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Real Estate
For 1QFY2012, we expect residential volumes to report flat to
moderate growth on a sequential basis on account of weak
demand due to high interest rates and elevated property prices.
Revenue of real estate companies is expected to be largely driven
by execution of existing projects and new launches, though
execution delays remain a cause of concern. Companies such
as DLF and Unitech (through UCP) are expected to continue to
see sustainability in office-leasing volumes on a sequential basis.
Accordingly, we believe commercial rentals have bottomed out,
and we do not foresee any material uptick until inventory levels
come down.
In our universe of stocks, we expect HDIL to report flat growth
in Transfer of Development Rights (TDR) volumes and prices,
given low inventory of TDRs left on account of earlier stoppage
of the MIAL project, which has re-started and, thus, we expect
TDR sales volume to increase in the coming quarters. HDIL is
also expected to continue to book partial revenue from the
2mn sq. ft. (msf) FSI sale (worth ~`1,400cr) in 1QFY2012.
DLF's revenue is expected to be largely driven by the sale of
plotted properties in Gurgaon. For ARIL, we expect revenue to
be driven by the residential segment and rental income.
Escalating input cost and interest rates causing concern
Cost overruns continue to be a big cause of concern for real
estate developers. Around 70% of the construction cost is
contributed by material and labour costs. The major components
of these costs are steel, cement and labour. Currently, on a
two-year basis, cement price has increased by ~27% from
`202/bag to `275/bag, steel price has increased by ~13%
from `30,750/tonne to `38600/tonne and labour cost has
increased by ~50% from `250/day to `325/day. DLF reported
a one-time expense of `475cr in the previous quarter on account
of higher costs, which resulted in a sharp margin decline. Apart
from increased costs, rise in interest rates has also resulted in a
slump in demand. In May 2011, on a yoy basis, Mumbai
witnessed a decline in residential registration by 1%. Higher
RBI tightens liquidity further to curb speculative demand
In its bid to curb excess liquidity and speculative demand in the
real estate sector, the RBI had initiated measures in 4QFY2011,
including: 1) capping the LTV ratio to 80% (previously 85%),
2) increasing risk weight on residential housing loan of above
`75lakh and 3) raising standard asset provisioning for teaser
loans from 0.4% to 2.0%. We believe these measures will
marginally affect demand and may lead to postponement of
buying in the short term. Also, the debt refinancing requirement
is expected to come under pressure during 1QFY2012, which
could lead to prices cooling off in regions such as Central
Mumbai and Gurgaon, where prices have overheated since
the last six months.
HDIL – MIAL gets the green signal
HDIL, which had stopped work on the MIAL project, recently
got the green signal from the government to start the MIAL
project. The MMRDA has also started shifting eligible slum
dwellers to the Kurla Premier Compound. This is a positive sign
for the company, as it can quickly ramp up its Phase-I project
and start work on Phase-II of the project. The company, which
had already generated 11mn sq. ft. from the MIAL project so
far, despite a delay of over a year in shifting the families in
Phase 1, will benefit with the continuation of work and increased
TDR generation. In the current quarter, we expect flat growth in
the sale of TDR; however, going ahead, we expect TDR sales to
improve to 1-1.2msf vs. our earlier expectation of 0.7-0.8msf.
The Maharashtra government is expected to hike FSI from 1.0x
to 1.33x in the suburbs, which will have a negative impact on
TDR prices. Thus, we have factored in lower TDR price of
interest rates may compel buyers to postpone their purchases
or investments in new houses. With increasing input cost and
demand failing to pick up, we expect execution delays for many
new as well as old properties. We also believe that cost escalation
will impact margins over the coming quarters; however, margins
will improve once revenue from new projects increases.
`2,400/sq. ft. (i.e. 20% discount to current levels of `3,000/sq.
ft.) for arriving at our target price and do not expect any negative
impact incrementally. We have assumed 4.5msf of TDR sale for
FY2012 to factor in the hike in FSI. It should be noted that a
10% decline in TDR prices would impact our NAV by mere 3%
and target price by 2.3%. Given the delay in shifting of families,
we have excluded 10msf (potential 65 acres), which HDIL is
expected to get at the airport vicinity as it rehabilitates 85,000
families. Overall, we expect the share of TDR sales in HDIL's
revenue mix to fall from 60% in FY2011 to 30% in FY2012.
DLF – Working towards reducing debt
In FY2011, DLF's net debt increased by ~`2,314cr yoy to
~`23,990cr from ~`21,677cr. Thus, DLF's net debt-to-equity
now stands increased from 0.88x to 0.98x yoy, which continues
to remain a key overhang on the stock price as debt repayment
of ~`2,910cr is required to be made over the next 15 months.
Further, clarity on whether DLF will buy out the promoter's stake
in DAL remains another key concern since it could potentially
further dilute the equity of minority shareholders. However, the
company has increased its overall target on divestments to about
`10,000cr mainly to reduce debt, which would be about
`4,500cr if the wind segment is excluded. Further, the company
has added `6,000cr-7,000cr to its disinvestment target over
the next two to three years.
Sluggish residential volumes adding to margin pressure
In Mumbai and Delhi, residential prices are currently ruling
15-30% above the peak levels of 2008, whereas prices in most
other markets are still 10-15% lower than their last peak levels.
This has resulted in tapering of volumes in regions like
Mumbai and NCR. India's top two real estate players – DLF
and Unitech – have recently stated that slower sales are leading
to a build-up of inventory and, thus, they may see some price
correction, leading to margin pressures. On the back of sluggish
demand, HDFC and SBI have also seen a drop in their mortgage
loan transactions. For instance, HDFC has seen a drop of
15-20% in its mortgage loans in Mumbai (although
disbursements have been good otherwise), while SBI expects a
downward revision in its growth target. We believe CY2011 will
see consolidation with residential prices remaining soft in
Mumbai and Gurgaon (could see a correction of 15-20% in some
overheated micro markets), with a modest to flat 5% increase
expected in other markets.
Commercial demand to pick up over the next 12 months
After registering a sharp decline in the past few quarters, capital
values have started to strengthen, registering a marginal
appreciation across most micro markets. Industry participants
have indicated that the surge in leasing enquiries has come on
the back of renewed interest shown by corporates.
In 1QFY2012, commercial area in Mumbai witnessed a
12-month high with 1.84msf of area leased out. Of this,
the financial sector was the major contributor with a share of
40%. We expect demand for office space to start picking up
from 2HCY2011 as we expect 20% net employee addition in
the IT/ITES sector over FY2011-13. Cushman and Wakefield
estimates cumulative pan-India demand for office space during
CY2009-13 to be 196msf.
Retail segment – Still some pain left
Vacant space in shopping centres had increased during
2008-09, primarily on account of high real estate costs and
lower consumption, owing to which many retailers shifted gears
from the rapid expansion mode to the consolidation mode.
Therefore, in the short term, vacant spaces are likely to increase,
given the considerable rationalisation in the supply pipeline.
On the other hand, we believe demand is yet to pick up,
especially in tier-II and III cities, which is not the case with metros,
where catchment areas are witnessing high demand. 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 vs. realty stocks
During 1QFY2012, the BSE realty index widely underperformed
the Sensex by 1,049bp on the back 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 stocks’ performance. However, we believe the recent
correction gives a good entry opportunity on account of
1) companies trading at a 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
India's realty index is currently ruling near its life-time low seen
in 2008. However, things are much better than 2008 with respect
to project visibility, cash flow, net debt-equity and growing
disposable income. Further, refinancing of loans from the
banking sector will give some respite to developers in the falling
volume scenario. Having said that, we believe absorption and
not price appreciation will drive residential growth over the next
six quarters. Amidst this scenario, new launches have been more
rewarding for developers who have launched projects at a
10-15% discount to the prevailing market rates. Further, high
inventory is still hampering commercial recovery, though there
has been an uptick in absorption levels. We expect rentals to
remain firm at current levels with an uptick likely over the next
12 months. We believe that 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, taking into account growing
disposable income, shortage of 25mn houses in India and
reasonable affordability. Given the current scenario, we expect
stability in residential prices with the exception of certain micro
markets, where prices have overheated, and expect an uptick
in the commercial segment over the next 12 months.
We prefer companies with visibility in cash flow, low leverage
and strong project pipeline with attractive valuations. Our top
picks are HDIL and ARIL, which are trading at ~38% and
~56% discount to their NAVs, respectively. We maintain our
Neutral view on DLF, owing to concerns of weak operating
cash flow, increasing gearing and just ~12% discount to our
one-year forward NAV.
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