»5 Minute Wrap Up by Equitymaster

On This Day - 30 JANUARY 2018
Is India's Real Estate Sector Going 'Lollapalooza'?

Kunal Thanvi, Editor, Smart Money Secrets

Have you heard about the 'Lollapalooza effect'?

According to Buffett's partner, Charlie Munger, the 'lollapalooza effect' is what happens when lots of little things add up, snowballing into an extraordinary outcome, often an extraordinarily bad outcome.

But the opposite happens too. Sometimes lots of little good things can add to an enormous good thing.

I am a firm believer of the lollapalooza effect. I love to investigate situations where there are chances of a lollapalooza, and how investors can benefit from it.

Now, over the last two months I have been reading about the real estate sector of India. I wrote a couple pieces as I went, like about how this orphaned sector got a father and my best pick in the sector.

Today, though, I am looking at it with different eyes. I want you to do the same. Just looking at the multiple events that have been taking place - I believe you will see, as I do, that there is a real chance here of a 'Lollapalooza' outcome in the real estate sector of India.

#Event 1 - Real Estate (Regulation & Development) Act 2016, RERA

The introduction of RERA set a strict tone for unethical and un-organized players. These strict guidelines, along with better disclosures have taken these players by surprise.

We believe the advent of RERA can bring consolidation to an otherwise fragmented sector.

#Event 2 - Notebandi

Cash has always been the king for the real estate sector. In fact, it is believed to be one of the biggest sectors for laundering black money in the country.

Notebandi disrupted the whole sector causing bookings and site visits dropping to multi-year lows.

A check on the black money coming into the sector will help consolidate this otherwise fragmented sector.

#Event 3 - Union Budget 2017-18

One of the key agenda items of the current government has been housing for all by 2022. And we should note that India has a shortage of 20 million houses.

In the Union budget 2017-18, the government launched the following initiatives to revive demand:

Union Budget 2017-18 - Housing for All
InitiativeImpact
Infrastructure status to Real Estate Sector (Affordable Housing)Lower cost borrowing for the sector and faster approval of the projects.
Tax on Long-Term Gains (Holding Period reduced to 2 years from 3 years)Spur investment demand in real estate
Benefit on the Unsold Inventory (No notional Rental Income for one Year)Give some breathing time for developers to liquidate inventory.
Tax Relaxation on Joint Development (Tax on Land Transfer after the completion of Project)Reduce litigation on the point of taxation for landowners and will provide an impetus to the execution of more JDAs
Credit Linked Subsidy Scheme for Middle Income Groups Spur Demand in first-time buyers
Change in the Definition of Affordable Housing*Make Homes more affordable
Source: Union Budget, Company Annual Reports

The government has increased carpet area for the houses to be qualified for affordable housing. In the first middle income category (Rs 0.6-1.2 milllion/annum), the carpet area was raised from 90 to 120 sq. m (968 sq. ft - 1184 sq. ft). In the income category of Rs1.2-1.8 million/annum, the carpet area was increased from 110 sq. m to 150 sq. mt (1291 sq. ft - 1614 sq. ft)

All these initiatives in the light of low interest rate regime bode really well for the sector.

#Event 4 - Goods & Service Tax (GST)

One of the biggest events of last year was the introduction of Goods and Service tax. Even though it was painful in the short term, it is expected to be revolutionary in the long term.

Apart from making life tough for un-registered & un-organized players, the GST council is also rationalizing GST rates to revive demand in the sector.

Initially, the sector got a rate structure of 12% across segments.

However, in order to revive demand in the sector the council has reduced the GST rate to 8% for the affordable housing segment.

This reduction in tax is applicable to up to 645 square-foot homes purchased by availing the Credit Linked Subsidy Scheme (CLSS) under the Prime Minister Awas Yojana (PMAY).

Bringing all the players under the GST regime will throw un-organized players out, and bring consolidation in the sector.

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If we connect the dots it is easy to see something big is happening in India's real estate sector.

All these events are more or less directed in one direction: Consolidation in the real estate sector.

In fact, I strongly believe the union budget 2018-19 will have a flurry of initiatives to revive the real estate sector, especially the affordable housing segment.

Now, the question is, how to benefit from this 'Lollapalooza effect' emerging in India's real estate sector?

Well you have two options:

Option 1: Invest in Stocks (Smart Money Secret Team recently recommended one of the best company in the sector).

Option 2: Invest in Real Estate (Follow Ashwin Ramesh who has a knack of finding best real-estate properties to invest)

PS: Ashwin Ramesh is the real estate guru to watch out for. If you have ever even mildly considered real estate, but worried it is too complicated, this is your chance. Ashwin's free webinar airs in 3 hours! Register now and do NOT miss it.

E-Commerce Gains Prominence

The growing clout of e-commerce is slowly turning it into a formidable distribution channel that's hard for companies to ignore. This is reflected in the sales growth clocked in various distribution channels as per Euromonitor.

The traditional segment - your neighbourhood mom & pop stores or the kirana stores - is the largest and widest distribution network. This channel saw its sales grow at an annual rate of 9.8% during the period 2014-17. Modern stores - supermarkets, hypermarkets and convenience stores - grew their sales at a much faster pace of 16.1% over this period. However, the fastest growth is in the e-commerce channel, ie the relatively new kid on the block. During the period 2014-17, internet sales in each of the food and drinks, personal care and home care segments grew more than 20%.

While e-commerce functions on a smaller base and is not directly comparable with modern or traditional retailing, FMCG companies can't ignore the rapid rise in its distribution power. Modern retail and internet retail will continue to outgrow the traditional distribution channel over the next five years, according to Euromonitor. Moreover, e-commerce, being less capital-intensive compared to modern retail, is expected to sustain higher growth over the long run.

The Growing Importance of E-Commerce

Therefore, it is hardly surprising that established FMCG companies such as Hindustan Unilever swear by the growing importance of e-commerce. No wonder, Patanjali Ayurved Ltd, a rapidly growing and relatively new player in the FMCG market, has tied up with e-commerce companies to quickly scale up its ante against well-entrenched players.

Modern retail and internet retail are less fragmented and enjoy better pricing power than traditional retail. Therefore, the growing dominance of these formats carry the inherent risk of the bargaining power tilting in favour of the customer. But given their strong emergence, companies cannot afford to ignore them anymore.

The Indian Arms of MNCs Outshine their Parents

Indian subsidiaries continue to surge ahead of their global parents in terms of market capitalisation. This is partly because of better financial performance by Indian subsidiaries as parent companies are hit by a slowdown in the developed world. A study by Business Standard shows that in the last five years, the combined market cap of 52 Indian arms of multinational companies rose by 120% in dollar terms vis-a-vis a 10% rise in the combined market cap of the parent companies. Therefore, the market cap of Indian subsidiaries presently accounts for 6.3% of the global parents' market cap. This share stood at 3.1% at the beginning of 2013.

Resultantly, the price-to-earnings multiple of Indian subsidiaries is at 150% premium to that of their parents, up from a premium of 80% in 2013. But going ahead, sustaining such expensive valuations will be a tall order. This is because, earnings recovery for companies in the developed countries is expected to be faster than Indian companies whose financials are bogged down by notebandi and the Goods and Services tax.

What the Markets Looked Like Today

Indian equity markets opened the day in the red. At the time of writing, BSE Sensex was trading lower by 102 points and NSE Nifty was lower by 39 points. Both the mid cap and small cap indices are trading down by 0.4% and 0.8%, respectively. Stocks from the pharma and IT are among the losers.

Regards,

Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

Investment Mantra of the Day

"For some reason, people take their cues from price action rather than from values. What doesn't work is when you start doing things that you don't understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it's going up." - Warren Buffett

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