2.8 Lakh Crore Worth Residential Projects Stuck in COVID-19

We expect stranded inventory worth Rs2.8 tn [2.8 Lakh Crore] to put debt worth Rs1.2 tn (28% of total real estate loans in India) at risk. Adverse market dynamics and regulatory factors have strained the real estate sector over the past five years, leading to increased capital requirements and diluting return profiles, and in turn plunging ratings of around one-third developers to below investment grade. Covid-19 induced disruptions have dealt another crushing blow.

Real Estate Developer loans nearly doubled to Rs4.2 tn over the past five years. Buoyed by easy access to funding, NBFCs/HFCs aggressively captured this financing demand. Despite severe headwinds for the real estate sector putting about 28% of the loan book at risk, most wholesale NBFCs/HFCs have not reported any significant NPLs as a large proportion (40%) of the real estate book is under moratorium. However, rating-wise breakup of loans sanctioned exposes the poor underlying asset quality.

We estimate the real estate sector would need immediate capital infusion of Rs390-650 bn. While the recent (August 6)window provided by RBI for restructuring will augur well, long-pending NPL recognition of unviable stressed projects is crucial. Recognition of inter-creditor agreement under IBC to provide flexibility in structuring last mile funding.

We can’t quantify the impact on the real estate sector and its lenders, however a wave of consolidation in the sector is imminent. Asset quality challenges for new real estate lending players, now accentuated by higher NPL recognition, coupled with debt market consolidation will lead to the real estate lending business being consolidated with banks and select NBFCs.

Accountablity Slowed Down BlackMoney Dominated Realty

The past few years have been the worst for India’s real estate market, constrained by the implementation of RERA, GST and demonetization ebcause the sector was largely under the influence of corrupt politicians, bureaucrats and tax evading business houses.

Household income has increased at ~10% CAGR over the past three years, while residential real estate prices have increased by less than 1%, thus signifying improving affordability. However, investor interest has reduced due to declining capital appreciation, which remains a challenge.

FDI has almost doubled over the past five years, with inflows increasing primarily towards commercial projects. Interest by foreign players like Blackstone, Canadian Pension Fund has increased considerably in the past five years or so. 

India’s office space has more than doubled in the past decade to 550 mn sq ft. This is still far less than the developed markets, thus signifying considerable future potential. There is increased interest from foreign players to rent office spaces in India, with US having the highest proportion at 44% of total office space acquired in India. Within this, 39% is occupied by IT/ITeS sector, 12% by manufacturing, 13% by BFSI and 10% comprising shared working spaces.

India’s warehousing absorption has tripled over the past three years to ~32 mn sq. ft. in FY2018 from ~10 mn sq. ft. in FY2015 with the quantum of Grade A projects almost quadrupled. Also, vacancy levels have dropped below 10%, thus signifying an improving market scenario.

 

Real Estate in COVID-19 - Slow but not Out

Residential sales for listed developers were down 35% YoY; most reported ~50- 60% YoY decline, except GPL (+70% YoY). Seamless adoption of online booking systems, higher share of NRI sales, and demand for larger homes helped. Collections saw a sharper decline, down 50% YoY, owing to lower construction activity and deferral of demand letters, although lower outflow on construction spend/overheads aided operating cash flows and debt levels. The momentum has improved since July, especially in new bookings, where the outlook on recovery is better than collections/operating cash flows.

Rental collections for Office have been >95% for 1QFY21, with broadly stable occupancy levels and most developers witnessing no material rental re-negotiations. The capex outlook was largely restored across developers, as commentary suggests that the LT demand outlook remains intact and supply from smaller players is likely to falter on lack of funding. Near-term leasing outlook is tepid due to the ongoing lockdown, marginal increase in vacancy levels and muted escalations in rentals are likely for FY21  

Mall developers offered rental waivers (minimum guarantee rental) − ranging over 50-100% − to tenants, for 1QFY21 (lockdown period). Mall owners are also likely to offer graded waivers over a large part of FY21, till business is back to normalcy. Footfalls across malls remain weak, with Bangalore malls reporting just 20-25% footfalls, and overall pan India retail sales down 63% YoY in July (Source: RAI). The hospitality portfolio for most developers reported low-to-nil occupancy (due to the shutdowns) and losses at the Ebitda level. Mall owners expect sales to improve by 3Q during the festive season and with the opening of Multiplexes / Dining, although a full recovery may still be some quarters away.

Realty Developers are sanguine on a recovery in 2Q, and are lining up new launches in 3QFY21, by when labour availability is also expected to reach pre-Covid levels.