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Real Estate
For 3QFY2011, we expect residential volumes to report flat to
moderate growth on a sequential basis on account of festive
demand. Revenue of real estate companies will be largely driven
by execution of existing projects and new launches. Companies
such as DLF and Unitech (through UCP) will continue to see
sustainability in office leasing volumes on a sequential basis.
Banks have tightened lending norms in line with the RBI’s
mandate that loan to value (LTV) should not exceed 80%, which
may marginally impact housing demand in the short term.
In our universe of stocks, we expect DLF's revenue to be driven
by the execution of its existing projects. We expect HDIL to post
flat growth sequentially in transfer of development rights (TDR)
volumes and prices. This is on account of the anticipation of
Maharashtra state government overruling the Bombay High
Court's decision and hiking FSI from 1x to 1.33x. However,
HDIL's new launch of Paradise City project Palghar (W) has
taken off well and phase-I has been completely sold. For ARIL,
we expect revenue to be driven by the residential segment and
rental income.
HDIL's new launches continue to be rewarding
HDIL opened the booking for phase-II of its mega township
project, Paradise City, on December 24, 2010. The project is in
close proximity to Palghar railway station and offers over 20,000
homes at affordable prices coupled with modern amenities.
The first phase involving sectors 1, 2 and 3 of 4,332 flats and
399 shops was launched on December 10, 2010, with
residential units being completely sold out within two weeks of
the launch. Phase-II involves shops from phase-I and sectors 4,
5 and 6 with 6,407 flats (340-930sq. ft.) and 320 shops (5,155-
7,950sq. ft.) for sale. The company has been able to pre-sell
75% of its residential projects (7mn sq. ft.) launched since
FY2009, thereby providing `5,000cr of revenue visibility over
FY2010-12E. In FY2011/12, HDIL plans to launch new projects
of 27mn sq. ft., largely in Mumbai.
Increasing land acquisition by ARIL
During 1HFY2011, ARIL acquired 153 acres of land for a total
consideration of `564cr. These land parcels were primarily
bought in Gurgaon (125 acres), Sonepat (10 acres) and
Neemrana (18 acres). Out of the 125 acres in Gurgaon, 110
acres of land is agricultural land, where the company intends
to develop group housing and township. On the remaining 43
acres, it intends to launch a mid-income residential project over
the next six months. This is in line with the company's strategy
to acquire land at a cheaper cost.
Delay in Unitech's Golibar project
Unitech's upcoming Golibar SRA project, which was being jointly
developed with Shivalik Ventures at Santacruz (Mumbai), has
been delayed on account of fresh litigation following protest
from slum dwellers. Unitech has so far invested `600cr for its
50% stake in the JV. Phase-I of the project is expected to generate
~11mn sq. ft. of saleable area. Further, overhang of Comptroller
and Auditor General of India’s (CAG) report on Uninor has led
to correction in the stock price by 24.9% over the last three
months. Unless we get more clarity on both the above issues,
we expect the stock price to remain range bound.
Improvement in leasing; new launches hold key for
DLF stock performance
DLF's non-residential segment constitutes 55% of our GNAV. In
FY2010, the company leased only 0.93mn sq. ft. of commercial
and retail space. However, it witnessed improvement in leasing
in 1HFY2011 by leasing out 2.7mn sq. ft. DLF expects the leasing
activity to continue its uptick in FY2011. Further, in CY2012, it
expects to list DAL as a business trust/REIT, which could be value
accretive for DLF's shareholders at the lower cap rate. However,
much will depend on the sustainable recovery in the commercial
leasing segment. Post the merger of DLF and DAL/Caraf, the
company has 20mn sq. ft. of rent-yielding assets, which will
generate `1,500-1,600cr of rental income in FY2011. However,
new launches have been delayed because of delays in getting
new approvals. Therefore, in 1HFY2011, the company was able
to launch only 1mn sq. ft., much below peers. In light of this,
we believe management's guidance of achieving >12mn sq.
ft. of development volumes in FY2011 will prove to be a
challenging task.
RBI tightened liquidity to curb speculative demand
In order to curb excess liquidity and speculative demand in the
real estate sector, the RBI introduced the following measures
viz. 1) capped the LTV ratio to 80% (previously 85%), 2) increased
risk weights on residential housing loan of above `75lakh and
3) raised standard asset provisioning for teaser loans from 0.4%
to 2.0%. We believe these measures would marginally affect
demand and may lead to postponement of buying in the short
term. Further, we believe debt refinancing requirement in
1HFY2012 will come under pressure, which can lead to cooling
off in prices in cities like Central Mumbai and Gurgaon, where
prices have overheated since the last six months.
Residential recovery has slowed, but not stopped
Prices in Mumbai and Delhi are 15-30% above their peak levels
in 2008, whereas prices in most other markets are still 10-15%
lower than their last peak levels. This has resulted in the tapering
of volumes in cities like Mumbai, where prices have increased
substantially. Volumes slowed down in 2QFY2011 on account
of seasonal weakness. Launch activity also remained subdued
during this period. However, for 3QFY2011, while new launches
have been robust, we expect volumes to be benign on the back
of tightening measures by the RBI. Response to new launches
and absorption trends over the next quarter should provide us
greater clarity on sustainability of volumes witnessed in FY2010,
especially in Mumbai/NCR.
Commercial demand likely to pick up over the next 12
months
After witnessing a sharp decline in the past few quarters, capital
values have started to strengthen and have registered marginal
appreciation across most micro markets. Industry participants
have indicated that the surge in leasing enquiries is because of
a renewed interest from corporates. This has already been
reflected for companies like DLF, which leased out 2.7mn sq. ft.
in 1HFY2011-higher than the entire area leased out in FY2010.
In the IT/ITES sector, we expect net employee addition of 15%
over FY2010-12E. Accordingly, we believe demand in office
space will start picking up from 2HFY2011E. Cushman and
Wakefield estimates pan India cumulative demand for office
space during CY2009-13E to be 196mn sq. ft.
Retail segment - Still some pain left
Vacant space in shopping centres increased during 2008-09.
This was primarily on account of higher real estate costs and
lower consumption, because of which many retailers started
shifting from their rapid expansion mode to a consolidation
mode. Consequently, absorption of retail space fell to 4mn sq.
ft. in CY2009. Retail supply is projected to be around 16.4mn
sq. ft. in CY2010, with an expected absorption of only around
8.9mn sq. ft. Therefore, vacant spaces are likely to increase in
the short term, given the considerable rationalisation in the
supply pipeline. We believe demand is yet to pick up, especially
in tier-II and tier-III cities, which is not the case with metros
where catchment areas are high. We expect prices to remain
under pressure, as the segment has fragmented supply
dynamics. Initial recovery volumes are likely to be cornered by
experienced players, such as Phoenix Mills, and not necessarily
large ones.
Sensex v/s realty stocks
During 3QFY2011, the BSE realty index strongly
underperformed the Sensex by 2,555bp on the back of the
housing loan scam, which stoked fears of 1) corporate
governance, 2) restricted credit-flow to the sector and 3) the
expected increase in cost of funding for future projects. Moreover,
the RBI's measures to tighten liquidity and curb speculative
demand by increasing LTV and risk weight on teaser loans have
further dampened stock performances. We believe the recent
correction gives good entry opportunity on account of
1) companies trading at significant discount to our one-year
forward NAV, 2) stability in volumes and 3) comfortable balance
sheet position, unlike that in 2008. We believe HDIL, Oberoi
Realty and ARIL are best placed in the sector.
Outlook and valuation
The risk reward ratio is turning favourable for the sector, with
recovery widening towards tier-II and tier-III cities in the
residential segment. Lending from the banking sector is slowing
down and the new RBI circular shall further hit affordability in
the `10mn and above segment. Having said that, we believe
absorption, not price appreciation, will drive residential growth
over the next six quarters. New launches have been rewarding
for developers who have launched projects at 10-15% discount
to ongoing market rates. Further, high inventory is still hampering
commercial recovery; however, there has been an uptick in
absorption levels. We believe rentals to remain firm at current
levels with an uptick apparent over the next 12 months. We
believe stock performances are related to macro factors
interspersed with company-specific issues, such as the DLF-DAL
merger translating into higher debt and 2G-related scam for
Unitech. We are positive on the long-term outlook of the realty
sector, with growing disposable income, shortage of 25mn
houses in India and reasonable affordability. Given the current
scenario, we expect stability in residential prices, with an
exception of certain micro markets such as Mumbai and
Gurgaon, where prices have overheated, and expect an uptick
in the commercial segment over the next 12 months.
In our universe of stocks, we prefer companies with visibility on
cash flow, low leverage and a strong project pipeline with
attractive valuations. Our top picks are HDIL and ARIL, which
are trading at 52% and 49% discount to their NAVs, respectively.
We maintain a Neutral rating on DLF with concerns of a weak
operating cash flow, increasing gearing levels and the stock
trading at 12% discount to our one-year forward NAV.
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