It's real! Realty sector facing rough weather

Reliance Money has come out with report on various key sectors of Indian Economy. Here is the one pertaining to Real Estate.

Slowdown visible in Topline

Negative macro factors have taken a toll on the real estate sector. Except Akruti and
Phoenix mills all the other companies reported negative growth in topline (QOQ) in
the range of 2% to 16%. Companies in our universe reported negative growth of 1%
and 8% on YoY and QoQ respectively. Lower volumes were realized by most of the
developers because of increase in home loan rates and high price points. Companies
like DLF launched mid income housing (lower margins) which received a positive
response. Companies like Puravankara and Omaxe are planning to develop 64,500
and 10, 00,000 affordable house units in medium to long term.

Input cost pressure dents profitability

Higher input cost clearly impacted margins. Companies in our universe reported
negative EBITDA growth of 11% on QoQ basis and 2% on YoY. Except Phoenix, Akruti
and Peninsula all companies reported negative EBITDA growth QoQ. EBITDA Margins
remained flat YoY and declined by 200 bps on QoQ.

Bottomline under pressure

The current low volumes, rising input cost and tight liquidity has lead to a decline in bottomline. Liquidity crunch in the global and domestic market impacted the sector
adversely. Drying out of funds from all sources has lead to rise in cost of debt to 15% for most of the companies. Interest cost increased significantly by 123% from Rs.
1295 mn in Q2FY08 to Rs. 2889 mn in Q2FY09. With recent measure like reducing
CRR, Repo rate, & SLR by government to reduce interest rates most of the banks has
responded positively by reducing their PLR. PAT reported negative growth of 500 bps
YoY and 200 bps QoQ. PAT margins for top two real estate i.e. DLF and Unitech
declined 1000 bps and 400 bps YoY.

We beleive there is a close relationship between the economic growth and the prices
of commercial (office) market and retail demand. Demographic factors determine
the prices of housing segment though the interest rates in the economy also plays
important role in price discovery of housing segment. The BSE real estate index has
slipped by over 85% from its high of 13848 on 08th Jan 2008. Liquidity crunch in the
economy has badly hit the sector in the last quarter. Fund flow from the primary
market and private equity (PE) has dried out and therefore real estate companies are
in need for more debt. Raising debt has become difficult due to global liquidity crunch in the international market and ECB restrictions. Banks continues to postpone leading decision, despite sanctioned limits to the sector. As per various media reports property prices have corrected in the range of 15% to 35% from its peak depending upon the location and region. Most of the developers which were confident of sales picking up in the diwali festival season were wide of the mark.

Sector Outlook

Drying up of volumes, liquidity issues along with rising input cost is a curse to real estate companies. Inspite of these issues developers are not ready to reduce the list price. However indirect reduction in prices through discounts and freebies are part of the transaction. Real estate companies are taking several cost cutting measures to improve their margins in the face of the global economic turmoil. Most of the developers are now focusing towards Lower Income Group (LIG) and Middle Income Group (MIG)housing segment (Affordable housing). Also the focus has shifted from accumulating land to execution of current projects. Most of the developers are keeping away from launching of new projects. Malls rental rates are also expected to rationalize. In commercial space focus has shifted from IT/ITES commercial development segment to non IT/ITES commercial development as slowdown is expected in the sector. It’s time for the developers to recalibrate and reprice their products. On the other side buyers are in “Wait & Watch Policy” and are in no hurry to entry any transaction. We expect Q3FY09 will be tough ride for real estate sector. Decreasing commodity prices and interest rates will help the sector get rid of dark clouds in medium to long term. However atleast for the next 12 - 18 months, real estate companies are likely to face rough weather.