Aug 30, 2011|
By when is Indian real estate sector expected to recover?
That the Indian real estate sector has seen some of the worst cases of wealth destruction is well accepted. In our previous article in this series we also discussed some of the factors that had led to the realty bubble. High property prices made buying a property unaffordable for Indian middle class and genuine home buyers. This led to a slowdown in demand for real estate. Developers who had made abnormal profits during the boom period saw volumes dropping.
The double whammy of plunging sales and rising costs (both operating expenses and interest costs) have taken their toll on the profitability of real estate majors. Also, banks turned cautious towards rescheduling debt or issuing fresh loans to real estate companies, as an aftermath of the bribe-for-loan scam. Few realty companies had raised funds from Non Banking Financial Companies (NBFCs) at interest rates as high as 16% to 20% and ended up defaulting on the same. Heavy debt burdens also put a lot of liquidity pressures on the smaller entities.
So what are the possible scenarios from here?
The prospects of recovery of the sector for investors remain bleak until the problem of poor financials of real estate majors resolves.
The wait and watch approach may have worked for the realty companies until a year back, when global economy was as shaky and several PE funds had invested in the sector. However, the economic scenario today is far more volatile. The sentiments of buyers remain weak and they are holding back on purchases in anticipation of a price correction. In such a scenario, do the realtors have the liberty to keep inventory piling up? In our view, as the companies get weighed under heavy debt and interest costs they will get pressurized to sell and generate cash.
- Affordability is the key: Affordability is the most important factor when it comes to real estate prices. Of course there is a huge demand for housing in India but people can only buy what they can afford. The current high prices-high interest rates scenario has started denting the home affordability of prospective buyers.
- Decline in interest rates: Looking at current inflation numbers, RBI seems to be in no mood to reduce interest rates in the near term. At best, it might keep the rates stable. A significant decline in interest rates is only possible if we see a considerably slower growth in the economy. However, if that happens, slower economic growth will also reflect on the income levels and job confidence. This will impact the demand for real estate.
- Drop in real estate prices: Reducing property prices will likely serve dual purpose for developers. It will help them clear inventory and will also increase their cash flows helping them get rid of debt and interest expense which is eating up their profits. Though the move may affect their margins in the near term, it should help them in the long run with a cleaner balance sheet. However, real estate companies are reluctant to do so and currently adopting a wait-and-watch policy with regard to price reductions.
- Economic recovery: Economic recovery both in Indian and globally will boost the confidence of both home buyers as well investors in real estate. While this may seem an ideal scenario, it is dependent on macro-economic environment, which is currently shaky and may take time to recover.
The key to better prospects for the sector is rational prices. The same can not only improve the financials of the realty companies but also free the sector from the disdain of regulators and investors.
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