Avoid realty stocks despite sharp rise

Investing in indirect beneficiaries of govt policies such as HFCs may be more fruitful

Real estate stocks are seeing increasing investor interest after the Budget announcements on affordable housing. The Nifty Realty index gained the most in the past three months and one month, with returns of 30.21 per cent and 9.18 per cent, respectively. Infrastructure status means that those constructing projects in the segment would be able to raise loans at a cheaper rate, akin to other infra projects. A lower cost of funds could translate into lower cost for houses.

Stock market analysts, however, say that investors should stay away from the sector. "We feel that the industry is headed for a big crisis in the next 18-20 months. Sales are at their lowest in the past many years. Inventory levels are high. The prices are unaffordable for buyers. There's a slowdown in the industrial sector and employees in many industries are staring at job losses," say G Chokkalingam, founder and managing director at Equinomics Research & Advisory. He points out that inventory levels at present are 100-1,000 per cent of sales. If a company has Rs 500 crore revenue, the inventory could be worth Rs 2,500 crore. A slight correction in prices can drastically impact the profitability of such companies.

There are very few companies - for example, Oberoi Realty and Godrej Properties - that have a healthy balance sheet and can tide over the problems plaguing the industry, according to investment advisors. But if an investor feels that affordable housing would be a segment to benefit from, they should instead look at sectors that can directly or indirectly benefit from these developments, provided the valuations are appropriate, advises Arun Kejriwal, founder of KRIS Research. Housing finance companies, for example, would be beneficiaries as buyers would need loans to fund the purchases. Investors can also look at companies that have products in the housing interior and are leaders in their niches such as paint makers, tiles manufacturers, and so on.

The real estate sector flourishes when there's wealth creation in the economy. Gains made in the proprietary business and stock markets are invested in property. None of these is happening right now. While the government has made affordable housing a priority, it has also brought in regulations that discourage investment in real estate. An individual could claim unlimited tax deduction on the interest component of a home loan for a property that was not self-occupied. This is now capped at Rs 1.5 lakh a year.

"There have always been concerns over transparency in the sector, and they still remain," says Shankar Raman, chief investment officer, third party products, Centrum Wealth Management. When there was demand for housing, many realtors launched multiple projects without having the cash flows to complete them. They would collect the booking amount in one project and use it to fund the other. Cash flow mismanagement issues have started cropping up as sales of flats have seen a continuous slowdown for the past four-five years.

Residential is one part of the property market. There is also lack of demand in commercial real estate except in few restricted pockets. Sales are down in the commercial segment as businesses are yet to see any meaningful growth and also because investors who buy commercial properties are staying away as rents have also been falling.