BNP Paribas: India realestate -Office recovery gathers pace

Office sector in the ‘recovery’ phase
We believe, the Indian Office sector is in the ‘recovery’ phase of the property
cycle (see Exhibits 2 and 3). We have begun to see an improvement in the
absorption of new supply in 1H 2010 in most key metros. Improvement in
absorption levels is usually the first indicator of a cyclical recovery and helps push
up overall market occupancies. Recent trends in the top seven cities of India
indicate that absorption levels have improved significantly (vis-à-vis prior years),
and in a few cases they have exceeded the supply by 1.5x (see Exhibit 1). NCR,
Pune and Chennai have shown the maximum improvement.
Supply concerns recede as banks tighten the noose
Our checks with various lending institutions suggest that they have turned
extremely cautious over the past 6 months to lend to new Office constructions.
This in turn has put a cap on new construction activity in the Office sector. Data
from Industry Participants also suggest that new Office supply in top seven Indian
metros have been getting pushed back or scrapped. Despite the near-term supply
overhang in the Office sector, we see an improving outlook in FY11 and FY12
with occupancies starting to increase in select metros. This in turn should lead to
a cyclical re-rating of rents starting FY12 in our view.
Developer stock valuations tend to peak as high as 3x P/B
Our analysis of past cycles of global developer stocks suggest that mean midcycle
valuations are 1.5x P/B (refer Appendix). Cyclical peak valuations tend to
re-rate developer stocks to as high as 3x P/B which tends to coincide with cyclical
peaks in Office and Retail sectors. For developers to achieve these peak cycle
valuations, a recovery in new Office ‘construction starts’ is essential in our view,
the timing of which remains unclear. Hence, we continue to prefer to value larger
Indian developers at mean mid-cycle valuations of 1.5x P/B.
DLF is a key beneficiary but mostly prices in the upside
DLF has the largest exposure to Office sector and generates approximately 69%
of its Gross Asset Value (GAV) from non-residential segment. However, it
remains the most expensive developer in our comparable universe trading at 2.3x
FY11E P/B versus sector average of 1.7x FY11E P/B. Our top sector pick is
Anant Raj Industries, which has a strong balance sheet, is inexpensive (trades at
1.1x FY11E P/B) and generates approximately 48% of its GAV from Office and
Retail sectors.