In-house Trou­ble

Business Today - - CONTENTS - By MA­HESH NAYAK

As more res­i­den­tial prop­erty re­mains un­sold, com­pa­nies may have to re­think their strat­egy

Rahul Patil, 36, a mar­ket­ing ex­ec­u­tive with a big me­dia group in Mum­bai, changed his mind about buy­ing a house at Mira Road – on the city’s out­skirts – at the last minute. The rea­son was two-fold: first, a gen­eral ap­pre­hen­sion of forth­com­ing re­trench­ments across cor­po­rate In­dia – if it hap­pened to Patil, he would find it im­pos­si­ble to re­pay his hous­ing loan. But more im­por­tantly, he knew he would lose noth­ing by de­lay­ing. “I don’t know if real es­tate prices will fall in the near fu­ture, but they sure won’t rise any time soon,” he says.

It is a sen­ti­ment widely held in the res­i­den­tial real es­tate mar­ket. “Be­tween 2009 and 2013, real es­tate prices were es­ca­lat­ing every month and the developer was king,” says Sharad Mit­tal, Di­rec­tor and Head, Moti­lal Oswal Real Es­tate Fund. “Prop­erty prices be­came un­af­ford­able for most peo­ple. Prices re­main the same to­day, and it is my sense that in mi­cro mar­kets like Lower Parel in Mum­bai, they will stay the same for the next three to four years. This has led to se­ri­ous trust deficit and af­ford­abil­ity is­sues for the in­dus­try.”

Most im­por­tant is the prob­lem of cash flow. “The slow pace of sales over the last 24 months is caus­ing cash flow mis­matches for devel­op­ers,” says Vikas Chi­makurthy, Se­nior Ex­ec­u­tive Di­rec­tor, Ko­tak Re­alty Fund. Caught in a pin­cer are pri­vate eq­uity ( PE) play­ers who have in­vested in res­i­den­tial real es­tate. With in­ven­to­ries re­main­ing piled up, they are forced to stay in­vested – ex­its, with de­cent re­turns, are ex­tremely dif­fi­cult. Chi­makurthy be­lieves that more than half the es­ti­mated $3 bil­lion PE debt in­vest­ment in res­i­den­tial real es­tate is un­able to get re­fi­nanced. “These non-re­fi­nanced devel­op­ers have to ei­ther bring in more eq­uity and re­duce some por­tion of their debt, or re­duce prices of prop­er­ties to in­crease the pace of sales to ser­vice ex­ist­ing debt obli­ga­tions,” he adds.

Not sur­pris­ingly, PE in­vest­ment in res­i­den­tial real es­tate was marginally lower in 2016 com­pared to the pre­vi­ous year – $2.8 bil­lion against $3 bil­lion, ac­cord­ing to mar­ket re­search firm, Ven­ture Intelligence. Even the cap­i­tal in­vested was more debt than eq­uity. To raise cash, devel­op­ers are re­sort­ing to all kinds of in­duce­ments, short of ac­tu­ally slash­ing prices. Omkar Real­tors, for ex­am­ple, has taken the pre­vi­ously un­heard of step of giv­ing buy­ers pos­ses­sion of flats at its pre­mium project, ‘Omkar 1973’, in Worli, Mum­bai, on pay­ment of just 25 per cent, the rest payable in in­stal­ments over the next four years.


The only PE in­vestors in res­i­den­tial real es­tate who are not com­plain­ing are those fo­cused on the af­ford­able hous­ing seg­ment. “We have un­der­stood the In­dia story, which is all about the ur­ban­is­ing mid­dle class in the six or seven top cities where jobs are be­ing cre­ated,” says Sunil Ro­hokale, CEO, in­vest­ment and wealth man­age­ment com­pany ASK Group. “In­vest­ing in the rest of In­dia does not make sense for a PE player. De­spite the slow­down in the in­dus­try, there is still in­ter­est in the `50 lakh to `1 crore hous­ing seg­ment and that is the area we will con­tinue to in­vest in.” ASK is cur­rently rais­ing `2,000 crore – along with a `1,000 crore ‘green shoe’ (ad­di­tional shares) op­tion – from fam­ily of­fices, high net worth ( HNI) in­di­vid­u­als and global in­sti­tu­tions – its fourth pure eq­uity real es­tate fund.

Other in­dus­try experts agree. “One should stick to in­vest­ing in homes which cost be­tween `3,000 and `6,000 per sq. ft.,” says Mit­tal of Moti­lal Oswal. “For any­thing

higher, there isn’t much de­mand, while any­thing lower squeezes mar­gins.” Ajay Jain, Ex­ec­u­tive Di­rec­tor, In­vest­ment Bank­ing and Head, Real Es­tate Group at fi­nan­cial ser­vices firm Cen­trum Cap­i­tal, be­lieves the range is a lit­tle higher, `4,000-8,000 per sq ft. “It is the only lu­cra­tive space,” he says. “Only 18 months ago, even `8,000-15,000 per sq. ft. houses were in de­mand, but no more.” As it hap­pens, most PE in­vest­ment in res­i­den­tial real es­tate is in the pre­mium bracket – with in­evitable re­sults. “Most in­vest­ment has been in hous­ing for the high in­come group,” says Ra­jesh Kr­ish­nan, CEO and Man­ag­ing Di­rec­tor at hous­ing in­vest­ment firm, Brick­Ea­gle. “This cat­e­gory isn’t see­ing any sales. The PE play­ers are stuck.”

Ex­its are still tak­ing place, but not in the tra­di­tional man­ner – mostly, they con­sist of PE play­ers sell­ing out to non-bank­ing fi­nan­cial com­pa­nies ( NBFCs). In the last two years, NBFC ex­po­sure to the real es­tate sec­tor has more than dou­bled to `125,281 crore in March 2016 from `54,730 crore in March 2014.

For devel­op­ers, profit mar­gins are down from 20-25 per cent un­til 18 months ago to 15-20 per cent now. Fi­nanc­ing is not only more dif­fi­cult but also more ex­pen­sive. Their pri­or­ity is to com­plete on­go­ing projects as in­vestors are re­luc­tant to buy prop­erty that is un­der con­struc­tion. While in 2015, 65 per cent in­vest­ment in real es­tate went into the res­i­den­tial seg­ment, it is now only around 36 per cent. “Lenders are also un­will­ing to fund hous­ing projects out­side city limits un­less the developer has a strong track record and a high rep­u­ta­tion,” says Jain of Cen­trum.

Not only are devel­op­ers in­her­ently dis­in­clined to lower prices, but it is also now more dif­fi­cult for them, as in­put costs have in­creased. The im­ple­men­ta­tion of the uni­form Goods and Ser­vices Tax ( GST) later this year is likely to raise costs by an­other 5 per cent or so. “We’ve seen price cor­rec­tion in some mi­cro-mar­kets like the NCR, but in other places, es­pe­cially Mum­bai, there isn’t much scope to lower prices,” says Mit­tal of Moti­lal Oswal. “Be­tween 2009 and 2013, most devel­op­ers bought land at a high cost, and they can­not af­ford to sell their flats cheaper un­less they are pre­pared to make losses.” He says, “While price cor­rec­tion doesn’t seems to be hog­ging the lime­light, time cor­rec­tion will con­tinue.”


PE firms in the res­i­den­tial sec­tor have re­duced their ex­pec­ta­tions of re­turns to 12 to 18 per cent, com­pared to 20 to 22 per cent in 2014. Some are also handholding devel­op­ers, per­form­ing the dual roles of con­sul­tant and in­vestor. “We have brought down the ticket size of projects we par­tic­i­pate in and are in­vest­ing with devel­op­ers who have land


and ap­provals,” says Kr­ish­nan of Brick­Ea­gle. In any case, Brick­Ea­gle’s in­vest­ment in projects is in the range of 5-10 per cent of the cost and only at the pre-launch stage. It is also very clear about in­vest­ing only where the cost of homes is be­tween `10 and `30 lakh. This strat­egy is dif­fer­ent from what they be­gan when they used to buy land and ask devel­op­ers to de­velop. “The money used is for mar­ket­ing and ad­ver­tis­ing,” he adds. “While devel­op­ers’ mar­gins have come down to about 15-20 per cent, we are able to main­tain an in­ter­nal rate of re­turn of 20 per cent.”

There is money to be had in the mar­ket, but devel­op­ers have had to ad­just in nu­mer­ous ways to get hold of it. “There is no dearth of money but the rules of the game are chang­ing,” says Jain of Cen­trum. “Un­like be­fore, when 50 to 60 per cent cash in­come came from saleable prop­erty, to­day only 25 per cent comes from such prop­erty. The rest is debt raised from fi­nanciers or PE play­ers. This is be­cause con­sumers are in­ter­ested largely in com­pleted projects. PE play­ers are will­ing to put in 50-60 per cent project cost pro­vided the developer has a record of de­liv­er­ing on time.”

In­vestors have still not en­tirely writ­ten off res­i­den­tial real es­tate. “We still get en­quiries,” says Vi­nayak Bur­man, Man­ag­ing Part­ner, Ver­tices Part­ners, a Mum­bai-based law firm. “In­vestors are keen to take ad­van­tage of the cur­rent sit­u­a­tion when com­pa­nies and projects are reel­ing un­der stress so as to get bet­ter terms, but their approach is nat­u­rally cau­tious. There is lot of dry pow­der wait­ing to come into the sec­tor, but there is a lot of ap­pre­hen­sion. Eq­uity deals based on land own­er­ship have slowed down as buy­ing ca­pac­ity of land is low. Fu­ture re­ceiv­ables-based deals be­come sticky un­less there is a sud­den surge in de­mand due to price cor­rec­tion.”

While re­fi­nanc­ing and re­struc­tur­ing is hap­pen­ing, most experts ex­pect merg­ers and ac­qui­si­tions to catch up. “The mar­ket grapevine says PE funds want to ac­quire projects for 30 to 40 cents to a dol­lar,” says Bur­man. “While devel­op­ers aren’t bow­ing to their de­mands yet, they will have no choice if cash flow prob­lems re­main and banks start to crack the whip, more so with the bank­ruptcy code com­ing into ef­fect. Banks want a health­ier bal­ance sheet. This could well lead to a surge of trans­ac­tions in the sec­tor.” For the present, how­ever, the game plan of PE play­ers is sim­ply to ex­haust the in­ven­tory of devel­op­ers as soon as pos­si­ble, see to it that un­der­de­vel­oped projects are com­pleted fast and there­after make a quick exit.~


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