Will real estate cos. learn a lesson this time? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Will real estate cos. learn a lesson this time? 

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In this issue:
» Impact of rising interest rates on gold
» Will midcaps be star performers in 2011?
» India's growth to be robust in the next 5 years
» US interest rates to be near zero for 2 years
» ...and more!!


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00:00
 
It was bound to happen at some time. Real estate companies are seeing demand for residential properties dwindle. And this does not spell good news for them especially since residential homes constitute a major chunk of their overall revenues. There are several reasons for this.

For starters, it is a well documented fact that real estate companies have been demanding exorbitant rates for homes. So much so that genuine buyers have been deterred from buying properties. This is despite the fact that many Indians still do not possess their first home which means that long term demand for housing is very much there.

Although the supply of homes has increased in the residential space, most have come in the luxury homes segment. Not much attention has been paid to affordable housing. Further, interest rates have been rising. This has further dampened demand for homes and is expected to do so in the future as well.

The only silver lining in the cloud for real estate companies is that commercial properties are seeing a pickup in demand. But at the end of the day, in a rising interest rate scenario, real estate companies are expected to face considerable challenges. Many of these companies have piled up debt on their books. Servicing this debt will be an added burden. Plus, execution risks remain as well. The most obvious solution is to bring down house prices to affordable levels. This would ramp up demand and volumes and help counteract to some extent the impact of rising interest costs. But we will hardly be surprised if real estate companies fail to see reason.

01:24  Chart of the day
 
Today's chart of the day shows that it was a rather mixed year for global stock markets in 2010. For instance, both India and China saw their economies grow at a brisk pace. But while Indian stock markets gained 15% during 2010, Chinese stock markets witnessed a decline of 17%. This was largely on account of concerns that Chinese assets were in bubble state and so a meltdown was bound to take place. On the other hand, the US and UK, despite having weak economic growth, saw a surge in stock prices. This was largely on expectations that these economies are expected to recover and so money flowed into stocks given that valuations were cheap.

Data Source: The Economist

02:01
 
Reversion to the mean is indeed one of the most powerful concepts in the field of finance. Simply put, it means that if an asset has given above average returns for a good number of years, sooner or later, a period of below average returns will follow. So, how does the yellow metal gold fare in this reversion to the mean examination? A cursory glance at its price performance would make us believe that gold prices are indeed in for some serious long term correction.

Furthermore, the rising interest rates in the US are also akin to death knell for gold as people would start moving into US dollar. However, nothing could be further from the truth. If interest rates rise in the US, it is quite likely that there will be a huge wave of defaults given the high debt prevailing in the economy. Thus, in order to avoid the same, the US Fed may have to go in for few more rounds of money printing. Neither of the scenarios is good for the US dollar. Hence, do not fret if gold has been the asset of the decade. Given the macroeconomic environment, another decade of good returns for gold cannot be ruled out. And rising interest rates will only accelerate gold's price rise rather than bring about its demise.

02:45
 
Midcap stocks as a category may not have been the biggest money makers in 2010. But unlike beaten down stocks that have the potential to 'reverse to the mean' we do not think that the logic holds true for all midcap stocks. By reversing to the mean, we mean catching up with peers in terms of average valuations.

We recently came across an article about brokers pushing 'midcap stocks' in general to their clients citing underperformance in 2010. Their optimism on the category stems from the fact that these stocks may catch up with their larger peers in terms of upward revision in valuations in 2011. But we believe otherwise. The critical reasons why stocks are unlikely to be the best performing asset class in 2011 apply as much to the midcaps as they do to their larger peers. Key amongst them being higher input costs, rise in interest rates and FII pullback. If the companies' margins are impacted this year, the FIIs are unlikely to favour midcaps any more than large caps. On the contrary in the case of a huge sell off, the impact on midcaps may be a lot harder.

This is not to say that midcaps are not worth buying in 2011. But only if the investor is comfortable with the long term sustainability of the business. And more importantly, if the valuations offer sufficient margin of safety.

03:26
 
Rising food prices have already given the government much headache. Now the impact of the same is also being seen in its finances. As per reports, the food subsidy bill for the current year that ends in March, is expected to rise to Rs 800 bn. This is 44% higher than what was estimated in the last budget! A large part of this rise in subsidies is the higher minimum support prices that the government paid for crops this year. Indeed, if the subsidy bill keeps rising at this rate, it will be interesting to see how the government sticks to its roadmap of bringing down deficit by FY12.

03:44
 
Predicting India's growth rate to the last decimal seems to be the 'in' thing. Recently Fitch revised its forecast for India's GDP growth to 8.7% for the fiscal year 2011. Now rival Crisil has come up with its own estimates and predicts India's growth to touch 8.5% in 2011. What is more, it opines that India's economy will maintain an 8.4% growth over the next 5 years. True that at the end of it all these are just statistics. But Crisil has highlighted a few concerns that we thought were more critical than the 'correct' estimate for India's growth. These concerns are poor infrastructure, skill shortage, faltering agriculture and subsequent inflation, inadequate spending in key areas like health, education, etc and finally the fiscal deficit. Unless these concerns are addressed by the government, spectacular growth rates year on year would soon become meaningless. And would eventually start to falter.

04:13
 
The Fed seems to be done throwing money at the American recovery. Trillions of dollars later, the US central bank seems to have had enough, according to a Goldman Sachs top economist. After the latest round of US$ 600 bn purchases of T-bills, no additional money is expected to be added to the kitty. The unemployment rate, on the other hand, seems to be the only rate hitting double digits. It is currently at 9.8% and is expected to reach 10% before long. Even if new jobs are created, these will be grabbed by people who have been unemployed for a long time. This will not lead to a decline in this key indicator. Which is why interest rates are also expected to be in and around the zero mark for the next 2 years. All in all, the giant seems to be sluggishly moving along. Not a very encouraging sign for a global resurgence.

04:41
 
In the meanwhile, Indian markets had a weak day today. The BSE-Sensex was trading lower by around 103 points (0.5%) at the time of writing this. Today's losses were led by stocks from the banking and realty sectors. Most other key Asian markets were also trading weak, with the exception of Hong Kong and Singapore, which closed with gains of around 0.33% and 0.26% respectively.

04:54  Today's investing mantra
"I've found that when the market's going down and you buy funds wisely, at some point in the future you will be happy. You won't get there by reading 'Now is the time to buy." - Peter Lynch
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2 Responses to "Will real estate cos. learn a lesson this time?"

sethu

Jan 6, 2011

The public sector banks have been forced to finance these real estate operators to keep the prices high.

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Ashok Khanna

Jan 5, 2011

Regarding Realty prices -- we hear that demand is low, house sales are down etc. Yet builders do not lower prices. You tell us they have debt & you also comment that builders will not learn form the experience and not lower prices. Then how do the builders fianance the debt. Or maybe there in no huge debt on their hands and they are cash rich to hold on till demand develops. If not so how do they sustain the investment made ? Is it that the rumours of ill gotten wealth of politicians is fanancing realty ? money is routed through 'hawala' and re-enters the country as FDI ? somebody should know the truth. Lets maybe ask a realty company !

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