Monday, January 20, 2014

Opinion: Real Estate prices in India: Running out of fuel?

Intro: Real Estate has been the most desired asset of poor’s and the dearest asset of wealthy. There were several reasons for its spectacular performance as an asset class, like opening of Indian economy two decades ago took out many from below the poverty lines, newly created jobs provided a descent income for the educated class, towns got bigger, consumption patterns and lifestyle changed, aspirations only got bigger. That was the period during 2000 to 2008.
a.  Healthier growth (2000 to 2008): Economic growth of the last decade led to a steep rise in demand for housing, and land requirement for infra projects. Real estate prices soared overnight but the valuations were justified. There were lenders lined up for all these projects which were expected to produce superior returns. Real Estate, construction and infrastructure industry created the new billionaires. (But many are off the list already). There were real estate brokers on every street helping the buyers and sellers conclude deals in a hurry. Govt. registrar offices got a new lease of life with ever increasing transactions. Banks thrived. Any new housing project would be sold off in a few hours. All rich and poor thought they would miss the bus if they did not do something in this space.

b.   Liquidity & fight against inflation (2008-2012): Along with growth, inflation too made its mark. Crisis in 2008 after the fallout of Lehman and the subsequent impact to housing sector in US led to a slow down in global growth rates affecting India’s own growth story. Many other financial issues suppressed until then began to surface. A term ‘PIIGS’ started doing rounds on the newspapers and TV channels. Central banks, Fed and ECB, took the route of easy monetary policy attempting to revive growth or at least avoid the possibility of a break down in the financial system. This led to a stubborn inflation during the times of a slowing growth. Gold and Real Estate became instruments to lock the wealth for those who prospered and who were already rich. A portion of the easy money flowed into commodities and also to emerging countries. This higher liquidity helped to maintain the real estate prices high.

Forming a top:

So what changed by the end of 2013? It is the reducing optimism and the belief in India’s growth story. 5% growth rate had become the new norm. Banks had to lick their wounds inflicted by Infra sector in the form of non-performing assets. US Fed announced tapering of QE3. Credit growth became tight with the measures taken by RBI. And the appetite in the house buyers reduced significantly. Small builders who could not hold on had to sell to bigger developers. This made the real estate prices stop from reaching new highs or at least it appeared so. Gold, another asset we are looking in tandem appears to be in correction zone.

Reducing new loans. Source: HDFC Sep'13 Quarterly results.

Declining sales trend at Unitech. Source: Unitech Q2'13-14 results
Has everything turned bad?
No and cannot be. The fall in Rupee had made the property in India cheaper by 20% for the Non-resident Indians. Those NRIs who earlier thought they missed the bus had an opportunity to board it again. And there were many new projects being launched to cater to this market segment.

What are the warning signals for the sector?

                           i.          RBI in its latest 'Financial Stability Report’ warned that, in the event of a credit risk due to failure of a major corporate, banks would fall out and the contagion would spread leading to a major collapse in the financial system. It identifies infra and construction sectors as being most risky and public sector banks being more vulnerable to this. If Govt. rescues these public sector banks it owns partially, it would avoid the collapse of but profitability of these banks would be gone. While this may or may not happen, this would limit the funds flowing into the reality and infra sector.
                          ii.          Liquidity would reduce as Fed increases the pace of its QE3 program. This would mean the end of easy and cheap money and markets will witness those funds leaving India back to their home country. This would make the cash king again at the expense of gold and real estate prices.
                         iii.          Drop in demand to due to slower economic expansion, fewer jobs being created than earlier decade, salaries not rising like in the last decade will impact the demand. A slump in new car market during last year proves that purchasing power of consumers has taken a hit.
                         iv.          Many (well most) real estate companies are running in losses, their stock prices are trading at multi-year lows and they are struggling to raise funds for their new projects. They may not be in a position to hold on the rising inventory for long if demand does not come back.

An analysis by Liases Foras shows correction is due. Source: Liases Foras company website

Conclusion: 

While it is difficult to say whether there will be a correction or not, which depends on how long the co-operation or nexus of banks and developers last, one can be sure that this industry is in troubled times. If it is a bubble already, it may not get any bigger this year.