Optimism over housing, realty looks overdone

Analysts say rising debt levels will reduce developers ability to tap any recovery in demand

The BSE Realty Index has gained about seven per cent on expectation of a positive impact of pay increases for government employees, DLF’s debt-cutting plan, hopes of lower interest rates, and recent relaxation in real estate investment trust (Reit) rules.

The plan by DLF, the largest listed realty entity in the country, to bring down its debt is a positive. The promoters plan to sell their share of preference shares in rental arm DLF Cyber City Developers to investors and infuse the proceeds into the company. Preference share entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends.

Qualified institutional placement would be undertaken to bring down the promoters’ stake, now 74.96 per cent. The proceeds will help the company reduce net debt, Rs 22,202 crore at end-March, mostly (over 80 per cent) attributable to the rental business.

The other trigger for the company is the extra realty space made available on Metro Rail routes in Gurgaon, on the back of the recent transit-oriented development policy. This will increase developable area for sale, benefiting DLF (among others) as the company has the highest land bank in the region. The reduction in debt and positive cash flow from the residential operations could lead to further re-rating, say analysts. Given these triggers, the stock rose about 13 per cent in three trading sessions.

Securities and Exchange Board of India’s plan for a consultation paper on changes to Reits is another positive for the sector. These include allowing them to invest up to 20 per cent in under-construction assets and allowing a holding company structure, which will help transfer of assets as compared to direct holding in a Special Purpose Vehicle.

The other impact is the salary (and allowance) increase for nearly 10 million government employees and pensioners, who get an average of 23.5 per cent more. While this puts extra money in their hands, analysts say smaller-size discretionary items (white goods, two-wheelers, home improvement) could see higher demand but it might not be such a major trigger for realty. Analysts at Spark Capital say the real estate market was a major beneficiary during the earlier pay commission cycle as they could use arrears (of about 30 months) for a down-payment to book a house. This time, the arrears would be less than a third of the earlier occasion, making it difficult to fund a property purchase.

The other reason is higher property prices. Analysts say these have gone up too much and too fast as compared to income levels. Either the former has to come down or salaries have to go up substantially, to make properties more affordable. However, any reduction in interest rates could rub off positively on demand.

There could be some recovery, especially in the affordable segment which is witnessing inventory reduction.

Also, liquidity for developers is improving, with non-bank financial companies raising their exposure to builders. Even so, analysts at JM Financial say rising debt levels will reduce developers’ ability to tap any recovery in demand.

Given the sluggish demand, analysts continue to put their faith in the listed space on companies with a strong balance sheet such as Oberoi Realty or those with a good record in implementation such as Godrej Properties. The other realty plays investors can look at are where demand is stronger, such as in Bengaluru with entities such as Prestige Estates and Brigade Enterprises.