalore volumes as it had new launches in 1QCY14. While Prestige has not reported its operational update, we expect its presales number to be healthy too

Gurgaon – low demand is keeping developers away from new launches: In 1QCY14, demand was weakest since 1Q CY10 (-63% YoY). Low demand and high inventory (9.4qtrs of sales) is keeping developers away from new launches (-71% YoY, lowest since 2Q CY10). DLF and Unitech have seen
poor sales in 9MFY14 and we expect 4QFY14 to be low too.

Launches in Mumbai increased to ~12,700 units (from avg of 8,000 units/ qtr in CY13). This was driven by launches in certain micro markets of eastern suburbs and Navi Mumbai. Inventory levels remain high at
~10 qtrs of sales as high prices and an uncertain macro-economic environment are keeping buyers away (absorption down 7% to ~7,100 units).

Decoding private equity in Real Estate

The Big four large real estate funds (together managing over US$5 bn of India-focused money) and present in India since foreign direct investment was permitted first in 2005, along with an MNC bank (estimated real estate book of around US$3 bn) and an infrastructure finance company (estimated investments in real estate about 15% of the `400 bn book). Around US$4 bn was raised by PEs in the past two years for investments in real estate in India. Key highlights of the discussion were

Investors partly accepted some decisions with their first investments, mainly on (1) appreciating development timelines of larger projects, (2) dependence on government approvals and (3) execution risks and scalability of developers, missed/erred in estimations in the past. But for most investors, better realizations (restricting to metros) have helped garner returns.

The difference between expectations on equity and debt returns should increase going forward (currently only 200-300 bps) with an improving market and better learning for both developers and investors from the earlier investments. We expect equity investments to grow in select developers over the next 12-18 months.

Although real estate growth is visible in tier-2/3 towns as well (along with the metros and tier-1 towns), their scale is much lower. Larger investors are now looking to invest only in the top 3-6 markets of India, unlike in the 33 cities invested by the PEs since 2005-06.

Tide of change - perception or reality

More maturity in place. Developers argued about more maturity over the past few years. (1) Operations are more organized, scalability and execution capabilities understood and utilization and deployment of capital thoughtful unlike during the bull run of 2003-07, while (2) expectation on institutional requirement has fallen in place on parameters of returns, governance and control.

Indian high net-worth investors (HNIs) are among the smartest set of real-estate investors in the past with better returns from direct (even unstructured/unorganized) investments with developers/in real estate projects. With markets maturing, most investors are seeking the organized route with participation through funds

The key issues for investment in Indian real estate remain (1) cost and (2) options. Asset allocation to real estate in global market remains high (around US$530 bn in CY2013, of which around US$130 bn was allotted to Asia), but lack of quality supply has restricted investments in India (around US$1 bn).

There were mixed views on developers getting listed given the performance of listed developers since 2008 and expectations on valuations from unlisted developers planning to raise money through listing in the bourses.

Noida: Affordability is key to flattish sales

Absorption rate has remained choppy since the last 7-8 quarters. We foresee this trend to continue given contrasting market forces. On the one hand, Noida offers amazing infrastructure, connectivity and affordability; whereas on the other, the city struggles with poor migration, commercial leasing, project delays and high unsold inventory. A clear trend has emerged in Noida over 2011-13 wherein new sales have remained primarily limited to sectors within Noida city and sectors with direct access to Noida Expressway.

The rise in unsold inventory levels has been relentless approaching 100k units. Given current sales run-rate, Noida will require 7-8 quarters to clear this unsold inventory. We maintain our negative view on Noida except for sub-markets of Noida city and areas under sector 110. Extensive project delays and political
problems have restricted investor interest to locals only. We would recommend end-users to prefer ready-to-move-in units compared to new launches.

Noida Office Market
The rising rentals and lack of supply in prime micro-markets of Gurgaon has made Noida attractive for prospective clients. In the past 6-9 months, we have seen a notable increase in absorption in Noida along the Noida-Greater Noida Expressway. We expect the trend to continue given good quality supply of IT SEZ
office space at a 30% discount to Gurgaon and better infrastructure in Noida. However, the rental recovery in Noida might take more time.

Gurgaon: Oct-Dec sales dipped to 2009 levels

The Gurgaon market continues to show stiffness on the demand side despite launches by top developers during the festive season in the Oct-Dec quarter. We attribute this weak poor trend in demand to 1) poor affordability; 2) high investor unsold inventory exerting pressure on primary markets; 3) slowdown in migration causing significant drop in commercial leasing, thereby denting end-user demand; and 4) notable shift in end-user interest from a primary market to secondary market (de-risk strategy given tough macro-economic conditions).

Although we continue to believe Gurgaon is a robust market, current market dynamics confirm the key risks are playing out. We have been highlighting two risks for Gurgaon market – 1) rising prices amid slowing income growth and 2) stock dump by investors in projects nearing completion (launched in 2009-10).
Absorption rate fell further to 11.5% in 4QCY13. We worry that the absorption rate might touch singledigits if ongoing trends sustain. If absorption does not improve soon, we foresee a notable drop in new launches and price cuts in primary markets to resurrect sales and cash flows.

Bangalore: Highest # of launches (39k) in CY13

CY13 emerged as the best year for Bangalore residential markets across most measurable parameters – highest new launches (c 39,000 units), highest sales (c30,000 units) and the arrest in rise of unsold inventory. Bangalore witnessed new launches by top developers such as Prestige, Brigade and Puravankara. We
foresee CY14 to see quality launches (similar to 2013) at discounted prices of up to 5-7% to sustain the current healthy absorption run-rate of 14-15% (the highest since 2010).

We continue to reiterate our belief the robustness of the Bangalore residential marketis primarily due to its affordability attracting end-users and investors. Significant areas in Bangalore are priced at c Rs4,500-5,500 per sq ft equating to US$100-130k per unit. We strongly reiterate our view that residential products
within the sweet spot of US$75-200k sell the most in India.

Mumbai, NCR, Bangalore - Account for 70% of Indian real estate market space

The three Tier I cities in India, namely Mumbai, Delhi-NCR, and Bangalore, together represent about 70% of the real estate market (calculated across the top seven metro cities). About 70% of annual new residential unit launches and sales in the past 4-5 years have been in these three cities. Similar is the case with the retail sector, where the three cities represent about 71% of total retail mall stock and annual transactions.

Residential prices in the three key cities have largely remained flattish to single digit correction in FY14whereasthey increased by up to 30-50% since the previous cycle in 2009. We expect prices in Mumbai to correct by up to 5-10% in the next 2-3 quarters followed by time correction over the next year. Whereas Gurgaon primary market is expected to correct up to 5% in the same time frame. On the other hand, we expect prices in Bangalore and Noida to stay firm given their increase was limited to inflation+ levels. Price correction will primarily be driven by the need to trigger sales volume recovery, generate cash flows and curb rising unsold inventory.

Latest Land Prices in Mumbai MMRDA Region

The land parcel being sold by Tata Steel is located in Borivali (a western suburb of Mumbai). The total land size is 25 acres with a development potential of 2.5-4msf depending on the availability of public car parking. If the bidding settles at the current price of Rs11.55bn, and assuming a selling price of Rs12,000/sf, cost of construction of Rs4,000/sf and sales cycle of 5 years, we estimate IRRs for the project to be 12% (if saleable area is 2.5msf) or 23% (if saleable area is 4msf).

Paucity of clean title land in Mumbai has been keeping bidding prices high. Even in this deal, six developers like Tata Housing, Indiabulls, Lodha, Kalpataru, Peninsula Land and Oberoi have been participating. The last few land deals in Mumbai (details on pg2) indicate that land prices continue to rise across the city. The physical market in Mumbai continues to remain weak due to high prices and uncertain macroeconomic environment.

Map showing Mumbai residential property prices at various locations

The Land Prices are Benchmarked Against the Prices in South Mumbai's Commercial Business Disctrict - Price = US$1700/sq ft. USD to INR In Our Calculation is at Rs 60 / $.

In Parel the Ruling Land Prices are Price = US$500/sq ft, distance from CBD = 15km
In Bandra, Land Price = US$500/sq ft, distance from CBD = 20km
In Ghatkopar, Land Price = US$250/sq ft, distance from CBD = 25km
In Andheri Land Price = US$350/sq ft, distance from CBD = 25km
In Goregaon, Land Price = US$250/sq ft, distance from CBD = 32km
In Thane, Land Price = US$180/sq ft, distance from CBD = 40km
In Borivili, Land Price = US$200/sq ft, distance from CBD= 40km
In Kalyan, Land Price = US$90/sq ft, Distance from CBD = 70km

Why Land Prices Not Falling Despite Weak Demand ?

Given weak demand, general credit tightness and a willingness from developers to sell, one would expect land values to be trending down. However this has NOT been the case and begs the question: why is it so? We think this is partly due to most cash rich developers’ willingness to bet on demand improvement, and
there is a development margin of 25-30% to be had on current rates. More importantly, there is also optionality on potential increases in FSI across most markets (Gurgaon/Noida could benefit on this account.  In Mumbai gradual increases are being affected as well).

At these transacted land rate levels we think most developers are sitting on huge MTM gains (5 to 10x) on their land holdings, however business remains cash poor on account of cash drain on legacy projects / weakness in new sales. Correspondingly on a generally low Net D/E (0.5-0.7x) levels most developers are still running tight cash flows. A balance hence needs to be restored; however this could require developers to shed 15-20% of their B/S, and asset sales are likely to continue well into the next 12 months.

Some developers have had success in these transactions and have been able to reduce debt materially. However far more is required especially given uncertain environment around pre-sales in Mumbai / NCR. However we note that most asset sales done even in this environment have been done at valuations which are far above holding cost levels and there are no signs of any decline in land values.

Delhi Absorption lower than 2008 levels; unsold stock at peak

A weak economic environment under the Corrupt Congress led Government led to low volumes (below 2008 levels). Our recent interactions with market participants in Gurgaon showed that most developers emphasized weak sentiment and expected volumes to recover after the elections.

The National Capital Region (NCR), of which Gurgaon is a part, is the only major investment market in North India (unlike South India, which has five large markets). This, along with a growing service sector, led to high real estate demand in Gurgaon, mainly from investors and eventually end users (on job creation).

Most markets in North India, including Gurgaon, work on an investor/broker sale model during project launches. Such participants underwrite developer stock and down-sell in the market over the period of project construction. Large supply of high-priced units and low liquidity resulted in such brokers not participating in new launches (brokerage rates have increased from 2-3% to 7-8% for select developers). This resulted in brokers and underwriters moving away from the market, as some have started booking losses on their investments.

Prices of offerings in Gurgaon have increased by over 3X in the past six years . Most project launches, in almost all Gurgaon’s micro-markets by tier 1 and 2 developers focus on premium and luxury products. Under-construction projects in locations like Golf Course Road, New Gurgaon and Northern Peripheral Road offer projects at prices above ready-project prices and secondary units in under-construction projects. Ticket sizes have also increased in Golf Course Road and Golf Course Road Extension areas with unit sizes on offer increasing by 40-100%.

India Property Sales Dip in 2013

Residential absorption (area sold) in key cities in India fell whopping 45% YoY / 16% QoQ in 3Q FY14 (as per Prop Equity data). Residential absorption fell 28% YoY in 9M FY14 v/s +9% growth in FY13. 3Q FY14 is the third consecutive quarter of accelerating decline in residential absorption and points to a big drop in residential demand due to the economic slowdown and high prices.

Residential prices have been increasing despite weak volumes due to the rampant corruption by Congress Government in 22 various departments from where Real Estate developers seek permissions. Over the past 3-4 years. But different data points are now suggesting some decline in prices in a few areas. At least the sharp price rise has moderated over the past few months. In key cities, the residential prices grew 10% YoY in 3Q FY14 – a deceleration from 12-17% YoY increases seen in 2Q FY12-4Q FY13

Commercial absorption in key cities fell 34% YoY in 3Q FY14 on an already weak 3Q FY13
base. Commercial absorption had declined 18% YoY in FY13. High inventory due to the slowdown in economy (~68 months of available supply) has kept rentals in check. Rentals are flat to down (-1%) YoY despite high inflation.

What is Sample Housing Start Up Index in India ?

RBI has today launched the Housing Start Up Index taking baseline data from 27 cities from 2009-11. The aim is to first stabilize the methodology and then extend the coverage to 300 cities and eventually improve the frequency to release the data on a frequent (quarterly) basis. Compilation of housing starts has never been done exhaustively, given the presence of multiple authorities at different levels and lack of any methodical approach to collating data. This index, if stabilized, may eventually lead to better policy prescription for the Real Estate sector (10% of GDP and relationship with 250 ancillary industries) which has frequently complained about excessively tight policies and regulations governing it. Also this will give markets likely a better nuanced understanding of the wide variation seen in trends across different cities.

HSUI could improve policy prescription-RE sector has been very tightly controlled in terms of overall policy and suffers from various procedural delays in granting approvals. An HSUI, by reflecting the data back to relevant government authorities and also making it public, could help reduce approval lags and also reduce lead times on timeliness and extent of measures regarding policy. At the margin we note that regulators have taken a slightly lenient view given the general slowdown, by reducing risk weights and provisioning norms for residential construction lending

Data read through confirms long held belief that Tier2 is doing better than metros- the data albeit released with a huge lag confirms the belief that new construction growth has largely been led by Tier 2 cities as opposed to Metros, which in general have seen limited recovery post 2009. Post 2014, however, we think the equation will likely change in the favor of metros as city expansion, localized infrastructure creation will likely create opportunities for suburban growth. Bangalore as of now continues to be the most favored market

Residential Market Outlook 2014 - Narendra Modi Factor

Residential markets ended 2013 on a sluggish note with the festive season remaining fairly quiet due to the launch/ approval delays and weak macro. We expect the residential markets to see an improvement in 2014 driven by the pick-up in demand in the suburban markets. Some price softening, lower mortgage rate and reduction in unit sizes (already being witnessed in 1BHK launches in Mumbai) should bring improvement in the affordability levels. However, we think recovery is likely to be more 2H weighted and 1H may remain quiet until the elections.

We have seen some evidence of price discounting in the select markets of Mumbai and Gurgaon in terms of subvention schemes and lower prices in secondary markets. Prices in the Bangalore market, however, have continued to firm up; while Chennai has been largely stable. Mortgage rates have also come down by 25bps given the competition between banks / HFCs to build out low risk secured portfolio.

Comparison of Residential Property Sales Across India in 2011, 2012, 2013

In terms of markets, Mumbai continued to witness sluggish trends; while Gurgaon saw a sharp decline in volumes in 2HCY13 and trend is likely to continue near term. Bangalore witnessed stable trends (absorption flat Y/Y) as also evinced in strong presales performance of key Bangalore developers; while G Noida registered a sharp revival off a low base post the notification of the G Noida master plan and commencement of the Yamuna expressway.

Mumbai is the key candidate for a turnaround in CY14. Mumbai market has been witnessing sluggish trends over the last 3 years due to regulatory changes, approval/launch delays and high prices. Gurgaon has seen a significant moderation in absorption / launch activity in 2HCY13 and we expect the market to remain muted in CY14. After being an outperformer market in CY12 and CY13, we expect Bangalore to witness some moderation going into CY14.