Should you rush to ride realty rally as RERA comes into force today?

Realty shares such as Indiabulls Housing and DLF have gained anywhere between 30% and 90% this year

The beaten-down shares from the real estate sector are on fire these days, with the BSE Realty index soaring 52% year-to-date, compared with just 12% rise in the BSE Sensex during the same period. 

This is amid multiple developments on the reform front - from the implementation of Real Estate (Regulation and Development) Act, 2016 (RERA), to amendments in Real Estate Investment Trust (REIT) regulations, which are seen as a long-term positive.  

The government's renewed focus on affordable housing and hopes that the reforms taken so far will instill confidence among the home buyers, along with the ongoing re-monetisation process, outlook for the sector looks better today.  

That said, near-term hurdles and a spike in stock prices have made brokerages turn cautious on the sector. Realty shares such as Indiabulls Housing, Dilip Buildcon, Godrej Properties and DLF have gained anywhere between 30% and 90% this year, even as there could be operational uncertainty post RERA, which came into force today.

"We choose to remain cautious in the near-term, rather than chasing stock prices, owing to multiple headwinds like notable increases in customer litigations post RERA, a reduction in liquidity, a weakening of buyers’ sentiment, developers’ efforts to complete under-construction projects will lead to erosion of margins and no meaningful recovery in pre-sales," said brokerage HDFC Securities in a research report. 

The brokerage although downgraded the real estate sector's coverage to 'neutral', but noted that over the long term, RERA will drive transparency, reduce cost of capital, improve liquidity and lead to significant re-rating in the sector. 

Rating agency India Ratings and Research (Ind-Ra) has maintained a negative outlook on the sector for FY18 based on the expectation of continued slump in the sale of residential units and rising debt.  

"Finances of real estate developers continue to remain stretched due to elevated inventory and debt. We estimate that debt levels will further rise given the negative operating cash flows," said Ind-Ra in a report. 

The debt-to-equity ratio of most realty companies is ruling above 1. For Sadbhav Engineering, it is as much as 4.49, while 2.07 and 1.77 for Phoenix Mills and Dilip Buildcon, respectively. 

RERA in detail

RERA is expected to bring in transparency in the sector bridging the trust deficit between buyers and developers. Under the RERA norms, the developers would need to keep 70% of collection from project in escrow account for better execution and timely completion. In case of breaching the deadline and going against the regulation, the developers will get penalised by respective state regulators. Maharashtra has already detailed final regulations and has established an authority, with more states soon fowlling suit. 

"Although first impression of RERA was that it is more end-buyer friendly, but it is blessing in disguise for the organised and clean developer in the space. RERA required enrolment of the developers, agents, projects, submission and disclosure of all project related documents like approved design, land acquisition document and even project status on the regular basis will automatically create the brand equity for the developers and will also help them to raise funds at lower rates," said Abhishek Lodhiya, senior equity research analyst - infrastructure, capital goods and real estate at Angel Broking.