Real estate: No more an attractive investment

Rags to riches’ and ‘to rags again’ — this is the current state of the real estate industry. From a high of 13848 on January 8, to a low of 1403 o

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n December 2, the BSE realty index has fluctuated wildly this year and is still trading near its lows. A movement of almost 90% in one year is unprecedented.

In early ’08, land was the most coveted asset for individuals and corporates, be it textile companies, cement makers or commercial banks (which began to revalue themselves based on their land assets). Sky-rocketing property prices offered an easy route to rake in the moolah via capital appreciation or stocks of realty companies. But not anymore. Earnings capability will now come into play, rather than valuation of one’s land bank.

Companies with low borrowings do not have to bother about rising interest costs and can focus on completing projects. Developers whose business models are skewed towards mid-market or affordable housing will be better placed than those in the luxury segment. Hence, the business models of HDIL, DLF and Puravankara can work well for them.

The land-buying spree was so rampant that most builders ignored liquidity constraints. The industry’s borrowings have now shot up to a few thousand crores from a few hundred crores earlier. With sales drying up, highly leveraged companies are facing the pressure.

Cash flows are constrained, thus affecting working capital cycles. This may lead to consolidation in the industry but bigger players will be able to survive the mayhem. Amidst this chaos, one cannot ignore the mass wealth creation for promoters and investors. The primary market, which was an easy route to build equity wealth, has also helped to organise the sector. The real estate industry has matured greatly and become more transparent.

At its peak in January, DLF emerged as the fourth most valuable company and its promoter KP Singh became the world’s richest realty tycoon. The realty sector’s share in the Sensex grew to almost 4% then. But after the market crash, the sector’s outlook has undergone a 360-degree shift.

Investors have shed 50-60 % of their investments in realty stocks. Investors’ perception has been dealt a severe blow. Measures like interest rate cuts for low-value homes and correction in property prices don’t seem to be working. But a further 200-250 bps rate cut and a 20-25% price cut can spur demand. And people may once again start buying houses to live in them, rather than for investment purposes.