58 65 cover story EPC Age Magazine in 2008

58

AUGUST 08

C O V E R S T O R Y

HHeeaattiiss oonn!!

TThhee

cover story_Real Estate_Aug-08.qxp 8/11/2008 10:13 PM Page 2

The growing whispers of a slowdownin the realty market in the country areincreasingly becoming louder. And,now, with the banks tightening theircash belts, the real estate market seemsheaded for a slump. Shashidhar V &Remona Divekar find out.

With the inflation rate breaking the 12percent barrier, Indian economy isstaring at a phase that could spelldisaster. All sectors of the Indianeconomy are facing tough times, the

real estate sector being one of them. Real estateplayers are, currently, grappling with dwindling sales,correction in land prices, tepid demand, and a risinginput cost, even as they face a liquidity squeeze.Tomake matters worse, banks have tightened theirpositions and hiked the interest rates on home loansfurther hitting the property and real estate market.The Reserve Bank of India’s (RBI) decision to raiseRepo Rate and cash reserve ratio is expected toonly add to the woes of the real estate sector.

Harsh situations do, at times, call for harshmeasures. But, this sustained series of Repo Ratehikes by the RBI has definitely pushed up the cost offunding a home by a substantial percentage.The realestate companies, developers, both big and small, arein dire need for credit and other sources of capitalto complete projects at hand and also to sustaintheir expansion plans.These are visible signs that theglobal liquidity crunch has started to impact realestate companies in India making it difficult for bothsmall and large realty companies to organisefinancing.

Currently, the lending rate of banks is between 18and 20 percent.The top notch real estatedevelopers, like DLF, MGF-Emaar, ShobhaDevelopers, Unitech, Omaxe, Parsvnath Developers,Hiranandani Group, Ansal API, BPTP Developers andTDI Group are facing severe cash crunch, as

reported in The Economic Times. In fact, the situationis so bad that most of them have reported a 50-70percent cash shortfall.

Says Pranay Vakil, chairman, Knight Frank (India)Pvt Ltd., one of the leading realty consultants in thecountry, “You have to be clear about the finance bit.Banks have not stopped financing projects per se.What they have done is stopped providing easyfinance for the purchase of land for housing projects.The cost of land is currently inflated and not realistic.And, that forms the major cost of the project. So,those developers who are amidst a project arecaught between the devil on the one side and thedeep sea on the other. On the one hand, developerwho have sold some properties at a particular rate,cannot now reduce it to sell off the rest of theproperties, while on the other hand, there is nodemand for the rest of the properties at the currentrate. And, that’s why you feel that the real estatemarket is facing a tough time.”

Some industry experts aver the liquidity crunch isartificial, to force developers to pick up cash fromthe unorganised market at interest rates as high as35 percent to 50 percent annually. Says Ajoy Kapoor,managing director, Saffron Asset Advisors, “Theproperty markets in India have been witnessing adownturn in the last six to seven months. Not acrossthe board but, in several micro markets, propertyprices have been going down by 15-30 percent.Weexpect this downturn to last at least for the next 18-24 months. Having said that, I would add that there isstill demand for property that is correctly priced, inboth residential and commercial segments.”

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“Not releasing funds to the developers may bespecific to an individual company. But, I would like tomention that banks have stopped financing forpurchase of land but construction finance is stillavailable,” notes R S Ajmera, MD, Ajmera Realty &Infra India Ltd., and President, CREDAI. Explainingfurther, he says, “Financial institutions usually keepsubstantial security margin before lending to anyproject. India has robust financial infrastructure likeany developed economy and many alternate meansare available today to raise project finance, like PEFunds, Mezzanine Finance, Realty funds, etc.” AddsAnshuman Magazine, chairman and managingdirector, CB Richard Ellis, South Asia, “The property

market is slowing down and it’s happening all acrossthe country. From the developer’s point of view, theyhave stock of flats as their source of income, buteven that is witnessing stagnation.The debt market,on which most of the developers were surviving, isalso stagnating. However, this phase will last for a fewmonths only.”

Agrees Ajmera, who says that this is a short-term

phenomenon. “The creditprofiles of the companies arenot affected by the currentsituation as credit profiles areusually individual matters,” hesays.

Correction in pricesAccording to a recent Fitchreport, large developmentplans and aggressive landpurchases have led to aconsiderable increase in thefinancial leverage(debt/EBITDA) of mostdevelopers, with the smallerplayers now being exposed to

liquidity pressures for project execution as well as ageneral slowdown in property sales. Says KishoreGotety, country head of RREEF India Advisors PrivateLtd., “No business would be able to grow throughaggressive leverage if underlying earnings do notsupport such borrowing.Thus, financial disciplinewould be important here.”

Some companies are able to access capital, albeitat very high cost, which, in the long run, may not bea sustainable solution, especially given the size of themarket and consequent need for large chunks ofcapital.The rising inflation and interest rates is leadingto a slackening in property demand; 1-1.5 percentincrease in interest rates could further impact the

real estate sector. Aslowdown in newproject launchescould also delayrefinancing, as debt istaken as project debt.India’s monetarypolicy, together withslowing demand andgrowing liquidityconcerns possibly hasa negative impact onthe credit profiles ofreal estatecompanies, notesFitch.

Says Anuj Puri, chairman and country head, JonesLang Lasalle Meghraj, “The market is currently in astate of extreme flux because of a liquidity crunchand muted sentiments. A correction, if any, will takefour to six months to happen, depending on themarket trends in a particular location and theholding capacity of the developers there. Certainover-heated micro markets in Gurgaon, Noida, Pune,

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“The market is,currently, in a state ofextreme flux because ofa liquidity crunch andmuted sentiments.”

Anuj Puri, chairman and country head, Jones Lang Lasalle Meghraj


Bangalore and other places will,in all probability, see a 5-15percent price decline. Anapproximate correction of upto 10 percent is also expectedin places like South Mumbai,some locations in Mumbai’ssuburbs and certain areas ofNew Delhi that have seenunrealistic price trends.”

Adds Vakil, “The realtymarket in India changedforever on January 20th. And,as developers would hope, themarket will see a correction inthe next couple of months, ifinflation level comes down.Theissue to be noted is that the market is over-pricedcurrently.There is minimal demand while there isenough supply. So, who’s going to blink first – will itbe the consumers, keeping the festive season, goahead and invest in the project at the prevailing rate,or will the developers be forced to bring down therates to reflect the real price?”

Very generally, there will be a period ofstagnation, followed by a fall of prices in certainsectors and locations.The market will thenconsolidate itself and rates will once again rise intandem with increased demand brought on by arevitalised economy, renewed purchasing power andalso, market drivers, etc. “The slackening in demand,coupled with liquiditycrunch, could lead toconsolidation in therealty sector assmaller players willfind it difficult tosurvive.The currenttrend of drop indemand wouldcontinue for another18-24 months asthere is no sign ofinflation coolingdown and highchance of interestrates becoming harder,” notes Puri.

The government is walking a tightrope in trying toarrest inflation as well as deal with the liquiditycrunch. Notes Magazine, “The priority of thegovernment should be to control inflation along withhigh interest rates on home loans. So, hopefully, withthe decrease in residential prices and lowering ofinterest rates, I hope we will have enough of demandalong with the supply.”

Realty RisksA slowdown in new project launches could alsodelay refinancing, as debt is taken as project debt.The risks would be higher for real estate companieswith a limited track record and limited cushion fordebt financing.While banks have taken a restrainedapproach to funding real estate developers, Fitchexpects some of the more established developers tocontinue to enjoy access to the loan market. Fitchalso notes that only large players with an attractiveportfolio of ongoing development and an establishedtrack record are in a position to attract capitalthrough the private equity route.The sharp rise inconstruction costs, driven by steel and cement costs,

could impact margins and, hence, liquidity.Vakil, though, feels that the main reason for the

high cost is due to the rise in the cost of land, onaccount of the high demand, and not due to the risein the prices of cement of steel. “The rise in theprices of steel or cement is only marginal whencompared to the cost of the land at which it hasbeen acquired. For example, the cost of land in a

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“The issue is that themarket is over-priced

currently. There isminimal demand while

there is enough supply.”Pranay Vakil, Chairman,

Knight Frank (India) Pvt. Ltd.


Tier-II city like Jaipur has gone up nearly 300 percentin the past two years. Compared to that, the rise incost of cement or steel is only marginal.”

Many in the industry feelthat, notwithstanding the finalverdict on the extent of globaleconomic slowdown andrecovery of financial institutions,real estate players in India maycontinue to face liquidityproblems in the near future aswell due to global credit crunchand unfavourable stock marketconditions for raising capital.Slowing demand and productoff-take in the residential sectorthat is still the largestcomponent of the Indian realestate sector will put pressureon developers, especially onsmaller developers. SaysKapoor, “On the commercialand retail properties fronts,price points may not hold up asexpected and may result in pain for the developers.”Some, like Sushil Mohta, managing director, MerlinGroup, are hopeful that the situation will stabilise in

the coming months.“We believe this is atemporaryphenomenon, I thinkby this year-end, thesituation will stabilise,”he says.

Testing Times“These are testingtimes for anyeconomy and, at thesame time, occasionsthat serve to set

apart the more focussed professional organisationsfrom the ones that probably are still trying to getthere. Any professional organisation is quite

circumspect and careful whilepredicting the future scenariosand the market conditions,”states, Anand Sundaram, COOOperations, Market CityManagement Pvt. Ltd.

Fitch Ratings also notes thatthe slowdown in the sectorand the growing liquidityconcerns have forced some ofthe developers to back out ofland deals, which had beenagreed upon.The sharpincrease in construction costs –driven by increased steel andcement costs – could alsoimpact margins – and, hence,liquidity.The rise in the cost ofraw materials, such as cementand steel that constitute asignificant portion of a project’s

construction cost, combined with the fall in the end-product pricing will squeeze developers’ margins.“This, in turn will impact liquidity adversely, and

combined withrestrained lending bybanks, is likely toresult in delayedproject take-offs,”adds Kapoor.

Propertydevelopers hit byfalling sales andliquidity issues wouldneed to reduce listprices to enhancedemand. But, manystill seem to be

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“On the property front,price points may not

hold up as expected andmay result in pain for

the developers.”Ajoy Kapoor, MD,

Saffron Asset Advisors

“The priority of thegovernment should be

to control inflationalong with high interestrates on home loans.”

Anshuman Magazine, Chairman and MD, CB Richard Ellis, South Asia


holding on to theasking price. Saleshave gone a littleslow but the scenariois not the sameeverywhere.Thenegative impact willbe only in thoseareas where thesupply is very highcompared to thedemand, say industryobservers. Kolkata,for instance, has notseen such high supply. “The prices will not comedown because construction costs have gone up and,in last year alone, it has gone up by 20 percent,”argues Mohta.

Volumes are expected tofurther decline if thedevelopers persist in holdingon to their current prices –and buyers anticipate a furtherfall with current rates beingbeyond reach, with affordabilityhaving significantly declinedwith rising interest rates.Though the sector has alreadyfactored some of the newsimpact, there is scope forfurther correction. However, asquoted in Realty Times, manydevelopers are holding ontoprices and even operating as acartel in some prime pocketslike Mumbai.Therefore, sayindustry observers, postponingpurchase decisions may notreally be a solution. Despite the fact that volumeshave fallen sharply, established developers are clearlyunwilling to drop prices.

The tightening bias of India’s monetary policy,together with slowing demand and growing liquidityconcerns could have a negative impact on the credit

profiles of real estatecompanies.The slowdown willalso aid the process of weedingout some of the weaker entitieswithin the sector, and increasingthe relative strength of some ofthe larger, more establisheddevelopers.

PE Please!While the primary market forreal estate has virtually driedup, private equity players arealso following a very cautiousapproach. Only thosedevelopers who have internalcash flows and have not gonefor recent land acquisitions willbe able to sustain these toughtimes. Earlier, they were seekingmortgage against property but,

now, credit requirement has forced them to pledgetheir own shares for securing mortgage, industryofficials say. Bankers say they may now get more

cautious towardslending to real estatedevelopers. Also,banks need tomaintain their reachamong their clients.However, it ispossible that allbanks may sanctionloans to only thosedevelopers withwhom they have hada long and profitablerelationship.

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“We believe this is atemporary phenomenon,I think by this year-end,

the situation willstabilise.”

Sushil Mohta, MD, Merlin Group

“These occasions setapart the professionalones from those that

probably are still tryingto get there.”

Anand Sundaram, COO – Operations, MarketCity Management Pvt. Ltd.


Real estate companies have many projects athand and the sales have been constantly dwindling.The persistence of inflationary pressure in themarket will further affect the recovery in the realestate sector. However, larger, established and well-capitalised companies with access to banks/financialinstitutions would remain better positioned tomanage this risk slowing demand.

Says Gotety, “We would agree to the extent thatcompanies, who expanded their scale of operationsthrough aggressive land acquisitions, etc., by over-leveraging and generally accessing high cost capital,will see some strain on their cash flows.This is alsobecause some of their revenues (on account of

sales) would have been pushed further in thetimelines. However, companies who have operatedwith restrain, got into calculated, planned expansionprogramme and have a strong culture of financialdiscipline are still well-positioned in this market andshould be able to tide over the current low-liquidityphase effortlessly.”

He further stresses that banks are definitely more

selective now in lending to real estatecompanies than earlier. Also, owing tohigher provisioning and capitaladequacy norms, the cost of lending toreal estate has gone up. As a result,developers have had to consideralternative providers of capital, such asmezzanine and private equity investors.There will be a slowdown as themarket goes through a correctionphase.

Says Ajmera, “Credit is still availablefrom banks for construction, if theproject is viable. India has a robustfinancial infrastructure like anydeveloped economy and manyalternate means are available today to

raise project finance, such as PE Funds, MezzanineFinance, Realty Funds, etc.”

However, a prolonged slowdown could alsoreduce the appetite of private equity. According toFitch Ratings, the liquidity risks on account ofsignificant bullet repayments falling due during thecourse of 2008 remain a key challenge across theboard.With access to capital markets likely to remainlimited at the parent level by attracting private equityparticipation would remain a key for managingoverall funding and liquidity requirements. But Gotetyfeels that committing to purchase large land banks,without necessarily having a financing plan in placewill be the single biggest factor that will see

developers facingliquidity pressures.

Second, given thepresent slow down indemand, howevershort-term it may be,will cause cash flowmismatches incompanies who willhave committed onexpenses (forexpansions,construction,marketing, etc.) andwould not seematching revenues

flow in as expected.They will have to resort to someshort-term borrowings.

Says Puri, “Concerns about liquidity will continueto plague the market since debt will not be easilyavailable. Real estate players had traditionally raisedmoney from debt funds via corporate deposits andcommercial paper. However, debt funds are currentlynot eager for more exposure in real estate and are

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“Banks have stoppedfinancing for purchase

of land but constructionfinance is still

available.”R S AJMERA, MD, AJMERA REALTY & INFRA

INDIA LTD., AND PRESIDENT, CREDAI


continuously rolling over the debt advanced to theseplayers.The primary source for institutional fundingwill, therefore, now is private equity.”

The road aheadHealthy and sustained economic growth, a strongcurrency, favourable demographic profile and risingincomes certainly positions India amongst the world’smost attractive investment destinations in the realestate sector. However, it is companies who haveoperated with restrain, got into calculated, plannedexpansion programme and who have a strongculture of financial discipline are still well positionedin this market and should be able to tide over thecurrent low-liquidity phase effortlessly.

Having said that, though, the real estate sector, likeall other sectors of the economy, will be affected byinflation, higher interests rates, an uncertain globalmacro environment and consequently, reducingdemand in the medium- to long-term.The extentthat companies who expanded their scale ofoperations through aggressive land acquisitions, etc.,by over-leveraging and generally accessing high costcapital, will see some strain on their cash flows.Thisis also because some of their revenues, on accountof sales, would have been pushed further in the timelines.

Given India’s performance in the last few years,there are many investors who are still willing to fundreal estate development in the country.These couldtake the form of private equity placements, listing onexchanges, REITS and others. “This is especially truefor the more ‘professionally’ developed assets with asound understanding of the business continuum,”states Sundaram.

((WWIITTHH IINNPPUUTTSS FFRROOMM RRAAHHUULL KKAAMMAATT))


58 65 cover story EPC Age Magazine in 2008

Real Estate

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notch real estate developers

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