Why are real estate prices still high despite weak demand?

India Ratings & Research has maintained a negative to stable outlook on the real estate sector for 2014-15 on the back of continued weak end-user demand and adverse consumer sentiments.

Real estate companies have been facing falling unit sales, flat revenue and earnings before interest, taxes, depreciation, and amortization (EBITDA) margins and continued deterioration in credit metrics and cash flows, the rating agency said.

Most of real estate companies rated the agency have a stable outlook, as the risks impacting the sector have been factored into their ratings.

The entities rated at investment grade are either single commercial properties with long-term lease agreements or residential companies with healthy sales and strong cash flows.

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The rating agency believes credit metrics will continue to deteriorate in FY15, as high residential prices continue to impact sales, even while rising bank credit to the sector indicates an increase in inventory for the sector.

The sale of fresh residential units (in square foot) by listed real estate companies has seen a downward trend in the first half of 2013-14.

This is due to weak consumer sentiments and low real estate affordability due to high prices.

Prices continue to remain high despite the weak end-user demand, as demand from investors and speculators could have been lifted by the government's efforts to curtail gold imports.

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The upward movement seen in National Housing Bank's house price index in 2QFY14 after a fall in the previous two quarters supports this argument, as it coincides with the imposition of import duty on gold.

Ind-Ra expects subdued commercial property demand to continue in 2014, due to the continued slow economic growth which will impact fresh hiring in most sectors.

Demand for retail space is also likely to remain muted in FY15, as retail companies continue to optimise their store portfolios.

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The real estate sector has seen strong interest from private equity and foreign investors. During 2013, strong investor interest was seen in rent-yielding commercial properties with conclusion of several large transactions by leading private equity players such as Blackstone.

Ind-Ra expects the introduction of real estate investment trusts to be positive for the sector, as it is likely to attract new investors and hence improve funding availability.

As these REITs are likely to invest most of their funds into rent-yielding commercial properties, this could provide further liquidity options to commercial property developers, it said.