Ind-Ra: Debt Driven Inventory Pile-up a Risk for Real Estate Sector in FY17

The Real estate sector continues to build-up stock and is sitting on inventory of close to three years of revenue, largely supported by high cost funding as banks have turned off the tap, believes India Ratings and Research (Ind-Ra). Inventory in the sector has risen to 2.9 years in 1HFY16 compared to 2.6 years in FY15 and 2.2 years in FY12, which is a concern especially in the current scenario when sales are falling.

The implementation of Real Estate (Regulation and Development) Act, 2016 is likely to improve confidence of buyers in the sector, as it improves transparency, provides for various buyer-friendly measures and encourages timely completion of projects. However, the Act is unlikely to lead to a significant improvement in sales volume during FY17, as it does not impact the two key variables impacting sales - prices and economic growth.

Sale of residential units has been weak due to persistent high property prices, making units unaffordable to end-customers and leading to deferral of purchase decisions. Revival of property demand would depend on a meaningful reduction in prices or a drastic improvement in economic growth resulting in positive customer sentiments. This is unlikely until FYE17, as property prices will remain high due to the refinancing of sector companies' debt through higher-cost funding from non-banking finance companies/ private investors. Also, Ind-Ra expects GDP growth to improve only marginally to 7.9% in FY17 (FY16: 7.4%).

Ind-Ra revised its rating Outlook on the real estate sector to negative for FY17 from stable in our report Demand Not Expected to Improve for Real Estate Sector in FY17, on the back of rising debt and falling profits and cash flows. Growth in bank credit to the Real estate sector has slowed down to single digits in 2015 from the earlier double digits growth seen in 2014. Many companies are relying on higher-cost funding from non-banking finance companies and private investors to refinance bank loans, which only shifts the stress to the future.

The interest of investors in the sector remains high. However, investments are increasingly through debt or debt-like hybrid instruments and bulk apartment purchases, instead of equity investments. The use of debt/hybrid instruments is a concern, as it only shifts the funding gap to the redemption date with high funding costs.

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