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Factors driving the growth in the Real Estate Sector


Factors driving the growth in the Real Estate Sector

Last updated: July 19 2007
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  • Factors driving the growth in the Real Estate Sector

    A combination of a few events has led to discussion on whether the real estate bubble will burst. The fact is, however, that various fundamentals have created a huge demand supply gap in all sectors of the real estate market Wise investments, buying raw materials at the right price, ensuring quality and efficiency and selling at a premium can ensure better investments. Since February the headlines have changed in tenor - from "everything booming on the back of 8% GDP growth this year" to "inflation getting out of hand, "interest rates hiked to control liquidity", "SEZs (Special Economic Zones) put on hold", "farmers interests ignored in the concerted landgrab"… all of it ending with the conclusion that the real estate bubble is going to burst.

    One has to understand why the Indian real estate sector has presented itself as an asset class for international and institutional investors. All the factors driving growth and investment in this sector are driven by three key fundamentals.

    Strong Economic Growth: The world’s fourth largest economy, growing at over 8% the last two years and forecast to grow at over 7% over the next five; Growth measures supported across the political spectrum; a boom in the services sector with a strong revival of industry; powerful internal consumption and demand.

    The Rise of the Middle-Class: 300 million and growing with higher disposable incomes and even higher aspirations; educated, professional workforce driving urbanization beyond the traditional metro cities.

    Enviable Demographics:
    The world’s second most populous nation of 1.09 billion with 75% below the age of 50!

    These fundamentals in turn have created a huge demand supply gap in all sectors of the real estate market - commercial, residential, retail, healthcare, hospitality to name a few. According to research conducted by ENAM Securities (a leading financial services firm) in late 2006, the market is expected to touch USD 50 billion by 2010 at a CAGR of 33% over five years. A requirement of 20 million new housing units; a five-fold increase in office space; 200 million square feet of organised retail and 50,000 new hotel rooms will drive this growth.

    What then causes this widespread talk of this so-called bust in the real estate market?
    It is a combination of a few events coming together in February - defeat of the ruling central coalition parties in two state elections due to rise in prices, a middle-of-the-road Union Budget, the central bank controlling inflation by tightening liquidity through interest rate increases, an isolated but well publicized agitation by farmers in a designated SEZ and the Stock Market Regulator (SEBI) asking real estate IPOs to disclose details of land banks and their valuations in their respective listing documents.

    In many locations, especially around the bigger urban agglomerations, the prices being quoted by land owners were way out of line with reality. In many cases land is being offered by owners even before being acquired. Title deeds and records in many states are unclear and sometimes non-existent. It is also a fact that the initial acquisition of land by state bodies has at times been forceful and coercive.

    What then can be reassuring to an Advisory and Management company such as ours? How can we ensure that we are making the right investments and are able to provide the level of returns expected by our investors?
    The answers are very basic and follow the principles of any good business enterprise. Buy the raw materials at the right price, use the most stringent measures of quality and efficiency during conversion and finally market and sell at a premium.

    The drivers of profitability in the Indian Real Estate as follows:

    • Knowledge of the business:
    Though the principles of doing business are simple, over the many years of unregulated development, dealing in real estate in India has its own peculiarities, often at a local level and particularly in the area of transparency and legal documentation, and a thorough knowledge of these remains vital. However, we find that the new, more stringent documentation norms being introduced by the Government greatly reassuring both at the time of investment and in case of later disputes.

    • A wide network: There are developers and there are developers, and in a boom market everybody has got into the act. It is important to quickly sift the wheat from the chaff when forming JVs and SPVs for specific projects. We look to form partnerships with a developer over several projects, which in themselves are of considerable size and stature. This ensures adequacy of resources in terms of raw materials and project skills, timely execution and above all a final product with all the enabling licences in place. Once again, Government regulations enforcing the above are reassuring.

    • The longer-term approach: Real value to investors will accrue only on the sale of the end product in terms of its multiplier effect. Also longer-term investments are more likely to weather the hiccups of short term breaking news. Regulatory efforts to keep out hedge funds and such short term profiteers will go a long way in ensuring that this practice is sustained.

    • Focus on quality: This, more than anything, will derive the best value for investors, not just in monetary terms but also lasting goodwill. This entails not just the final product but also the totality of the environment where the development is located. Governments efforts to ensure that resettlement and social development of the displaced form part and parcel of all large projects is the most encouraging news of all.

    Economic Times [ 19/07/07]
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