19 MAY, 2011, 10.27AM IST, SUDHIR VOHRA,
Why real estate investments are getting riskier

Why real estate investments are getting riskier - The Economic Times

The first quarter of this financial year promises to be a difficult one for the real estate sector. Many of the big players in metropolitan cities have had to borrow funds to pay their installments on loans due to banks by the end of March 2011. In smaller cities and towns, the situation is not getting any better. Realtors who had overestimated actual end user demand for housing, and had received advances from speculators and investors are coming under pressure to deliver promised projects to enable them to cash in on their investments.

Projects are not moving because of lack of cash, and banks are not falling over themselves to lend money to the sector any longer - especially as the RBI has restricted such flows and has asked banks to be wary of lending out too much money to real estate companies. What does all this mean? And how are these indications going to affect the person who wants to invest in real estate? First, potential investors should now be very, very wary of where they invest in. In the absence of a real estate regulatory body in place (even though the government has been promising one for six years now), the old dictum of caveat emptor , or buyer beware is more relevant today than ever before. Developers are facing a double whammy this year.

Even if their projects come up, the support of infrastructure promised by government agencies - power, water , sewage, and above all, road and transport connectivity - is just not happening on time, so projects may be finished, painted and polished, but may not be livable . The high cost of borrowing money is also hitting developers - and with banks becoming wary of extending credit to the sector, many developers are now looking towards private equity and similar sources of finance, many of which are more expensive than bank funds. Apart from expenses, many financiers are also more careful about the money they lend out.

Secondly, the return on investment ratios are dropping fast - even in large cities where one would expect rents to be higher, returns are pitifully poor. While it is true that most people feel that low rentals are compensated with an increase in capital value over the years, this mind set is fast changing, mainly because real estate is now part of the portfolio of investments which a person makes, and not just a house to live in and draw rent from. Today, there's a growing number of people which looks upon real estate as an investment, and not much more. Three, the cost of money is going up.

The posted results of the dozen odd big players in the real estate industry this financial year show that they have debt burdens totaling about Rs 90,000 crore this year. With the RBI monitoring monetary policy aggressively, money is becoming dearer. To get around that, many players are borrowing from private equity funds to pay banks. That is adding to costs. With the overall increase in interest rates through the economy, we have a dangerous mixture waiting to blow up. Four, many large developers have borrowed too much.

According to a Bloomberg study, most large developers have debts which are at least 10 times the cashon- books figures declared by them at the end of the accounting year, with one large developer having borrowed 24 times its cash reserves. The old theory that large land banks would help them bail out of any debt trap is now history - the RBI has mandated that all banks which lend money to developers shall insist on a monitored escrow account for each specific project to ensure that the money borrowed for a particular project is not diverted for any other purpose than the development of that project.

Five, while the RBI has tightened money flows by increasing interest rates and the CRR, the recent policy announcement of increasing the limit for affordable housing loans from . 20 lakh to . 25 lakh shall further force developers to move towards projects for the aam aadmi , instead of banking on the high end products they have been presently concentrating on. Lastly, big developers have moved back again to selling land rather than built space - thereby disposing off land banks which have been a unproductive burden on their balance sheets. Will these plots that are being sold get adequate infrastructure ?

Will they be developed further? These are open questions, especially in the absence of a strong consumer protection body to push for timely development. There's another important issue involved : the recognition that a lot of black money, including from politicians, is sunk in real estate. Whether it's the apex court that wants speedy investigation of black money trails, or the 2G scam, there is evidence of real estate companies messing with political big wigs. Today, government investigating agencies and regulators are working on systems , incorporating many databases, to track down property undervaluation and track suspicious transactions. With developers sputtering, money getting costly, projects lying under-developed and a crackdown on cash, the real estate investor needs to be very careful.
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    Realtors gr with huge unsold stock; rising prices & costlier loans hit buying plans - ET

    Realtors gr with huge unsold stock; rising prices & costlier loans hit buying plans - The Economic Times

    NEW DELHI/BANGALORE: Dentist couple Sushma and Vikrant Mohanty had been looking to buy an apartment in Delhi-NCR for almost a year. But after several rounds of unsuccessful discussions with builders and umpteen visits to property sites, they decided to wait till prices came down.

    The 2009 real estate slump had created lots of buying opportunities, but prices have climbed since then to what some believe are unsustainable levels.

    Last week, as home loan rates shot up after RBI hiked interest rates, the couple saw their dreams come crashing down. They have now dropped all plans of owning a house.

    "This is like a double whammy. Now I don't know when we will be able to buy a house. We are already paying heavy rent in Delhi," says Mohanty.

    Across the city from where they live, RK Arora, managing director of Noida-based real estate company Supertech , is a worried man. He has seen a 10-15% drop in sales in the past few months. His company launched six projects in the past one year and prices have already risen 15-20%. He fears a further drop in demand. "Rising interest rates have already impacted demand," he said.

    Builders like Arora and prospective home buyers like the Mohantys are caught in a bind. Rising interest rates and soaring prices are forcing more and people to put off purchasing plans, affecting builders who desperately need money to pay off costly loans and start new projects. The unsold stock in major cities has been going up, forcing banks and equity investors to call for a price cut.

    "It's not interest rates that have spoilt the party, it's home prices," says Renu Sud Karnad, managing director of HDFC Ltd , one of India's biggest housing finance companies.

    "There has to be some rationalisation of prices-by at least 10-15%-in the next few months," she added. Unsold residential units in projects that are completed or are nearing completion within the next 6-12 months in Mumbai and Delhi-NCR are as high as 25% and 16%, respectively, of the total number of units.

    In other top cities, including Bangalore, Chennai and Kolkata , the numbers range between 12% and 19%, consultant Jones Lang La-Salle found in its real estate intelligence service for the first quarter of 2011 (see chart on Page 1).

    "A price correction is imminent. How long can developers hold back... I think prices will correct by a maximum 15%," says B Niyogi, chief general manager, real estate and housing, State Bank of India , India's largest lender. Real estate research firm Liases Foras says approximately 471.9 million sq ft of residential stock, one-fifth the size of Chandigarh, is lying un-sold in the country's top six markets.

    For real estate firms, with bad memories of the 2008-09 slump, these numbers are scary. But they also illustrate what could go wrong in a highly price-sensitive industry hugely susceptible to the vagaries of consumer sentiment, interest rates and commodity price changes.

    "Cost pressures are building up for developers. They will have to cut prices to retain volumes, failing which it will impact profitability and cash flow in the coming quarters and affect margins as well," says Aashiesh Agarwaal, real estate analyst at Mumbai-based Edelweiss Se-curities.

    Companies such as Gurgaonbased Unitech, one of the country's top builders, are feeling the pinch too. "Today, selling efforts need to be put in unlike earlier when all projects were selling on their own," says R Nagaraju, vice-president, corporate planning and strategy, Unitech.

    In the past one year, the industry managed to bounce back from the 2009 slump, though the recovery has been uneven. In 2010-11, the industry took full advantage of the positive sentiment, economic growth and softer rates to sell more. Prices rose, not just because of demand but also construction costs. Rising steel and cement prices fuelled a 60% jump in construction costs. Price of land is not coming down either.

    "It is becoming almost unmanageable," says Snehal Mantri, director-marketing at Bangalore-based Mantri Developers. Companies coped with the scenario by increasing prices and hoping that consumers would be able to pay. For some time they did, but the party may be coming to an end now.

    At the end of trading on May 18, 2011, the BSE realty index was at 2,120.45, down 47.5% from its 52-week high of 4,034.35 on October 7, 2010, and down 84.7% from its highest-ever level of 13,848.09 on January 8, 2008. Defaults, not unheard of in the real estate industry, are likely to re-turn. Bank lending is already down after a recent RBI directive and scams involving real estate companies. Private equity, the alternative to loans and IPO, is playing coy too. They want builders to cut prices and get rid off the inventory.

    "All private equity funds are working on the basis that there would be a 15% correction. No one wants to lose money," says V Hari Krishna, director-investments, Kotak Realty Fund , a sector-specific private equity firm.

    According to PropEquity, a real estate consultancy firm, in the last one year, prices of new and existing housing projects in some parts of the country have risen 10-40%. In the first quarter of 2011, Mumbai has seen a 17% drop in home sales, Bangalore 14% and Hyderabad 15%.

    Some builders think they can manage by focusing on small cities. Jaxay Shah, a real estate developer in Ahmedabad and vicepresident of Credai, insists that Mumbai and Delhi should not be considered as the barometer. These cities contribute hardly 4% of the national mar-ket. Sales in tier-2 and tier-3 cities are steady, though there is some panic due to hike in interest rates, which have climbed to around 11% from 8.25% a year ago.

    An executive at a large home loan lender gives the example of smaller cities where local developers understand the market demand and know how much people are willing to pay. So they price their projects according to the paying capacity. Markets like Lucknow, Indore, Ghaziabad, Faridabad and others are doing well because the ticket sizes are low.

    "The actual ticket size of a property is what matters. Rs 20-40 lakh is really the segment that will attract mid-income Indians," adds Karnad of HDFC. All this is happening at a time luxury projects are languishing. "Developers have not been able to interpret the activity in the mar-ket," points out Shveta Jain at Cushman & Wakefield .

    Mumbai-based Omkar Realtors and Developers recently launched apartments at Rs 7,100 a sq ft in Malad, a Mumbai suburb, where other builders are still selling at Rs 8,500-13,000 a sq ft. Within 20 days, Omkar was able to sell a tenth of its total inventory of 1,000 apartments. Similar price cuts have worked in projects in Chembur and Dadar as well.

    "Genuine demand still exists in the market. If one decides to stick to high prices, demand may remain elusive," said Babulal Verma, manag-ing director of Omkar Realtors & Developers. Across the country, many builders and lenders will hope that he is right. But there is another fear-the bottom could be a long way off. As Jaxay Shah of Ahmedabad says, "When buyers don't buy, they don't buy at any price, because of the sentiment." The industry will hope that he doesn't turn out to be right.