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Mumbai property sector
US$ 1 million and nothing to buy?!
Volumes down to a trickle, yet prices continue to rise
Home buyers in Mumbai are going through a tough time. Wages are rising by
12-15% and mortgages are available at around 10%. But prices are 15-20%
higher than the 2007 peak, even without adjusting for the poor efficiency ratios,
which continue to fall. Volumes are down 70% from the run rates seen in late
2009, and inventory levels are around 25%. We also believe there is another 10-
15% ‘shadow inventory” with speculators. Affordability is clearly an issue. Per
capita income in the city is three-times the national average, but is still only
US$3,000. And to get to an area where prices are US$200/sqft, one has to travel
40kms, or 2 hours from the CBD. Yet prices continue to rise on near-zero
volumes.
Why don’t Mumbai residential prices fall?
Few reasons for mis-pricing are valid. Land supply in the island city of
Mumbai is indeed limited. Approval delays were more common in the last 6
months. But this does not explain why developers have not cut prices for
clearing inventory.
Structure of financing is the key. To avoid the discipline (read: pain) of interest
payments, many developers (especially unlisted ones) use pre-sales to
speculators for raising construction finance. The speculator gets a discount in a
‘soft launch’ and an assured return. The eventual repayment is made from the
sale of that unit during the ‘official launch’. The structure is, in essence, a zero
coupon bond and an assured return which is the difference between the ‘soft’
and ‘official’ launch price. Developers find it difficult to cut prices as a cut would
lead them to miss the assured return. Since this source of financing is the lifeline
for many (or all) other projects, a price cut would be the last resort for the
developer to ensure that the core ‘investor’ base is not alienated.
Is equity really free? Many developers focus on absolute profits, even at the cost
of material delays. For minority shareholders, the worrisome aspect is the implicit
assumption that “Equity is Free,” since there is no recurring interest payment.
Weak investment case whether prices fall or not
The V shaped recovery in 2009 reinforced the overwhelming belief among
developers and speculators that investing in residential property never results in
a loss. To refute this clearly false notion, one just needs to look back at the mid-
90s. Many brokers believe that “it is different this time”…. We rest our case.
We expect a 15%+ correction in property prices across Mumbai in FY12.
Speculators are already undercutting developers in many suburban projects.
What if prices don’t fall? With a WACC of over 15%, the postponement of cash
flow could lead to a rapid destruction of NAV. We would avoid value traps and
wait for developers to drive volumes through price cuts before investing.
HDIL the best Mumbai play; Prestige, Sobha, Phoenix outside Mumbai resi
Realities have changed since the credit crisis. Investors are unlikely to be
attracted to pure land/asset value plays. We would stick to developers willing to
cut prices to drive asset turnover and generate free cash yields in excess of 8%.
In Mumbai, HDIL fits the bill, while IBREL does not. Outside the Mumbai
residential market, we favour Prestige, Sobha and Phoenix.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Mumbai property sector
US$ 1 million and nothing to buy?!
Volumes down to a trickle, yet prices continue to rise
Home buyers in Mumbai are going through a tough time. Wages are rising by
12-15% and mortgages are available at around 10%. But prices are 15-20%
higher than the 2007 peak, even without adjusting for the poor efficiency ratios,
which continue to fall. Volumes are down 70% from the run rates seen in late
2009, and inventory levels are around 25%. We also believe there is another 10-
15% ‘shadow inventory” with speculators. Affordability is clearly an issue. Per
capita income in the city is three-times the national average, but is still only
US$3,000. And to get to an area where prices are US$200/sqft, one has to travel
40kms, or 2 hours from the CBD. Yet prices continue to rise on near-zero
volumes.
Why don’t Mumbai residential prices fall?
Few reasons for mis-pricing are valid. Land supply in the island city of
Mumbai is indeed limited. Approval delays were more common in the last 6
months. But this does not explain why developers have not cut prices for
clearing inventory.
Structure of financing is the key. To avoid the discipline (read: pain) of interest
payments, many developers (especially unlisted ones) use pre-sales to
speculators for raising construction finance. The speculator gets a discount in a
‘soft launch’ and an assured return. The eventual repayment is made from the
sale of that unit during the ‘official launch’. The structure is, in essence, a zero
coupon bond and an assured return which is the difference between the ‘soft’
and ‘official’ launch price. Developers find it difficult to cut prices as a cut would
lead them to miss the assured return. Since this source of financing is the lifeline
for many (or all) other projects, a price cut would be the last resort for the
developer to ensure that the core ‘investor’ base is not alienated.
Is equity really free? Many developers focus on absolute profits, even at the cost
of material delays. For minority shareholders, the worrisome aspect is the implicit
assumption that “Equity is Free,” since there is no recurring interest payment.
Weak investment case whether prices fall or not
The V shaped recovery in 2009 reinforced the overwhelming belief among
developers and speculators that investing in residential property never results in
a loss. To refute this clearly false notion, one just needs to look back at the mid-
90s. Many brokers believe that “it is different this time”…. We rest our case.
We expect a 15%+ correction in property prices across Mumbai in FY12.
Speculators are already undercutting developers in many suburban projects.
What if prices don’t fall? With a WACC of over 15%, the postponement of cash
flow could lead to a rapid destruction of NAV. We would avoid value traps and
wait for developers to drive volumes through price cuts before investing.
HDIL the best Mumbai play; Prestige, Sobha, Phoenix outside Mumbai resi
Realities have changed since the credit crisis. Investors are unlikely to be
attracted to pure land/asset value plays. We would stick to developers willing to
cut prices to drive asset turnover and generate free cash yields in excess of 8%.
In Mumbai, HDIL fits the bill, while IBREL does not. Outside the Mumbai
residential market, we favour Prestige, Sobha and Phoenix.
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