"Fitch Ratings says it has a negative outlook for the Indian real estate sector in 2012 due to weak overall demand and higher construction costs, which are likely to continue to squeeze margins," the agency said in its report '2012 Outlook: India Real Estate Sector'.
It said high equated monthly installments, resulting from significantly higher interest rates, besides lower household surplus due to high inflation and high residential unit prices, have reduced affordability for properties.
"Both material and labour costs increased during 2011. Residential segment sales, which had improved in Q1 of 2011, moderated significantly and are likely to continue at the lower levels during the first half of 2012," Fitch said.
The report said that oversupply of commercial space continues in some markets.
"However, the demand for office space is likely to be maintained at 2011 levels as the hiring momentum of the IT/ITeS sector, the major driver of office space in India, continues in 2012.
Demand for retail commercial space is expected to be low in 2012," Fitch said.
According to Fitch the debt-equity ratio of most real estate companies continued to increase in the second half of last year.
"On the other hand, declining profits resulted in leverage (debt to EBITDA) at high levels in 2011... And this is expected to continue in 2012, negatively impacting the creditworthiness of real estate companies," the report said.
Fitch added that the dependence of realty firms on operational cash flows to fund growth and service debt is likely to increase.
It said that fund raising options are limited due to the cautious approach of banks, weak equity markets and dwindling investment by private equity funds.
"Improved macro-economic conditions leading to improved demand would have the potential to improve cash flows to real estate companies and see the outlook revised to stable.
Also, the ability to judiciously use cash from liquidating existing inventories, which would improve capital structures, may result in the selective upgrades of companies in the real estate sector, even while the overall outlook is negative," Fitch said.