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Real estate prices remain as an X factor

FILE PHOTO

FUNDING PROBLEMS: Work in progress at a construction site.

Equity and real estate markets were dangerous bubbles waiting to burst. Though many economists refused to comment on the real bottom levels of the current equity market, they believe the bubble in equity markets has been subdued. But the much bigger bubble, the real estate prices, continues to remain as an X factor in the economy. “Real estate is over-valued in India. The real estate prices need a correction. We are a growing economy and not a rich economy; people are not able to buy homes not only because of unavailability of credit or high interest rates but also because of high rates of housing and commercial properties,” says Vivek Kudva, President, Franklin Templeton Asset Management (India) Pvt. Ltd.

Last year, the Bombay Stock Exchange sensitive index had touched 21000 in January and it crashed nearly to half with the developments in the global economy. But markets didn’t move to a large extent after the Satyam scam announcement.

The recent fiscal as well as monetary stimulus packages announced by the Union Government and the Reserve Bank of India (RBI) gave thrust to the real estate sector. In a move to provide liquidity to the sector, the central bank reduced the risk weightage on commercial real estate to 100 per cent from 150 per cent, announced interest rate cuts, and the government allowed builders to raise foreign loans or external commercial borrowings (ECBs) to develop townships. In fact, the large chunk of measures announced by the Government and the RBI were aimed at helping the real estate sector. As the Reserve Bank of India Governor D. Subbarao puts it: “Although origins of the crisis are common around the world, the crisis has impacted different economies differently. ”

Fitch Ratings’ outlook for the Indian real estate sector in 2009 continues to remain negative. The sector has witnessed a significant slowdown in demand in the last 12 months to end-January 2009, both in the residential and commercial real estate segments.

The fundamentals of the industry have deteriorated due to the volatile external environment, weak economic and consumer sentiment, high interest rates, poor consumer affordability and rising construction costs. In addition, developers are reluctant to reduce prices and customers are opting to postpone their purchases.

Fitch believes these fundamentals could possibly improve marginally in the second half of 2009, as a result of a reduction in home loan interest rates, a reduction of the risk weights on commercial real estate, and government measures, all of which would provide some stimulus to the sector. However, improvements in affordability and stability in the economy remain the key for renewing end-user demand. The rating agency expects 2009 to be more challenging than 2008 for Indian real estate developers.

Companies in the real estate sector have leveraged substantially over the last two to three years to augment their land banks and increase the area under construction based on overly optimistic demand projections.

The expansion plans were largely funded by short-term to medium-term debt. As a result, developers face substantial debt redemptions in the short-term.

With significant debt maturities scheduled during the year, the availability of funding sources remains the key for all developers. With promoters’ equity holdings in most real estate companies at over 75 per cent, industry players have the ability to raise additional capital. However, looking at the current equity market environment, it appears highly unlikely that many developers will be willing to raise or successful in raising equity capital.

Bank loans, the key source of funding for developers, have become difficult to get due to banks’ reluctance to sanction fresh loans. Other investors like private equity (PE) funds are now demanding higher assured returns. Fitch also notes that developers are looking at other refinancing options such as receivable securitisation and lease rental discounting.

“Fiscal and monetary measures are unlikely to be of much help unless banks boost lending and real estate companies reduce prices, improving demand in the embattled sector,” stated the rating agency.

Given the adverse liquidity scenario, the ability of leveraged players to service their interest costs and fulfil their immediate term debt/land obligations remains a concern. However, the real estate bubble is unaffected at least for India as Indian authorities would be able to keep the bubble not to burst until the general elections are over.

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