Economy & Strategy Urban Residential Real Estate - No signs of pick-up yet In our July 2015 note, we said that a combination of supply-side and demand-side factors have led to a broad-based real estate pullback with prices correcting alongside sharp drops in transactions and new launch volumes. Since then press articles seem to suggest that the situation could have, in fact, improved over the past few months. Our primary checks across the top 3 cities however suggest that whilst the commercial real estate market has seen a pick-up in demand, the residential real estate market continues to be in an appalling state. Unless meaningful reforms are announced and implemented in the Budget and the Budget session (eg. passage of the Real Estate Bill, increased tax deductions on housing loans and granting an industry status), more pain will be evident in the sector with the BFSI sector being an obvious casualty. Further, with real estate accounting for nearly half of India s capital formation, a slowdown in the real estate sector does not bode well for GDP growth either. Quick Insight Analysis Meeting Note News Impact Introduction In our 14 th July 2015 thematic, Real Estate: The unwind and its side effects, we said that India is currently seeing a broad-based real estate pullback, with prices correcting alongside a sharp drop in transaction and new launch volumes. We further said that a combination of the following supply-side and demand-side factors has triggered this slide: Supply side: (a) According to RBI data, the banking system seems to have turned the tap off for property developers over the past year. This has, in turn, made developers either stop construction activity or cut prices. (b) The NDA has cut subsidies sharply (down 9% in FY16) and is shifting subsidies to Direct Benefit Transfer. As a result, the ability of the politician-and-builder to pilfer subsidies to fund real estate construction has been checked. (c) The knowledge that there is many years worth of unsold real estate inventory in most of India s tier-1 and tier-2 cities is causing investors to hold back further purchases. Demand side: (a) The Draconian Black Money Bill that went live on 1 st July 2015 has made HNW families reluctant to invest in Real Estate. (b) The 8% point gap between gross rental yield and the bank s base rate highlights the unattractiveness of real estate for investors. (c) Key state governments (Maharashtra, West Bengal, Delhi) have hiked ready reckoner rates sharply last year and thus prevented prices from dropping to a market clearing level. The press seem to suggest the real estate market has bottomed out Since the publication of our July note, several media articles have suggested that the situation has, in fact, improved over the past few months. For example, the following article suggests that the residential real estate market seems to have bottomed out in 2015 (http://goo.gl/szvqod). Another article suggests that residential real estate had shown considerable improvement in sales in the October to December 2015 quarter (http://goo.gl/5ogmaq). When it comes to commercial real estate the press coverage is only a little short of euphoric - the following research by CBRE suggests that over 38mn sq. ft. of prime office space was absorbed in 2015 - the highest annual absorption until date (http://goo.gl/aoaxma). Analysts Saurabh Mukherjea, CFA saurabhmukherjea@ambitcapital.com Tel: +91 22 3043 3174 Karan Khanna, CFA karankhanna@ambitcapital.com Tel: +91 22 3043 3251 Sumit Shekhar sumitshekhar@ambitcapital.com Tel: +91 22 3043 3229
Our checks, however, point to a mixed picture To understand the situation, we analysed the top three residential real estate markets in India: Mumbai Metropolitan Region (MMR), National Capital Region (NCR) and Bengaluru. More specifically, we contacted several real estate brokers and the management teams of listed real estate companies across these three regions. We also visited several property registration offices to understand the magnitude of the slowdown and to see if there are any visible signs of a meaningful pick-up in demand for residential real estate. Our discussion with these real estate brokers and the staff manning the property registration offices that we visited is summarized below: Overall feedback from our primary checks We spoke to ~25-30 real estate brokers spread across various parts of these three regions. In addition to this, we also spoke to the management teams of several listed real estate developers based in these regions. Feedback from our discussions with these brokers and corporates suggests: -The NCR seems to have been the worst affected by the slowdown with very little signs of recovery in the near-term followed by MMR; -Bengaluru, however, seems to have been the least impacted given that the Bengaluru market is essentially an end-user driven market (rather than a speculator driven market); -Almost all the recent property exhibitions (such as the CIDCO Property Exhibition in Vashi and the MCHI Property Exhibition in Thane in mid-jan 2016 to name a few) in the MMR have received a lacklustre response; -Given the financial crunch affecting most of the developers, across these three regions people have now started to prefer ready possession flats or projects that are at least 70%-80% complete over under-construction units; -Whilst new launches have gone down, the share of budget housing properties (with ticket sizes from Rs25-Rs50 lakh) in the overall new launches has gone up; -The investor community has withdrawn from investing in the residential real estate market and there are only genuine end-users in the market (but these are also limited); and -There is an increasing shift towards buying properties developed by credible developers with strong execution capabilities and robust track records. A visit to property registration offices across the MMR We also visited 5 property registration offices across the MMR during peak office hours only to find them wearing a deserted look (see exhibits 1 and 2 below).
Exhibit 1: Prabhadevi property registration office on 15 th February 2016 Source: Ambit Capital research Exhibit 2: The property registration office in Fort on the same day Source: Ambit Capital research Further, our discussion with the registration officers manning these offices suggested that there has been ~10%-25% decline [on a YoY basis] in footfalls across these offices. Furthermore, they also mentioned that whilst the number of people coming in for rental agreements has remained the same over the past year, the number of people coming to buy/sell property has sharply dropped over the past few months and so has the launch of new residential properties. For example, one of the registration officers mentioned that registrations for Agreement for Sale are down ~50% on a YoY basis this year. A discussion with another officer in the suburb of Thane led to the suggestion that in the month of January 2016, there has been a ~90% YoY decline in registrations for Agreement for Sale. Further, yet another officer that we spoke to mentioned that his discussion with real estate developers suggests 2016 is a complete write-off so far as demand for residential real estate in the MMR is concerned.
Sale of residential units across these three regions has witnessed a decline, as have new launches The overall sales of residential units too have been relatively sluggish across the three regions in 2015 (see exhibit 3 below). Further, given the overall sluggish demand environment, new launches of residential units have significantly gone down across the three regions in 2015 (see exhibit 4 below). Exhibit 3: Overall sales of residential units have continued to remain sluggish in 2015 Exhibit 4: resulting in a significant drop in new launches 2014 2015 70,000 65,000 60,000 55,000 50,000 45,000 2014 2015 90,000 80,000 70,000 60,000 50,000 40,000 40,000 MMR NCR Bengaluru 30,000 MMR NCR Bengaluru Source: Knight Frank research, Ambit Capital research Source: Knight Frank research, Ambit Capital research Unsold inventory, albeit arrested, is still relatively high Given the significant drop in new launches, in turn resulting from an overall sluggish demand environment, the unsold inventory of residential units seems to have been arrested. That said, the unsold inventory in Mumbai Metropolitan Region (MMR) and National Capital Region (NCR) is still relatively high (see exhibit 5 below). Further, assuming the current sales momentum, it would take as much as ~4.3 years to clear the existing inventory in the NCR and ~3.5 years to clear the existing inventory in MMR. Our discussion with real estate brokers suggests that in a healthy real estate market, the time taken to clear inventories should not be more than 8-10 quarters. Exhibit 5: The unsold inventory of residential units continues to remain high in MMR and NCR Source: PropEquity data as of Nov '15 (as published in the 25th January 2016 edition of Financial Express), Ambit Capital research
Price trends across these cities too have witnessed a time correction According to data as per Magicbricks.com (see exhibit 6 below), given the huge inventory pile up, NCR has witnessed the maximum correction in residential prices (until Sep '15). Even the MMR has witnessed price correction (albeit at a lower magnitude) given the relatively high levels of unsold inventory. In the case of Bengaluru however, residential prices have actually increased over the last two years. On an inflation-adjusted basis however, prices have actually gone down across most of these regions. Exhibit 6: Price trends across major Indian cities as per Magicbricks.com (as of Sep '15 over Sep '13) Source: Magicbricks.com, Ambit Capital research Further, according to data as per another property website (PropTiger.com, see exhibits 7 and 8 below), even the average base selling price (BSP) for new launches in the NCR has declined the most in 2015 (between 1%-11%). In the MMR, the average BSP has increased by ~2% in 2015 whilst in Bengaluru, this has increased by ~4.4%. Exhibit 7: Average BSP across major Indian cities as per PropTiger.com (cities with BSP > Rs 5,000 per sq ft) Exhibit 8: Average BSP across major Indian cities as per PropTiger.com (cities with BSP < Rs 5,000 per sq ft) Average BSP (Rs/sq. ft) 10,000 9,000 8,000 7,000 6,000 5,000 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 5,750 5,700 5,650 5,600 5,550 5,500 5,450 Average BSP (Rs/sq. ft) Average BSP (Rs/sq. ft) 5,000 4,500 4,000 3,500 3,000 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 3,480 3,460 3,440 3,420 3,400 3,380 3,360 3,340 3,320 Average BSP (Rs/sq. ft) Mumbai (LHS) Gurgaon (RHS) Delhi (LHS) Noida (LHS) Ghaziabad (RHS) Bengaluru (LHS) Source: PropTiger.com, Ambit Capital research Source: PropTiger.com, Ambit Capital research
The index that tracks the developers and financial institutions sentiments too has been trending downward Finally, Knight Frank's Real Estate Sentiment index that tracks the sentiments of developers and financial institutions too has been trending downward since the last one year (until Sep '15, see exhibit 9 below). Further, according to the report, these supply-side stakeholders are particularly pessimistic about the residential sector and they do not foresee any significant recovery in the next six months. Exhibit 9: Knight Frank's Real Estate Sentiment Index: Trending downward over past one year Source: Knight Frank research, Ambit Capital research Commercial real estate however, has seen a pick-up in demand As noted earlier, the residential real estate market continues to be in an appalling state. That said commercial real estate has been showing some signs of a pick-up in demand. According to a research report by CBRE (http://goo.gl/zvggfi), over 38mn sq. ft. of prime office space (implying 18% growth on a YoY basis) was absorbed in 2015 the highest ever annual absorption to date. Further, as noted in our 22 nd January 2016 thematic, The rise of the three speed economy, even as the broader economy reels under the pressure of a balance sheet recession, about one-thirds of the economy is protected from these forces. The demand for office space in particular has remained fairly robust in the recent past, thanks to increased demand from traditional IT/ITeS and new e-commerce companies. Investment implications On the basis of feedback from real estate brokers, company meetings and our visits to the property registration offices, we continue to believe that the real estate market is still under significant stress. Whilst the commercial real estate market has shown some signs of recovery, the residential real estate market is showing very limited signs of any meaningful pick-up in demand in the near term. Macroeconomic implications: The real estate sector has, by far, been the biggest source of capital formation (i.e. investment) in India (with nearly half of India s capital formation coming from this sector over the past decade). As a result, the throttling of prices, volumes and new launches does not bode well for GDP growth in the foreseeable future. Consequently, we reiterate our GDP growth forecast of 6.8% for FY16 and FY17 (which is well below the consensus expectation of 7.4% and 7.8% respectively for the corresponding years).
Exhibit 10: We expect investment growth to be lower in FY16 and FY17 Exhibit 11: resulting in a lower GDP growth rate Growth rate in GFCF (YoY change, in %) 6.0% 5.0% 4.0% 3.0% 2.0% 4.9% FY13 3.4% FY14 4.9% FY15 2.3% FY16 (E) 3.7% FY17 (E) GDP growth (YoY change, in %) 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 5.6% FY13 6.6% FY14 7.2% FY15 6.8% 6.8% FY16 (E) FY17 (E) Source: CEIC, Ambit Capital research Source: CEIC, Ambit Capital research Banking and Financial Services sector: A slowdown in the real estate sector does not bode well for the BFSI sector either on three distinct parameters: a) Direct exposure: The overall banks combined direct exposure to home loans/developers/housing finance companies amounts to ~US$147bn, which is ~16% of their total loan book (see exhibit 12 below). Note: this figure does not include working capital loans given to SMEs with real estate as collateral. Separately, housing finance companies (HFCs) have a total exposure of ~US$76bn to the real estate sector, out of which ~US$62bn is towards home loans; ~US$6bn is towards LAP and the remaining ~US$8bn is towards developer loans. Exhibit 12: Exposure of lenders to home loans, LAP, developer loans and HFCs Particulars US$ bn* As a % of non-food credit Exposure of banks to real estate ~147 16% Housing loans ~105 11% Developer loans ~25 3% Loans to HFCs ~16 2% Exposure of HFCs to real estate ~76 Housing Loans ~62 82% LAP ~6 8% Developer Loans ~8 10% Source: Company, RBI, Ambit Capital research. Note: *Assuming an exchange rate of Rs 68/USD b) Loan book growth: Further, over the last decade, the combined real estate portfolios of banks and NBFCs have increased at a CAGR of ~20%. A breakup of this growth between value and volume shows that two-thirds of this growth has been driven by increased ticket sizes (due to the continued increase in ticket sizes), and volume growth for the sector has been relatively modest at ~8%-9% CAGR over the last 10 years. Hence, loan growth of HFCs/banks would be an obvious casualty if real estate prices correct (see the exhibit below to get a sense of Indian banks exposure to real estate).
Exhibit 13: Banks have real estate exposure at 7%-37% of their total advances* Real estate exposure as % of advances Bank FY13 FY14 FY15 HDFC Bank 13% 12% 13% ICICI 33% 34% 37% Axis 31% 35% 34% IIB 9% 15% 19% KMB 25% 24% 22% SBI 17% 16% 17% Bank of Baroda 9% 11% 11% Bank of India 9% 10% 12% Union Bank 12% 15% 15% Punjab National Bank 17% 18% 17% Federal Bank 18% 18% 21% SIB 5% 6% 7% KVB 8% 10% 11% City Union Bank 10% 11% 12% DCB Bank 17% 17% 18% Source: Annual reports of Banks, Ambit Capital research. Note: * In this table we have used banks real estate exposure in the numerator and the total loan book in the denominator. However, this ignores the fact that the banks might have further off-balance-sheet real estate exposure. c) Asset quality: Finally rising real estate prices, we believe, helped the asset quality trends in the segment to some extent, as borrowers were able to refinance the loan (thanks to the extra value created by higher prices). Hence, asset quality could be another casualty of a real estate correction, given that asset quality in all kinds of real estate loans has been pristine over the last 4-5 years. Whilst we don t have data on Indian banks asset quality experience in home loans when real estate prices declined in India between 1998 and 2003, global experience indicates that a sharp slowdown in real estate prices almost always leads to spikes in the non-performing loans of the lenders. As seen in the exhibit below, 2-3 years into the slowdown, NPAs have a tendency to more than double from their pre-stress levels, as delinquencies rise in loans linked to real estate prices, such as developer loans, loan against property and home loans. Exhibit 14: Global experience of NPL impact from a fall in real estate prices Country Period of crash Real estate price correction NPA movements USA 2006-09 ~30-40% From ~2% in 2006 to ~5% in 2009 Japan 1991-99 ~70-90% From ~3% in 1992 to ~5% in 1995 SE Asia 1997-2000 ~50-90% Source: Ambit Capital research NPL ratios had doubled and even trebled for certain countries in the region over 1997-2000.