The reality of Indian realty: More downs than ups

'Most real estate companies, were listed during the period of irrational exuberance. The sector at the time was at a peak after seeing steady growth over the last seven years. Hence, a correction was inevitable.'

'These companies listed at significant premiums to their future cash flows and net asset values. Analysts were valuing returns even on future cash flows.'

Raghavendra Kamath reports on what ails India's real estate sector.

The collapse of Lehman Brothers and the global financial slowdown made private equity (PE) funds cut investments in the real estate sector, impacting property sales. While PE funds such as Wachovia and Lehman Brothers exited the sector, developers halted their hotel and special economic zone projects that needed large investments.

Developers almost stopped building office projects between 2008 and 2012, focusing instead on the residential market.

The residential sector looked up after 2011, but revival was short-lived. Observers say the sector has seen time correction of 8-10 per cent every year in the past five years, thus, becoming more affordable. The downward interest rate cycles also helped homebuyers.

A broad-based recovery is expected to take a year or two, according to experts.

"The past decade witnessed a gradual change in Indian real estate in terms of assimilation of global best practices into local work ethic. Mechanisation was the big move, towers soared to the skies. Indian real estate moved towards working as a corporate entity, self-regulation and made attempts at becoming transparent," said Niranjan Hiranandani, founder and managing director at Hiranandani Constructions.

The side effect of going global

From making homes, the sector gradually turned into an investment class, in which investors pumped in money based purely on excel sheets and architectural blueprints, he said.

But it was an interesting period for the initial public offering market, as several big-ticket IPOs of DLF, Oberoi Realty and so on hit the market.

The past five years saw global PE majors making big acquisitions in office and mall space. Blackstone invested more than $3 billion in buying information technology parks and building a portfolio of 70 million sq ft with its partners.

It has formed joint ventures with the Embassy group of Bengaluru and Panchshil of Pune. It also picked up a 20 per cent stake in K Raheja Corp of Mumbai.

The company also set up a separate company for malls and owns retail malls to the tune of over 5 million sq ft of retail space.

Other big funds such as Brookfield, GIC and CPPIB signed big deals in the commercial space. GIC signed a $1.4-billion deal with DLF to buy 40 per cent of the promoters stake in DLF's rental arm.

GIC bought 40 per cent in the rental arm of Prestige group for around $300 million.

Last year, the sector went into a tailspin with demonetisation, Real Estate (Regulation and Development) Act (RERA) and the goods and services tax (GST) affecting the sector. Demonetisation affected markets, such as National Capital Region, were cash transactions used to form a major portion of sales.

RERA and GST increased the compliance costs for developers, though these are considered customer-friendly.

Residential launches dropped 50 per cent in 2017, as developers focused on making their projects RERA-compliant. Many small developers went in for joint ventures with bigger ones or sold their projects to tide over the crisis.

Both developers and investors have started focusing on affordable housing in the past couple of months due to regulations supporting it and rising demand.

HDFC Capital, an arm of Housing Development Finance Corporation, tied up with the Prestige group to invest Rs 25 billion in affordable housing.

HDFC Capital floated a similar platform with Mahindra Lifespaces. HDFC Capital has readied a war chest of $1 billion to invest in the segment.

Mumbai-based Shapoorji Pallonji is also investing aggressively in the segment.

The government has come out with lower GST rates and a credit-linked subsidy scheme to promote affordable housing. From the market capitalisation perspective, real estate was among the worst performing sectors in the past 10 years.

"Most real estate companies, were listed during the period of irrational exuberance. The sector at the time was at a peak after seeing steady growth over the last seven years. Hence, a correction was inevitable. These companies listed at significant premiums to their future cash flows and net asset values. Analysts were valuing returns even on future cash flows," said Abhimanyu Sofat, head of research, IIFL.

Sofat says there is one clear silver lining on the horizon, which is commercial real estate.

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"Absorption rates in the office segment are likely to go up as we go through a cyclical upturn in the economy, leading to significant value creation. New structures like REITs (real estate investment trusts) will bring further liquidity to this space."

REITs are pooled investments like mutual funds that can be traded on stock exchanges.

Many PE firms are floating funds to invest in commercial real estate as residential developers are struggling to sell properties. Shapoorji Pallonji has tied up with Allianz of Germany to invest in office projects, while Godrej Fund Management entered the segment recently.

Vacancies in office markets such as Bengaluru and Mumbai have hit their lowest levels and absorption levels have remained steady in the past couple of years.

While REITs are the most-watched instruments, the first such issue is at least six months away as Blackstone-Embassy is yet to file its draft red herring prospectus.

Illustration: Dominic Xavier/Rediff.com.