Ind-Ra: Credit Metrics of Real Estate Cos Continue to Deteriorate on Weak Demand

India Ratings & Research (Ind-Ra) maintains a negative to stable outlook on the real estate sector for FY15 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 EBITDA margins and continued deterioration in credit metrics and cash flows.

Most Ind-Ra rated real estate companies have a Stable Outlook, as the risks impacting the sector have been factored in to 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.

Ind-Ra 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 sq.ft.) by listed real estate companies has seen a downward trend in 1HFY14. This is due to weak consumer sentiments and low real estate affordability due to high prices. However, bank credit to the sector saw strong double-digit yoy growth in 2013, which indicates build-up of inventories.

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

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 (REITs) 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 in to rent-yielding commercial properties, this could provide further liquidity options to commercial property developers.

What Can Change The Outlook

Demand Improvement: A rise in demand, leading to strong free cash flows and reduction in debt levels could change the sector outlook to stable.

Asset Monetisation: Sale of land and commercial property assets, leading to substantial reduction in debt levels could lead to an upgrade of individual ratings.

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