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%.