The subprime crisis in the US made its impact felt in India too as economic growth slowed and stock markets plunged. In that mayhem, stocks of realty companies were among the worst hit as many of them were trading at price levels that had run way ahead of fundamentals. What is more, the slowdown meant that demand for residential homes slowed down which had an adverse impact on the fortunes of the real estate industry.
FY10 saw the Indian economy post a reasonably stronger growth in GDP and real estate companies began to see better demand for homes. This led to better pickup in sales. That said, the problem that many real estate companies are facing currently is the large amount of debt on their books. The servicing of this debt has become arduous simply because although sales have picked up, the working capital cycle has not improved and many of them are still reporting negative cash flows. And so an improvement in topline has not necessarily translated into a healthy growth in net profits. Further, although demand has picked up, it has not really surged because property prices are still outside the gamut of many investors. The latter are waiting for a further drop in prices before they take the plunge of buying a house.
Now another problem has emerged for real estate companies. That of rising interest rates, which in some sense is a double whammy for the real estate sector. Because of higher inflation, the RBI has had to resort to tightening its policy measures. This has compelled banks to raise interest rates on both deposits as well as loans. With housing loans getting a bit more expensive, the negative impact that this may have for future demand for homes cannot be undermined. To add to the cup of woes, higher rates means higher interest costs for real estate companies already loaded with a lot of debt. This means that not only will the sector have to contend with possibly lower sales in the future, but profits could also shrink. Indeed, one way for real estate companies to emerge from this mess is to lower property prices, which will at least interest buyers in contemplating purchasing homes in a rising interest rate scenario. Only time will tell whether they will take that step though.