If there is one sector that has been incessantly beaten down by the stock market for every macro-economic concern in the country over the past year, it has to be real estate. And not without reason. Be it rising inflation, increased costs of borrowing, tightening liquidity, increase in defaults by retail borrowers, slowdown in the IT industry or the controversies surrounding land grab — you name it, and it has a direct impact on the realty sector's prospects.
The BSE Realty Index, flagged off only in 2007, has slumped by 34 per cent over the last year, taking a much harder knock than the Sensex (6 per cent down); it has the dubious distinction of being the worst performing sector index.
Are all the macro concerns linked to the sector justified? If so, are they likely to affect the performance of the sector and, as a result, listed stocks as well? The answer is a 'yes', with developers themselves now starting to acknowledge the challenges ahead. The financial results of realty companies in the listed space are also beginning to show signs of yielding to these macro pressures.
However, going beyond the near-term concerns and getting to the crux of the matter: Is the sector suffering from excess supply, and has demand peaked? The answer appears to be a 'no'. While it cannot be denied that there are a few pockets of excess supply, this could be the fallout of the above macro concerns, as individuals and corporates have chosen to postpone their buying.
The realty needs of the Indian market as a whole, nevertheless remain largely unaddressed. For instance, the demand for housing or office space is still unfulfilled in a good part of the country. Yet, the problem at the business level appears to be lack of proper pricing and a faulty product mix. The inability of developers to quickly shift gears to offer the right properties at affordable prices, has been the key reason for the snowballing problems.
Let's look at the impact of recent economic developments on the financials and business of key listed players in the sector. We also look at companies that appear better placed to ride out the difficult times either through their unique business model or through tactical strategy shifts.
Slowing sales growth
Concern: Growth in the home loan segment is reported to be slowing, indicating slower offtake of residential space, the reason cited being the increase in rates and the reluctance on the part of developers to slash the list price.
Simultaneously, offtake of commercial space, earlier aggressively bought by IT companies, is also said to be slowing, posing another challenge for the developers.
Impact: Quarterly numbers for realty companies are expected to be lumpy due to the uneven flow of revenues from projects. But with a good number of listed players following the 'percentage completion' method for accounting earnings (wherein revenues are accounted based on percentage of work completed), an increase in projects under execution should have translated into healthy growth for companies at least on an annual basis. However, 2007-08 witnessed slower sales growth for a number of companies. For instance, Parsvnath reported a 17 per cent growth in revenues in FY 08 as against 135 per cent in FY07.
Unitech witnessed a subdued 26 per cent growth in sales in FY 08 after a whopping 253 per cent in the previous year. Smaller companies such as Ansal Housing or Peninsula Land have slipped to single-digit growth in sales. The slowdown in the top line could point either towards a slowdown in offtake or longer execution cycles for projects (such as SEZs), which have not started yielding revenue. The former appears more probable for a good number of players as most of them are focussed on the residential or commercial space.
Margin pressure
Concern: The spike in commodity prices and the resultant surge in inflation have led to increased cost of construction for realty companies.
Impact: Increasing cost of key raw materials — steel and cement and inability on the part of developers to command higher realisations does present a risk to margins. While bigger players such as DLF have started to witness a mild dip in their lucrative margins, not much damage has been done to realty companies' operating margins so far. This again, could be partly due to the accounting method followed by them.
Most realty companies follow the percentage completion method for booking sale, with costs booked based on estimates until the project is over.
A revision in these cost estimates due to a steep escalation in raw material costs, does pose a risk to future profits. This risk is already evident in Omaxe's fourth quarter results.
The risk of more companies taking note of higher costs over the next few quarters, does pose a threat to the OPMs. However, for some companies, a land bank accumulated at low cost, may still ensure that margins remain superior to most other sectors.
Mounting debt and interest costs
Concern: Higher interest rates, tightening liquidity and higher norms for lending to the sector have resulted in fewer economical borrowing options for developers.
Impact: Despite recent fund-raising through IPOs, companies such as Orbit Corporation have reported a 15-fold increase in their secured loans in FY08 compared to FY07.
Listed realty players have witnessed at least a 3-4 percentage point increase in the borrowing costs in the last few quarters. For smaller companies such as Ansal Housing and Prajay Engineers, interest costs now account for 11 per cent and 12 per cent of their respective sales as against 3-4 per cent a year ago.
Akruti City's interest cost is as much as 12 per cent of sales. However, the difference between the first-mentioned companies and Akruti is that while the former firms have been witnessing a slowdown in revenue growth, Akruti City continues to see healthy growth in revenues and profits to comfortably service its interest obligations. Thus, while Akruti managed to improve its net profit margins, the other two have seen a dip.
Impact on balance sheet
Even as developers find it difficult to raise fresh funds, can they tide over these difficulties through internal resources such as advances received from customers? The latest balance sheets of companies do not indicate this. Customer advance is a key source of working capital required for executing realty projects.
While customers, even a year ago, may have been willing to pay huge advances upfront to secure property at prevailing prices, increasing borrowing costs appear to be dissuading customers from paying large upfront advances.
For instance, advance from customers in the books of Orbit Corporation has dwindled to Rs 21 crore in FY08 from Rs 110 crore a year ago. Puravankara, Sobha Developers and Unitech too have witnessed a decline in advances received despite increase in projects under execution.
While customer advances as a percentage of capital employed has been dwindling, the other indicator of crunch in working capital for realty companies, is the increase in debtor days (the number of days taken to realise cash from debtors). Parsvnath Developers for instance has seen its receivable collection days double in 2008 from 135 days a year ago.
While most players have witnessed this crunch in working capital, Puravankara and Unitech are notable for their relatively low debtor days in absolute terms (despite seeing an increase in the collection period).
Lower customer advances and increasing debtor days are likely to force players to borrow more to meet capital rotation.
Positive vibes?
While the above business and funding challenges continue to trouble the developers would the recent mild decline in inflation provide hope for revival? Could this mean that there would be no need to take up stringent monetary measures?
If so, are interest rates — which appear to be the key trigger for a revival from the developer's funding perspective as well as customer's borrowing capacity, likely to soften?
Even, if all these hopes turn true, it could take a good year for the effect to percolate into the home loan segment to revive demand. Until then, developers have to find ways to sell, even if it comes at the cost of their profit margins.
The accompanying article addresses a few strategies adopted by developers to tackle the present concerns.
The BSE Realty Index, flagged off only in 2007, has slumped by 34 per cent over the last year, taking a much harder knock than the Sensex (6 per cent down); it has the dubious distinction of being the worst performing sector index.
Are all the macro concerns linked to the sector justified? If so, are they likely to affect the performance of the sector and, as a result, listed stocks as well? The answer is a 'yes', with developers themselves now starting to acknowledge the challenges ahead. The financial results of realty companies in the listed space are also beginning to show signs of yielding to these macro pressures.
However, going beyond the near-term concerns and getting to the crux of the matter: Is the sector suffering from excess supply, and has demand peaked? The answer appears to be a 'no'. While it cannot be denied that there are a few pockets of excess supply, this could be the fallout of the above macro concerns, as individuals and corporates have chosen to postpone their buying.
The realty needs of the Indian market as a whole, nevertheless remain largely unaddressed. For instance, the demand for housing or office space is still unfulfilled in a good part of the country. Yet, the problem at the business level appears to be lack of proper pricing and a faulty product mix. The inability of developers to quickly shift gears to offer the right properties at affordable prices, has been the key reason for the snowballing problems.
Let's look at the impact of recent economic developments on the financials and business of key listed players in the sector. We also look at companies that appear better placed to ride out the difficult times either through their unique business model or through tactical strategy shifts.
Slowing sales growth
Concern: Growth in the home loan segment is reported to be slowing, indicating slower offtake of residential space, the reason cited being the increase in rates and the reluctance on the part of developers to slash the list price.
Simultaneously, offtake of commercial space, earlier aggressively bought by IT companies, is also said to be slowing, posing another challenge for the developers.
Impact: Quarterly numbers for realty companies are expected to be lumpy due to the uneven flow of revenues from projects. But with a good number of listed players following the 'percentage completion' method for accounting earnings (wherein revenues are accounted based on percentage of work completed), an increase in projects under execution should have translated into healthy growth for companies at least on an annual basis. However, 2007-08 witnessed slower sales growth for a number of companies. For instance, Parsvnath reported a 17 per cent growth in revenues in FY 08 as against 135 per cent in FY07.
Unitech witnessed a subdued 26 per cent growth in sales in FY 08 after a whopping 253 per cent in the previous year. Smaller companies such as Ansal Housing or Peninsula Land have slipped to single-digit growth in sales. The slowdown in the top line could point either towards a slowdown in offtake or longer execution cycles for projects (such as SEZs), which have not started yielding revenue. The former appears more probable for a good number of players as most of them are focussed on the residential or commercial space.
Margin pressure
Concern: The spike in commodity prices and the resultant surge in inflation have led to increased cost of construction for realty companies.
Impact: Increasing cost of key raw materials — steel and cement and inability on the part of developers to command higher realisations does present a risk to margins. While bigger players such as DLF have started to witness a mild dip in their lucrative margins, not much damage has been done to realty companies' operating margins so far. This again, could be partly due to the accounting method followed by them.
Most realty companies follow the percentage completion method for booking sale, with costs booked based on estimates until the project is over.
A revision in these cost estimates due to a steep escalation in raw material costs, does pose a risk to future profits. This risk is already evident in Omaxe's fourth quarter results.
The risk of more companies taking note of higher costs over the next few quarters, does pose a threat to the OPMs. However, for some companies, a land bank accumulated at low cost, may still ensure that margins remain superior to most other sectors.
Mounting debt and interest costs
Concern: Higher interest rates, tightening liquidity and higher norms for lending to the sector have resulted in fewer economical borrowing options for developers.
Impact: Despite recent fund-raising through IPOs, companies such as Orbit Corporation have reported a 15-fold increase in their secured loans in FY08 compared to FY07.
Listed realty players have witnessed at least a 3-4 percentage point increase in the borrowing costs in the last few quarters. For smaller companies such as Ansal Housing and Prajay Engineers, interest costs now account for 11 per cent and 12 per cent of their respective sales as against 3-4 per cent a year ago.
Akruti City's interest cost is as much as 12 per cent of sales. However, the difference between the first-mentioned companies and Akruti is that while the former firms have been witnessing a slowdown in revenue growth, Akruti City continues to see healthy growth in revenues and profits to comfortably service its interest obligations. Thus, while Akruti managed to improve its net profit margins, the other two have seen a dip.
Impact on balance sheet
Even as developers find it difficult to raise fresh funds, can they tide over these difficulties through internal resources such as advances received from customers? The latest balance sheets of companies do not indicate this. Customer advance is a key source of working capital required for executing realty projects.
While customers, even a year ago, may have been willing to pay huge advances upfront to secure property at prevailing prices, increasing borrowing costs appear to be dissuading customers from paying large upfront advances.
For instance, advance from customers in the books of Orbit Corporation has dwindled to Rs 21 crore in FY08 from Rs 110 crore a year ago. Puravankara, Sobha Developers and Unitech too have witnessed a decline in advances received despite increase in projects under execution.
While customer advances as a percentage of capital employed has been dwindling, the other indicator of crunch in working capital for realty companies, is the increase in debtor days (the number of days taken to realise cash from debtors). Parsvnath Developers for instance has seen its receivable collection days double in 2008 from 135 days a year ago.
While most players have witnessed this crunch in working capital, Puravankara and Unitech are notable for their relatively low debtor days in absolute terms (despite seeing an increase in the collection period).
Lower customer advances and increasing debtor days are likely to force players to borrow more to meet capital rotation.
Positive vibes?
While the above business and funding challenges continue to trouble the developers would the recent mild decline in inflation provide hope for revival? Could this mean that there would be no need to take up stringent monetary measures?
If so, are interest rates — which appear to be the key trigger for a revival from the developer's funding perspective as well as customer's borrowing capacity, likely to soften?
Even, if all these hopes turn true, it could take a good year for the effect to percolate into the home loan segment to revive demand. Until then, developers have to find ways to sell, even if it comes at the cost of their profit margins.
The accompanying article addresses a few strategies adopted by developers to tackle the present concerns.
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