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.

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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.