Over a 3 day tour over Mumbai / Delhi / Bangalore we explored the fundamentals of investment property assets (Office /Malls/ Hotels) along with longer term prospects of REITs in India. In summary we think Investment Property assets are entering a new bull market driven by positive rental reversions / peaking of new supply growth / market share consolidation and likely lower interest rates one year out. Cap rates then in our view will likely trend 100-150bps below current 9%-9.5% levels as market starts discounting positive rent reversions over the next 3 years
Office /Retail Real Estate markets are getting more consolidated, with the top 2-3 developers in each market increasingly controlling a higher share of new supply. This is because smaller developers are increasingly shying away from a capital intensive model and tenants too are now increasingly discerning across landlords.
Across our meetings with companies/ consultants/ funds in 3 cities, the clear trend that emerged was that office /retail real estate now is entering a new bull market. Rental revisions post lock in are rising 50-70% across portfolios for many companies. This is essentially driven by rentals catching up to market pricing and reflective of likely tight demand supply fundamentals in the space over next 3-4 years
Hotels are one of the worst affected asset class of the current slowdown but now seems poised to come back as peak supply is now starting to get over. Hotels in areas such as Gurgaon / Bangalore suburbs are witnessing near sell out levels as new industry is now moving towards city suburbs rather than conventional city centers. We think as peak supply gets over in the market, RevPAR reflation in the market will revert to double digit growth levels over the next 2-3 years
Friday, March 27, 2015
Monday, March 23, 2015
Modi Dislikes Investment in Gold / Real Estate
India has a higher savings rate than its peers. For instance, data from the World Bank suggests that a typical emerging market has a savings rate of 24% when its per capita income is US$1,600. India, on the other hand, had a savings rate of 30% when its per capita income was at US$1,500 in CY13.
Despite this, India is characterised by a high cost of debt capital and poor accessibility to capital, as more than two-thirds of India’s household savings are held in physical form, which includes real estate and gold.
Physical savings instruments are preferred to financial savings instruments in India because of the following two reasons: (1) Whilst the purchase of physical assets can be funded using black money, the purchase of financial assets cannot be funded using black money, and (2) Physical assets are perceived to be superior inflation hedge as against financial assets. The outright preference for physical assets in India is evident from the fact that an overwhelming 65% of households in a middle-income country like India own the houses they live in whilst only 59% of households have access to banking services.
Furthermore, the preference for gold over bank deposits has become even more pronounced in the last few years, as the size of India’s black economy has burgeoned (owing to the rise in corruption) and as inflation rates have soared. Besides explicitly targeting the black economy, PM Modi also aims to expand the white economy. He plans to exponentially increase the number of households with access to banking services.
Despite this, India is characterised by a high cost of debt capital and poor accessibility to capital, as more than two-thirds of India’s household savings are held in physical form, which includes real estate and gold.
Physical savings instruments are preferred to financial savings instruments in India because of the following two reasons: (1) Whilst the purchase of physical assets can be funded using black money, the purchase of financial assets cannot be funded using black money, and (2) Physical assets are perceived to be superior inflation hedge as against financial assets. The outright preference for physical assets in India is evident from the fact that an overwhelming 65% of households in a middle-income country like India own the houses they live in whilst only 59% of households have access to banking services.
Furthermore, the preference for gold over bank deposits has become even more pronounced in the last few years, as the size of India’s black economy has burgeoned (owing to the rise in corruption) and as inflation rates have soared. Besides explicitly targeting the black economy, PM Modi also aims to expand the white economy. He plans to exponentially increase the number of households with access to banking services.
Friday, March 20, 2015
Bangalore Residential Sales SlowDown
The primary residential sales dropped in Bangalore in CY2014. Slowing sales have resulted in a 30% drop in launches too in CY2014. As the pace of sales growth didn’t match the pace of launches in Bangalore, pricing power always remained with the buyer. This also resulted in building up of inventory (unsold under-construction area) in Bangalore. What surprised us, not matching our expectation of only super-luxury sales slowing down, is that units selling below Rs 5 mn each also slowed down while those selling above Rs 7 mn each showed volume growth.
Prestige's sales strategy and sales stand out as it entered various markets within Bangalore and launched projects starting below Rs 7 mn/unit, attractively pricing its projects, which have resulted in growth. While Sobha’s strategy of launching only luxury and super-luxury projects resulted in their sales volumes remaining flat (although an increase in value terms), Puravankara has managed to maintain marginal growth on volumes from its new launches. But unlike Prestige and Sobha, Puravankara has sizeable unsold ready units to be sold.
Sobha has soft-launched its ‘Aspirational Homes’ product in 4QFY15, with unit prices starting as low as Rs 3.5 mn/unit. We believe this project will see good response and Sobha needs to replicate such projects at multiple locations for growth from current levels. Prestige, too, acquired 15 projects in 3QFY15. Entry into new markets, we believe, will be the key to Prestige’s volume growth in its residential business.
CY2014 saw some large lease deals in Bangalore. Outer Ring Road (ORR) remains the most attractive location with the largest developments and the largest leases being discussed in the market. In the past five years, absorption contribution in Bangalore has increased from around 40% to around 65%, followed by Whitefield. All major office developers, Embassy Developers, RMZ, Prestige Estates, Salarpuria Group among others, are present in the market. Whitefield is the next desired location among occupiers.
Prestige's sales strategy and sales stand out as it entered various markets within Bangalore and launched projects starting below Rs 7 mn/unit, attractively pricing its projects, which have resulted in growth. While Sobha’s strategy of launching only luxury and super-luxury projects resulted in their sales volumes remaining flat (although an increase in value terms), Puravankara has managed to maintain marginal growth on volumes from its new launches. But unlike Prestige and Sobha, Puravankara has sizeable unsold ready units to be sold.
Sobha has soft-launched its ‘Aspirational Homes’ product in 4QFY15, with unit prices starting as low as Rs 3.5 mn/unit. We believe this project will see good response and Sobha needs to replicate such projects at multiple locations for growth from current levels. Prestige, too, acquired 15 projects in 3QFY15. Entry into new markets, we believe, will be the key to Prestige’s volume growth in its residential business.
CY2014 saw some large lease deals in Bangalore. Outer Ring Road (ORR) remains the most attractive location with the largest developments and the largest leases being discussed in the market. In the past five years, absorption contribution in Bangalore has increased from around 40% to around 65%, followed by Whitefield. All major office developers, Embassy Developers, RMZ, Prestige Estates, Salarpuria Group among others, are present in the market. Whitefield is the next desired location among occupiers.
Wednesday, March 11, 2015
Govt Exempts Capital Gains on REIT Sponsors
The government exempted the capital-gains tax on sponsors (which was only deferred earlier) to as and when the sponsor decides to monetize its holdings in an REIT (all other conditions remaining the same and provided the sponsor pays STT). This puts a sponsor on a level-playing field with most promoters’ equity offerings. For any asset/SPV created before FY2014, the sponsors can monetize their shareholding after FY2016
The government clarified the direct holdings of an asset in an REIT. The income will be a pass-through for the REIT. For the resident investor, there will be withholding tax of 10% while for a non-resident investor it will be as per the tax laws of the respective country. On the face of it, this remains a lucrative structure for institutional investors with a minimum tax leakage (provided the REIT takes a stamp-duty hit in stage 1). But one still needs to understand the taxation for FIIs as this falls under income from house property
While the above measures are progressive steps, they still do not address the issues of (1) upfront MAT payments while transferring shares in the SPV to the REIT and (2) direct transfer of an asset to the REIT. In both cases there is upfront cash outflow for the sponsors, without necessarily getting cash. In (2), there is a large stamp-duty consideration, which is governed by local states rather than the cent
We believe direct holding of an asset in a REIT is the most efficient structure in the long term—as the income in the REIT is a pass-through and with little leakage on distribution, we believe this will augment yields
MAT remains the biggest issue
MAT is still applicable during the initial transfer of shares from the SPV to the REIT. In case of asset transfer, the sponsor will have to pay capital gains. However, since in most cases assets are in SPVs, setting off of MAT credit could be difficult.
Stamp duty is another issue in case of an asset transfer. Stamp duty varies 6-9% as per state regulations. In such a transfer, this will also have to be taken into consideration and will affect yields. As in Exhibit 1, considering all other variable are similar, SPV transfer is better.
Sponsors are also seeking dividend distribution tax (DDT) exemptions in case of SPV holding assets and REITs investing in form of equity of debt. We continue to believe this will be hard to change, as the government is not giving exemption to other sectors on this parameter. Further, direct holding and investment through debt bypass the DDT. All said, we believe that one cannot set up a perpetual vehicle (REIT) based on financial engineering.
The government clarified the direct holdings of an asset in an REIT. The income will be a pass-through for the REIT. For the resident investor, there will be withholding tax of 10% while for a non-resident investor it will be as per the tax laws of the respective country. On the face of it, this remains a lucrative structure for institutional investors with a minimum tax leakage (provided the REIT takes a stamp-duty hit in stage 1). But one still needs to understand the taxation for FIIs as this falls under income from house property
While the above measures are progressive steps, they still do not address the issues of (1) upfront MAT payments while transferring shares in the SPV to the REIT and (2) direct transfer of an asset to the REIT. In both cases there is upfront cash outflow for the sponsors, without necessarily getting cash. In (2), there is a large stamp-duty consideration, which is governed by local states rather than the cent
We believe direct holding of an asset in a REIT is the most efficient structure in the long term—as the income in the REIT is a pass-through and with little leakage on distribution, we believe this will augment yields
MAT remains the biggest issue
MAT is still applicable during the initial transfer of shares from the SPV to the REIT. In case of asset transfer, the sponsor will have to pay capital gains. However, since in most cases assets are in SPVs, setting off of MAT credit could be difficult.
Stamp duty is another issue in case of an asset transfer. Stamp duty varies 6-9% as per state regulations. In such a transfer, this will also have to be taken into consideration and will affect yields. As in Exhibit 1, considering all other variable are similar, SPV transfer is better.
Sponsors are also seeking dividend distribution tax (DDT) exemptions in case of SPV holding assets and REITs investing in form of equity of debt. We continue to believe this will be hard to change, as the government is not giving exemption to other sectors on this parameter. Further, direct holding and investment through debt bypass the DDT. All said, we believe that one cannot set up a perpetual vehicle (REIT) based on financial engineering.
Thursday, March 05, 2015
REIT taxation clarity provided
Union Budget 2015 finally provided some clarity on the taxation of REITs. As a brief recap, going into the Budget, there were two primary demands from the industry regarding taxation: 1. Exempt transfer of assets from sponsor to REIT from capital gains as it’s similar to a company doing an IPO; and 2. Exempt the project SPV from Dividend Distribution Tax when paying dividends to REIT. These norms would have incentivized sponsors to put assets into the REIT without undergoing significant tax outgo and also be able to upstream higher dividends from assets to final investors.
On the first demand, partial relief given. Transfer of assets from the sponsor to the REIT is exempted from capital gains tax. There will be a levy of MAT at transfer but this can be offset on other residential business that the sponsor may have. On DDT exemption, no relief has been given as against industry demands. Thus REITs will now need to take out dividends as interest income from the SPV. This, however, attracts withholding tax which is lower for FIIs.
REITs can take out dividend in the form of interest income from the SPV. Under the regulations laid out, domestic investors pay higher tax on the REIT dividend as opposed to foreign investors that pay a withholding tax of 5% (additional paid depending on their tax jurisdiction). For both domestic investors and FIIs, REIT income is a pass through and is taxed at their hands (less withholding tax paid by the REIT). Thus for FIIs this is a good outcome. For domestic sponsors, technically, this will mean that entire rental income is taxed. Again for sponsors with large residential business can offset this. However, it might not be really attractive for pure commercial developers. We do note that the regulation is no worse than the existing tax structure. See pictorial representation below.
On the first demand, partial relief given. Transfer of assets from the sponsor to the REIT is exempted from capital gains tax. There will be a levy of MAT at transfer but this can be offset on other residential business that the sponsor may have. On DDT exemption, no relief has been given as against industry demands. Thus REITs will now need to take out dividends as interest income from the SPV. This, however, attracts withholding tax which is lower for FIIs.
REITs can take out dividend in the form of interest income from the SPV. Under the regulations laid out, domestic investors pay higher tax on the REIT dividend as opposed to foreign investors that pay a withholding tax of 5% (additional paid depending on their tax jurisdiction). For both domestic investors and FIIs, REIT income is a pass through and is taxed at their hands (less withholding tax paid by the REIT). Thus for FIIs this is a good outcome. For domestic sponsors, technically, this will mean that entire rental income is taxed. Again for sponsors with large residential business can offset this. However, it might not be really attractive for pure commercial developers. We do note that the regulation is no worse than the existing tax structure. See pictorial representation below.
Tuesday, March 03, 2015
Exiciting Times for Mumbai Home Buyers
Developers are now offering freebies and discounts to sell projects, as the supply on offer is different from demand segments.
Similar to the trend in other markets, Mumbai also saw fewer (official) launches in 3QFY15 as developers pushed sales at existing projects (with more supply, investor deals still remain high, we believe). Pricing still remains high in certain markets, but is not increasing anymore. More deals and offers are now being followed up with absolute price-cuts at many projects, including those of larger developers and high-value markets.
The residential market still remains slow and only strong brands are able to sell expensive products. Developers are open to giving discounts and cutting prices, but post definitive interest from buyers. Land buying has dropped and prices are not going up as only 4-5 developers have the capacity to buy land worth more than US$200 mn. Further, developers want to reduce absolute debt, but with changing approvals and increasing costs, we remain skeptical.
Launches continue to slow down in Mumbai too, with the official launches during the festive season 50% lower than the average of the past 10 quarters. But our channel checks suggest developers are pre-launching projects to investors, offering deals for large projects that are yet to be reported as official sales.
Developers continue to push sales at existing projects, with many introducing discounts in the form of subvention schemes, schemes without interest rates linked to banks and apartment registrations, deferred payment plans and most even offering high discounts on offered rack rates. Our channel checks suggest discounts in certain high-value projects / large developers ranging from Rs 500/sq. ft to even Rs 5,000/sq. ft depending on locations and projects. Having done this, sales continue to hold ground in Mumbai on a consolidated basis.
Similar to the trend in other markets, Mumbai also saw fewer (official) launches in 3QFY15 as developers pushed sales at existing projects (with more supply, investor deals still remain high, we believe). Pricing still remains high in certain markets, but is not increasing anymore. More deals and offers are now being followed up with absolute price-cuts at many projects, including those of larger developers and high-value markets.
The residential market still remains slow and only strong brands are able to sell expensive products. Developers are open to giving discounts and cutting prices, but post definitive interest from buyers. Land buying has dropped and prices are not going up as only 4-5 developers have the capacity to buy land worth more than US$200 mn. Further, developers want to reduce absolute debt, but with changing approvals and increasing costs, we remain skeptical.
Launches continue to slow down in Mumbai too, with the official launches during the festive season 50% lower than the average of the past 10 quarters. But our channel checks suggest developers are pre-launching projects to investors, offering deals for large projects that are yet to be reported as official sales.
Developers continue to push sales at existing projects, with many introducing discounts in the form of subvention schemes, schemes without interest rates linked to banks and apartment registrations, deferred payment plans and most even offering high discounts on offered rack rates. Our channel checks suggest discounts in certain high-value projects / large developers ranging from Rs 500/sq. ft to even Rs 5,000/sq. ft depending on locations and projects. Having done this, sales continue to hold ground in Mumbai on a consolidated basis.
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