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  • Aug 25, 2011 - By when is Indian real estate sector expected to recover?

By when is Indian real estate sector expected to recover?

Aug 25, 2011

Increase in demand and skyrocketing prices in India's real estate sector, have been a factor of higher economic growth and rising income levels. However, the sector was badly hurt by the global economic downturn. As the liquidity got choked with the rise in domestic interest rates, buyers lost appetite for high value properties.

Realty stocks too have reflected the slump in the sector. The BSE Realty index is down 52% from a year ago. Stocks of leading firms like DLF and Unitech have plunged between 40%-60% in last one year amidst weak earnings and scandals. Impending concerns over the global economic recovery and the US and Euro Zone debt crisis have not helped matters either.

The latest June quarter results of the construction majors are indicative enough of the troubled waters. All major realty players reported a fall in quarterly net profit for the three months ending June 2011. As if the rising interest rates were not enough, spiraling raw material, fuel and labour costs have spelt doom for the sector.

Real estate companies: Quarterly Review June 2011
NameJun-11Jun-10YoY %-Change
Net Sales (Rs m)PAT (Rs m)Net Sales Rs m)PAT (Rs m) Net Sales (%) PAT (%)
AHLUWALIA CONT3,1011063,936243-21.20%-56.40%
ANSAL PROP.2,3645312,2163696.70%43.90%
DLF LIMITED24,4583,61620,2854,07820.60%-11.30%
HOUSING DEV. INFRA5,0222,0904,5092,34311.40%-10.80%
OMAXE LTD2,4131251,81318233.10%-31.30%
PARSVNATH DEV1,8242051,7281065.60%93.40%
SOBHA DEVELOPERS3,1793093,1803430.00%-9.90%
Data source: Equitymaster Research

So when is this trend expected to reverse?

To establish a view on when is real estate sector likely to get out of this slump, it is important to first analyze the factors leading to this problem.

Tracing the roots of real estate bubble

  • Low interest rates and opening of the sector to FDI: The real estate bubble in India can trace its roots to the interest rate reductions during 2001-2004. Mortgage lending rates had then fallen to historical lows of 7.5%. Further, in March 2005, the current UPA government opened the sector for FDI. Both of these steps led to the inflow of cheap money into the sector. On the other hand, the economy had started picking pace with India clocking a GDP growth of ~8% during 2003-2005. Low interest rates and rising per capita income encouraged individuals to buy homes with attractive bank loans. This led to an increase in demand for real estate and prepared the base for the increase in real estate prices across India.

  • Demand-supply mismatch: Several demographic factors have also contributed to the increase in demand for real estate over the years:

    • Growing working age population (15 - 60 age group) which is expected to reach 918 million, nearly 64% of the population, by 2025, according to United Nations forecasts.

    • Rapid urbanization led by growth in the services sector - Information Technology (IT), IT enabled services (ITeS) and financial services. According to McKinsey Global Institute (MGI), India's urban population could balloon to 590 m-nearly twice the size of the United States-by 2030.

    • Increasing household income led by growth in per-capita income and rise in double income households.

    • Decreasing household size: Rising trend of nuclear families is leading to an increase in the number of households, especially middle-class households. India is expected to have 91 m middle-class households by 2030, according to MGI. This will be 300% increase from the current 22 m.

    However, supply failed to match the growth in demand, in turn leading to a demand-supply gap. Part of this mismatch is also artificial as the developers release inventory gradually wanting to sell later bookings at higher prices. Developers also create false claims of overbooking and huge response for their projects, in turn increasing the prices artificially.

Led by these factors, property prices in key cities in India, especially Mumbai, New Delhi and Bangalore, more than doubled during 2005-2008. Attracted by the glitter, several new real estate players entered the sector while existing players expanded big time. In 2006-2007, a number of real estate companies, both big and small, including DLF, Sobha Developers, Ackruti City, Kolte-Patil Developers and Omaxe, listed on the stock exchanges, in a bid to draw investors.

It is no secret that the real estate players have hardly been wealth creators for Indian investors so far. In fact the sector has seen some of the worst cases of wealth destruction. But can this trend reverse?

In our next article in this series, we will delve into the factors that can lead to a recovery in Indian realty sector and how investors can use the same to their advantage.

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