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Residential demand across 5 of the top 7
cities has slipped and we see downside
risks increasing
We expect FY11-12 volume guidance to
be missed. While stocks look cheap, we
see more downside and downgrades
Our bearish view on residential
undermines our more positive view on
commercial property
Residential demand has slipped. Recent data suggests
absorption (demand) volume in India’s top 7 cities has either
been flat or declined over the past two quarters. The Mumbai
region and Pune have reported sharp drops, while Gurgaon and
Bangalore have shown flat-marginally negative growth (figure
A.7-12, page 4). While developers could hold prices firm in the
near term due to stable balance sheet liquidity, we think this will
only hurt demand as interest rate rises and higher property
prices will curtail affordability. Likely stringent measures by
RBI towards the sector could curtail credit to the sector and hurt
execution. Looking ahead, the risks of sticky inflation, further
rise in interest rates and more stringent RBI policies imply
further downside risk to demand.
Downside risk to volume guidance remains high. We expect
sector leaders DLF and Unitech to miss their FY11 volume
guidance and issue conservative FY12 guidance. We cut
residential new volume estimates by up to 45% across our
coverage over FY11-13. We stay positive on commercial real
estate (CRE) but weak residential will overshadow CRE growth
Valuations are low – but going nowhere. The stocks in our
coverage have corrected 10-20% y-t-d, but we see further
downside from the risks stated above. Our revised target prices
peg sector valuation below their mean (around -1 standard
deviation), reflecting a likely deterioration in the business
environment and increased downside risk to earnings. Any
stock price bounce should be viewed as an exit opportunity.
Downgrading DLF, Unitech and IBREL. We downgrade
Unitech to UW(V) from N(V) and DLF and IBREL to N(V)
from OW(V). We retain our UW(V) rating on Anant Raj.
Retain OW(V) on HDIL. While we remain negative on the
Mumbai region, we believe HDIL may outperform on the
back of increased land sales, which would improve balance
sheet liquidity.
Growth has slowed
Five of India’s top 7 cities recorded slowing residential volume
growth over the past two quarters; downside risks are high
We expect companies to miss volume guidance. Large players
are likely to disappoint on Q3 FY11 earnings
Deteriorating business environment will suppress valuations.
Downgrade DLF and IBREL to N(V) and Unitech to UW(V)
Volumes have slipped
5 of the top 7 cities have seen
weak/negative growth
Despite a good macro environment (GDP growth
expectations of 8-8.2% over FY11-12), residential
demand across major Indian cities has fallen due
to high property prices coupled with rising
inflation and interest rates. New volumes across
most major markets like Mumbai Metropolitan
Region (MMR), Bangalore, Hyderabad and
Gurgaon have decelerated (refer figure A.6
below). The volume weakness has been highest in
MMR and Pune. Developers have not been able to
sustain the demand pick-up seen during the festive
season (July-October). Also, despite the
sequential pick-up in volumes during the festive
season, they remained low compared to the same
period last year. Volumes in Kolkata and Chennai
have reported strong growth, albeit on a low base.
New launch rush to capture demand
at high prices
In H2 FY11, developers have rushed to launch
new projects. Part of the reason was a weak
launch schedule during FY10, when developers
chose to liquidate existing inventory (refer Figure
A.13 for more details) and keep property prices
firm. New launches during Q2 and Q3 FY11 have
increased substantially to take advantage of high
property prices. Sustained high intensity of new
launches in a falling demand environment will
expand the inventory stock (c10-12x average
monthly sales). This will increase pressure on
property prices, capping growth in the near term.
Volumes are at risk
Interest rates have started to move up
In our view, residential volumes have peaked and
we expect rising interest rates and high property
prices to start to dent demand. This is reflected in
rising funding cost for banks, which are the major
home loan financers. Deposit rates in the system
have already increased by 225bps since July 2010,
while home loan rates have gone up by 100bps
during the same period. Several home loan agents
we contacted (a direct selling channel) said that
banks have indicated rates will keep moving up
over the next 12-18 months and that there is a big
near-term push to attract buyers
Sustained tight liquidity conditions in the system
(refer figure A.15) have helped keep upward
pressure on interest rates constant. Additionally,
with inflation remaining high at 8.4% (HSBC est.
8% for 2011), our India economist expects India’s
central bank to raise policy rates aggressively by
25bps in January 2011 and 125bps in 2011.
RBI may issue stricter lending guidelines for
the sector
The Reserve Bank of India could announce
monetary policy measures to curb lending to the
residential property sector after a loan scam was
revealed (see our report dated 25 November 2010
titled Corporate brokers’ illegal nexus with
financers alleged). This, coupled with high
property prices could act as a catalyst for banks
and financial institutions to take a tough stance on
lending to the sector. This could manifest itself
through multiple actions such as 1) withdrawal of
teaser home loan rates, 2) higher borrowing costs,
3) increased collateral requirements for restructuring or refinancing of existing and
incremental debt.
Channel checks/city visits reinforce
our cautious view on residential
Our city visits over the past two months,
corroborate the weak demand story. Refer to
figure A.16 for a quick reference to our city
analysis across multiple parameters, which has
reinforced our cautious view on the residential
property sector. Our analysis suggests risk to
property price growth is highest in Mumbai,
Gurgaon, Noida, Greater Noida and Pune, all of
which have seen property prices grow 20-35%
from their last cycle-bottom in March 2009. We
believe risk to demand is lowest in Chennai and
Kolkata where developers have not increased
prices aggressively (prices are up only 10-20%
from their last cycle bottom).
Secondary market sales in some projects
trading at a discount
The last upcycle in the Indian residential property
market saw a similar trend, where fresh volumes
from developers commanded a premium over
units that were under construction or already
developed. We see a similar trend across many
projects in certain markets like Gurgaon, Noida
and Pune, where the secondary market in projects
under construction is trading at a 10-15% discount
to primary market prices (quoted by the
developer). While this is also prevalent across
other markets like Mumbai and Bangalore, the
premium is far lower at 5-8%. This suggests
investor appetite for the residential segment is
waning, and they are keen to liquidate inventory.
This will keep pressure on fresh volumes
launched by developers.
Local brokers remain bullish –that’s usually
the case?
Our discussions with local brokers across the
cities highlight that they remain bullish on their
respective markets, except Mumbai and Pune
which showed a mixed view. We observed the
most bullishness in Gurgaon, Noida and Chennai,
where developers expect prices to rise 10-15%
over the next 3-4 months. Gurgaon and Noida are
also the two markets that are witnessing the
maximum discount on their underconstruction/completed inventory.
However, we don’t expect residential property
prices to correct in the near term
Most large developers have over the past 18
months raised sufficient funds and their balance
sheets remain healthy (refer figure A.17a). This
will allow developers to hold inventory without
substantial pressure on cash flows. Also, valuation
of real estate companies is more sensitive to price
growth than volumes. Hence, we think developers
will be willing to forgo volumes and hold prices
firm in the initial period of weak demand. We
have built in flat pricing growth over FY11-13e
Conclusion: We turn more bearish on the
residential sector
We expect residential property prices to remain
firm in the near to medium term across most cities,
while volumes could be down by 10-15%. The
Mumbai region, though, could see a sharper
volume correction. However, we also expect
developers with the ability to cut prices and launch
product at a competitive price to attract demand.
Sector players likely to miss
volume guidance
Large residential property developers within our
coverage like DLF and Unitech have seen a sharp
slowdown in new project launches and have been
focusing on liquidating existing inventory. While
lack of approvals has been the major reason for
DLF’s delay in new project launches, Unitech has
renewed its focus on high income housing, where
it already has substantial inventory on board. The
delay in new launches coupled with rising risk to
demand will in our opinion lead to belowguidance performance by DLF and Unitech.
We have cut our residential volume estimates for
DLF by 15% in FY11, 35% in FY12, and 33% in
FY13, while we have retained our below-guidance
estimates for Unitech. We have cut our Transfer
of Development Rights (TDR) sales volume
estimate for HDIL by 20% in FY12 to 4mn sq ft.
(please refer figure A.17 for more details).
Still positive on CRE, though
residential weakness will overshadow
CRE growth
We maintain our positive outlook for the
commercial property segment and expect large
players to benefit disproportionately. Sustained
improvement in the IT/ITES sector’s business
environment, along with the growth of the
financial services industry, suggests commercial
office space demand will continue to rise. We
expect commercial volumes to grow 20-30%
during 2011, with marginal price growth of 5-
10%. However, commercial demand is unlikely to
percolate to mid-sized developers, as large
developers use their existing business
relationships to attract demand and increase
market share. But with most stocks under our
coverage deriving only 20-40% of their gross
asset value (GAV) from residential projects,
weakness in the residential segment will
overshadow CRE growth.
We turn more cautious on India
property stocks
We anticipate multiple stress points for real estate
stocks over the next 12-18 months, including
below-expectation volume growth coupled with
policy and debt refinancing risk (See figure A.18).
We expect DLF and Unitech to underperform
their volume guidance for FY11, and we expect
earnings to be at risk for FY12 and FY13. We
expect Anant Raj’s key high income launches in
Delhi to be delayed due to approvals. Both DLF
and Unitech need to refinance 22% and 30% of
their debt over the next 18 months, which is not
large, but if system liquidity remains tight, that
could elevate uncertainty (refer figures A.19 and
A.20 below).
Policy risk remains heightened for the entire
sector owing to the recent issue of corporate
brokers being revealed to have operated an illegal
nexus involving financers and high property
prices. In our view, IBREL faces additional risk
of potential withdrawal of parking FSI (Floor
Space Index) policy, which could reduce the
saleable area, thereby impacting valuation.
Stocks will likely underperform in
weak business environment
Lessons from the last property downcycle suggest
that tight liquidity, weak volumes and sustained
negative news flow will likely keep the Indian
property stocks under pressure (refer figure A.19
and A.20). We do not think residential developers
will cut prices to improve volumes as seen over
the past 6 months in the Mumbai market. This
could lead to longer than anticipated weakness in
volume growth.
In such a scenario, we expect the property stocks
to trade at a significant discount to their mid-cycle
valuation. We have revised our target valuations
for our sector coverage stocks to reflect the
weakening operating environment. We have
expanded our target NAV discounts by 20-30%
and they are now only 20-30% above cyclebottom valuations.
Unitech is our least preferred play,
while HDIL is our only OW play
We downgrade Unitech to Underweight (V) from
Neutral (V) and retain our Underweight (V) rating
on Anant Raj. While Unitech has a comfortable
debt-equity position at 0.6x, tight liquidity in the
system and rising interest rates pose a risk to
execution scale-up. We expect Unitech’s
execution to be slower than consensus estimates.
Our earnings forecasts for FY11-13 are 20-28%
below consensus for FY11-12. While we like
Anant Raj’s high value, Delhi-centric land bank
acquired at very low cost, its weak brand in the
commercial segment will continue to hurt
business volumes and in turn delay execution. We
expect the company to be a late beneficiary of the
CRE demand revival as large players corner
demand initially.
We also downgrade DLF and IBREL to Neutral
(V). DLF has not been able to launch new projects
in line with the market, and hence we expect the
company to miss its volume guidance during
FY11. A weak new launch schedule and a
deteriorating business environment will hit
earnings hard over the next two years. In line with
this outlook, we have cut our forecasts for DLF’s
net profit by c20-42% over FY11-13e. We expect
DLF to report mere 6% earnings CAGR over
FY11-13e, which is now the lowest within our
coverage. (Refer figure A.24 for earnings changes
for our coverage universe.)
IBREL’s large portfolio of luxury residential
projects will impact its new volumes in a weak
demand environment. This is also likely to affect
execution as balance sheet debt increases to fund
new projects using leverage. We cut earnings by
25-48% to factor in reduced other income as the
company deploys excess cash in new projects
with limited medium-term returns. We expect a
mere 6% EPS CAGR over FY11-13e.
While we remain negative on the Mumbai region,
we believe HDIL could outperform on the back
of increased FSI sales, which will improve
balance sheet liquidity. We expect the company to
report a strong EPS CAGR of 22% over FY11-
13e as old projects start to contribute to earnings
post completion. We retain our OW(V) rating.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Residential demand across 5 of the top 7
cities has slipped and we see downside
risks increasing
We expect FY11-12 volume guidance to
be missed. While stocks look cheap, we
see more downside and downgrades
Our bearish view on residential
undermines our more positive view on
commercial property
Residential demand has slipped. Recent data suggests
absorption (demand) volume in India’s top 7 cities has either
been flat or declined over the past two quarters. The Mumbai
region and Pune have reported sharp drops, while Gurgaon and
Bangalore have shown flat-marginally negative growth (figure
A.7-12, page 4). While developers could hold prices firm in the
near term due to stable balance sheet liquidity, we think this will
only hurt demand as interest rate rises and higher property
prices will curtail affordability. Likely stringent measures by
RBI towards the sector could curtail credit to the sector and hurt
execution. Looking ahead, the risks of sticky inflation, further
rise in interest rates and more stringent RBI policies imply
further downside risk to demand.
Downside risk to volume guidance remains high. We expect
sector leaders DLF and Unitech to miss their FY11 volume
guidance and issue conservative FY12 guidance. We cut
residential new volume estimates by up to 45% across our
coverage over FY11-13. We stay positive on commercial real
estate (CRE) but weak residential will overshadow CRE growth
Valuations are low – but going nowhere. The stocks in our
coverage have corrected 10-20% y-t-d, but we see further
downside from the risks stated above. Our revised target prices
peg sector valuation below their mean (around -1 standard
deviation), reflecting a likely deterioration in the business
environment and increased downside risk to earnings. Any
stock price bounce should be viewed as an exit opportunity.
Downgrading DLF, Unitech and IBREL. We downgrade
Unitech to UW(V) from N(V) and DLF and IBREL to N(V)
from OW(V). We retain our UW(V) rating on Anant Raj.
Retain OW(V) on HDIL. While we remain negative on the
Mumbai region, we believe HDIL may outperform on the
back of increased land sales, which would improve balance
sheet liquidity.
Growth has slowed
Five of India’s top 7 cities recorded slowing residential volume
growth over the past two quarters; downside risks are high
We expect companies to miss volume guidance. Large players
are likely to disappoint on Q3 FY11 earnings
Deteriorating business environment will suppress valuations.
Downgrade DLF and IBREL to N(V) and Unitech to UW(V)
Volumes have slipped
5 of the top 7 cities have seen
weak/negative growth
Despite a good macro environment (GDP growth
expectations of 8-8.2% over FY11-12), residential
demand across major Indian cities has fallen due
to high property prices coupled with rising
inflation and interest rates. New volumes across
most major markets like Mumbai Metropolitan
Region (MMR), Bangalore, Hyderabad and
Gurgaon have decelerated (refer figure A.6
below). The volume weakness has been highest in
MMR and Pune. Developers have not been able to
sustain the demand pick-up seen during the festive
season (July-October). Also, despite the
sequential pick-up in volumes during the festive
season, they remained low compared to the same
period last year. Volumes in Kolkata and Chennai
have reported strong growth, albeit on a low base.
New launch rush to capture demand
at high prices
In H2 FY11, developers have rushed to launch
new projects. Part of the reason was a weak
launch schedule during FY10, when developers
chose to liquidate existing inventory (refer Figure
A.13 for more details) and keep property prices
firm. New launches during Q2 and Q3 FY11 have
increased substantially to take advantage of high
property prices. Sustained high intensity of new
launches in a falling demand environment will
expand the inventory stock (c10-12x average
monthly sales). This will increase pressure on
property prices, capping growth in the near term.
Volumes are at risk
Interest rates have started to move up
In our view, residential volumes have peaked and
we expect rising interest rates and high property
prices to start to dent demand. This is reflected in
rising funding cost for banks, which are the major
home loan financers. Deposit rates in the system
have already increased by 225bps since July 2010,
while home loan rates have gone up by 100bps
during the same period. Several home loan agents
we contacted (a direct selling channel) said that
banks have indicated rates will keep moving up
over the next 12-18 months and that there is a big
near-term push to attract buyers
Sustained tight liquidity conditions in the system
(refer figure A.15) have helped keep upward
pressure on interest rates constant. Additionally,
with inflation remaining high at 8.4% (HSBC est.
8% for 2011), our India economist expects India’s
central bank to raise policy rates aggressively by
25bps in January 2011 and 125bps in 2011.
RBI may issue stricter lending guidelines for
the sector
The Reserve Bank of India could announce
monetary policy measures to curb lending to the
residential property sector after a loan scam was
revealed (see our report dated 25 November 2010
titled Corporate brokers’ illegal nexus with
financers alleged). This, coupled with high
property prices could act as a catalyst for banks
and financial institutions to take a tough stance on
lending to the sector. This could manifest itself
through multiple actions such as 1) withdrawal of
teaser home loan rates, 2) higher borrowing costs,
3) increased collateral requirements for restructuring or refinancing of existing and
incremental debt.
Channel checks/city visits reinforce
our cautious view on residential
Our city visits over the past two months,
corroborate the weak demand story. Refer to
figure A.16 for a quick reference to our city
analysis across multiple parameters, which has
reinforced our cautious view on the residential
property sector. Our analysis suggests risk to
property price growth is highest in Mumbai,
Gurgaon, Noida, Greater Noida and Pune, all of
which have seen property prices grow 20-35%
from their last cycle-bottom in March 2009. We
believe risk to demand is lowest in Chennai and
Kolkata where developers have not increased
prices aggressively (prices are up only 10-20%
from their last cycle bottom).
Secondary market sales in some projects
trading at a discount
The last upcycle in the Indian residential property
market saw a similar trend, where fresh volumes
from developers commanded a premium over
units that were under construction or already
developed. We see a similar trend across many
projects in certain markets like Gurgaon, Noida
and Pune, where the secondary market in projects
under construction is trading at a 10-15% discount
to primary market prices (quoted by the
developer). While this is also prevalent across
other markets like Mumbai and Bangalore, the
premium is far lower at 5-8%. This suggests
investor appetite for the residential segment is
waning, and they are keen to liquidate inventory.
This will keep pressure on fresh volumes
launched by developers.
Local brokers remain bullish –that’s usually
the case?
Our discussions with local brokers across the
cities highlight that they remain bullish on their
respective markets, except Mumbai and Pune
which showed a mixed view. We observed the
most bullishness in Gurgaon, Noida and Chennai,
where developers expect prices to rise 10-15%
over the next 3-4 months. Gurgaon and Noida are
also the two markets that are witnessing the
maximum discount on their underconstruction/completed inventory.
However, we don’t expect residential property
prices to correct in the near term
Most large developers have over the past 18
months raised sufficient funds and their balance
sheets remain healthy (refer figure A.17a). This
will allow developers to hold inventory without
substantial pressure on cash flows. Also, valuation
of real estate companies is more sensitive to price
growth than volumes. Hence, we think developers
will be willing to forgo volumes and hold prices
firm in the initial period of weak demand. We
have built in flat pricing growth over FY11-13e
Conclusion: We turn more bearish on the
residential sector
We expect residential property prices to remain
firm in the near to medium term across most cities,
while volumes could be down by 10-15%. The
Mumbai region, though, could see a sharper
volume correction. However, we also expect
developers with the ability to cut prices and launch
product at a competitive price to attract demand.
Sector players likely to miss
volume guidance
Large residential property developers within our
coverage like DLF and Unitech have seen a sharp
slowdown in new project launches and have been
focusing on liquidating existing inventory. While
lack of approvals has been the major reason for
DLF’s delay in new project launches, Unitech has
renewed its focus on high income housing, where
it already has substantial inventory on board. The
delay in new launches coupled with rising risk to
demand will in our opinion lead to belowguidance performance by DLF and Unitech.
We have cut our residential volume estimates for
DLF by 15% in FY11, 35% in FY12, and 33% in
FY13, while we have retained our below-guidance
estimates for Unitech. We have cut our Transfer
of Development Rights (TDR) sales volume
estimate for HDIL by 20% in FY12 to 4mn sq ft.
(please refer figure A.17 for more details).
Still positive on CRE, though
residential weakness will overshadow
CRE growth
We maintain our positive outlook for the
commercial property segment and expect large
players to benefit disproportionately. Sustained
improvement in the IT/ITES sector’s business
environment, along with the growth of the
financial services industry, suggests commercial
office space demand will continue to rise. We
expect commercial volumes to grow 20-30%
during 2011, with marginal price growth of 5-
10%. However, commercial demand is unlikely to
percolate to mid-sized developers, as large
developers use their existing business
relationships to attract demand and increase
market share. But with most stocks under our
coverage deriving only 20-40% of their gross
asset value (GAV) from residential projects,
weakness in the residential segment will
overshadow CRE growth.
We turn more cautious on India
property stocks
We anticipate multiple stress points for real estate
stocks over the next 12-18 months, including
below-expectation volume growth coupled with
policy and debt refinancing risk (See figure A.18).
We expect DLF and Unitech to underperform
their volume guidance for FY11, and we expect
earnings to be at risk for FY12 and FY13. We
expect Anant Raj’s key high income launches in
Delhi to be delayed due to approvals. Both DLF
and Unitech need to refinance 22% and 30% of
their debt over the next 18 months, which is not
large, but if system liquidity remains tight, that
could elevate uncertainty (refer figures A.19 and
A.20 below).
Policy risk remains heightened for the entire
sector owing to the recent issue of corporate
brokers being revealed to have operated an illegal
nexus involving financers and high property
prices. In our view, IBREL faces additional risk
of potential withdrawal of parking FSI (Floor
Space Index) policy, which could reduce the
saleable area, thereby impacting valuation.
Stocks will likely underperform in
weak business environment
Lessons from the last property downcycle suggest
that tight liquidity, weak volumes and sustained
negative news flow will likely keep the Indian
property stocks under pressure (refer figure A.19
and A.20). We do not think residential developers
will cut prices to improve volumes as seen over
the past 6 months in the Mumbai market. This
could lead to longer than anticipated weakness in
volume growth.
In such a scenario, we expect the property stocks
to trade at a significant discount to their mid-cycle
valuation. We have revised our target valuations
for our sector coverage stocks to reflect the
weakening operating environment. We have
expanded our target NAV discounts by 20-30%
and they are now only 20-30% above cyclebottom valuations.
Unitech is our least preferred play,
while HDIL is our only OW play
We downgrade Unitech to Underweight (V) from
Neutral (V) and retain our Underweight (V) rating
on Anant Raj. While Unitech has a comfortable
debt-equity position at 0.6x, tight liquidity in the
system and rising interest rates pose a risk to
execution scale-up. We expect Unitech’s
execution to be slower than consensus estimates.
Our earnings forecasts for FY11-13 are 20-28%
below consensus for FY11-12. While we like
Anant Raj’s high value, Delhi-centric land bank
acquired at very low cost, its weak brand in the
commercial segment will continue to hurt
business volumes and in turn delay execution. We
expect the company to be a late beneficiary of the
CRE demand revival as large players corner
demand initially.
We also downgrade DLF and IBREL to Neutral
(V). DLF has not been able to launch new projects
in line with the market, and hence we expect the
company to miss its volume guidance during
FY11. A weak new launch schedule and a
deteriorating business environment will hit
earnings hard over the next two years. In line with
this outlook, we have cut our forecasts for DLF’s
net profit by c20-42% over FY11-13e. We expect
DLF to report mere 6% earnings CAGR over
FY11-13e, which is now the lowest within our
coverage. (Refer figure A.24 for earnings changes
for our coverage universe.)
IBREL’s large portfolio of luxury residential
projects will impact its new volumes in a weak
demand environment. This is also likely to affect
execution as balance sheet debt increases to fund
new projects using leverage. We cut earnings by
25-48% to factor in reduced other income as the
company deploys excess cash in new projects
with limited medium-term returns. We expect a
mere 6% EPS CAGR over FY11-13e.
While we remain negative on the Mumbai region,
we believe HDIL could outperform on the back
of increased FSI sales, which will improve
balance sheet liquidity. We expect the company to
report a strong EPS CAGR of 22% over FY11-
13e as old projects start to contribute to earnings
post completion. We retain our OW(V) rating.
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