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.