Developers to cut prices by 5-10%

Good news for property buyers! Mr. Rohtas Goel, President of National Real Estate Development Council (NAREDCO) and CMD of Omaxe, announced that real estate developers have decided to reduce the prices by 5-10% across the country. He said that this move will attract buyers who were just waiting for price reduction from developers into the market. Prices of apartments which cost over Rs. 1 crore will come down by 10% while those of affordable houses, in the range of Rs. 20 Lakhs to Rs. 40 Lakhs, will see a modest cut of 5%. They can not drop prices further because developers are already operating at a lower margin thanks to exorbitant land and commodity prices.

However, the big question to ask: Is it enough to attract buyers? hmmm..may be not. Property prices have zoomed to above 100-200% in the last 3 years and have become unaffordable to majority of middle class buyers. The rising interest rates have even more discouraged buyers from looking for properties. Even if interest rates come down from 14% to 11-12%, how many people will like to apply for new home loans or invest in properties in this gloomy world economy and uncertain environment? With private banks resisting to drop PLR and buyers not willing to look for loans, things may not be turn out to be the way developers want. This would be interesting to see how coming months unfolds for the industry.

FM asks for price cuts; industry ignores

Yesterday, Finance Minister Mr. P. Chidambaram requested industry leaders from automobiles, airlines and real estate to cut prices to boost demand. However, industry leaders have declined to do so or are not committal on the proposal. Mr. Rahul Bajaj, Cahirman Bajaj Auto, said that the two wheeler industry operates at a low margin of 4-5%; hence, it is not possible for them to reduce prices. Even car manufactures are not interested in reducing prices because the current inventories with them and dealers were manufactured at a time when commodity prices were high. They said that only interest rates cut could boost demand in the market.

Real estate firms too have same problems. The current inventories of cement and steel were purchased at a time when raw materials were quite expensive. Hence, they can not sell their properties at a steep discount. It might take few months for the construction costs to come down. Also, they are of the opinion that buyers would not be interested in properties unless interest rates come down to the level of 8-9% from the existing level of 13-14%. Higher interest rates have kept buyers away from the market.

What I believe is that a mix of rates cut and price reduction is the need of the hour. Even buyers with enough cash are not willing to buy houses because they believe prices are either too high or prices may come down soon! Both buyers and developers would be locked in a bridge game for a while!

Dip in realty index and real estate stocks since Jan 2008

Decline from 2008 highs (%)

Realty index -86.6843
DLF -81.6571
Indiabulls realestate -88.1458
Puravankara -90.148
Omaxe -90.9091
Ansal Prop -91.3448
Sobha developers -91.3793
Unitech -92.575
Parsvnath -93.495

Bangalore Property Values

Residential Property Values (Rs. Per sq. ft.)

Location	Oct 2008	Jan 2008	Oct 2005
South	5,000-9,000	4,500-7,000	2,900-5,200
South East	3,000-5,000	2,500-3,100	1,500-2,500
South West	3,000-4,500	2,800-4,000	1,200-2,500
East	2,800-3,900	2,500-2,800	1,200-1,800
North	2,700-3,800	2,500-3,000	1,200-1,800
North West	4,200-6,000	4,000-5,000	2,500-3,500
Central I	6,000-8,400	6,000-8,000	3,500-5,500
Central II	3,900-6,000	3,000-4,500	2,000-3,500

You can see that properties prices have increased by over 100%-150% in the last 3 years depending upon the location. The highest increase has been in South Bangalore due to excess demand by IT professionals residing in these areas. In the last few month land prices have started falling though the fall is not as high as it is for apartments. Developers may not openly admit it but once you are on the negotiating table they are willing to reduce prices. Table above reflects only the prices which developers are quoting openly. Be rest assure that actual prices are around 10-15% below those numbers. Land prices may not come down significantly because of acute shortage of prime properties. This proves the fact that India is a land of opportunities- without any land! Bangalore has an abysmal average FSI of 1.6 which has led to poor development of residential properties across the city. Hence, most of the prime land have single or double storey building or houses. In coming few weeks, you may see significant drop in property prices even from big developers like Sobha, Brigade and DLF, who till now have resisted price reduction.

Retail Property Rental Values (Rs. Per sq. ft. per month)

Location	Oct 2008	Jan 2008	Oct 2005
Koramangala	375-450	400-500	200-225
M.G.Road	175-250	200-250	100-150
Brigade Road	300-380	320-360	150-200
Cunningham Road	180-225	200-250	100-150
Commercial Street	200-250	175-225	100-150
Vittal Mallya Road	300-350	350-400	150-225
Indiranagar	200-250	250-300	100-150

Good news for retailers! Rental prices have decreased due to a mix of excess supply and lower demand. I believe this is the best time for retailers to engage in long term contract with developers at a lower rate. The developers, who are facing huge financial problem, would be more than happy to do so. Expect another series of price correction soon.

Commercial Property Rental Values (Rs. Per sq. ft. per month)

Location	Oct 2008	Jan 2008	Oct 2005
CBD	80-85	70-75	30-35
Suburbs	50-55	45-50	25-30
Peripheral Whitefielf	35-50	40-50	20-25
Peripheral E-City	25-30	25-30	12-15
Outer Ring Road	45-50	40-45	20-25

IT firms consumes over 80% of commercial/office spaces in Bangalore. With the economic slowdown across the world, IT sector has taken a severe beating. Businesses are down and so is the demand for office space. There may not be much addition of commercial space in Bangalore in the next 6-12 months due to global slowdown. Our research shows a drop in demand by over 60%. Realty firms may not undertake new projects in the coming months especially on Outer Ring road where there is already an excess supply of properties.

For the above table, I categorized different zones such as East and South based on following locations.
• South Bangalore includes Kormangala, Jakasandra
• South East Bangalore includes Sarjapur Road, Outer Ring Road, HSR Layout
• South West Bangalore includes Jayanagar, JP Nagar, Kanakpura Road, Bannerghatta Road, BTM Layout
• East Bangalore includes Marathhalli, Whitefiled, Airport Road
• North Bangalore includes Hebbal, Bellary Road, Yelahanka, Dodballapur Road
• North West Bangalore includes Malleshwaram, Rajajinagar
• Central I Bangalore includes Brunton Road, Artillery Road, Ali Askar Road, Cunningham Road
• Central II Bangalore includes Frazer Town, Benson Town, Richards Town, Dollars Colony, Indiranagar
• Suburbs includes Kormangala, Indiranagar, CV Raman Nagar

Sources
ABN Amro Research Reports
Cushman & Wakefield
Deutsche Bank Research Reports

Good time for retailers?

With the prices coming down, I believe this is a great opportunity for retail companies to expand their footprints. Commercial property prices and rentals have come down in all metros. They should plan to lock-in their ventures with the developers for the next few years. This would help them to improve their profit margin due to lower rentals until they are able to achieve decent economy of scale.

Price corrections on its way?

I believe poor demand for properties, higher interest rates and US slow down is significantly hurting real estate developers. I attended Bangalore Real Estate Expo on October 25 & 26 and unfortunately found poor response from :( My analyst friends in Mumbai told me that there were no bidders for MMRDA's Wadala Land and Railways properties as well. Investors believe property rates are too high in this uncertain and slowing economy. Even IT/ITES firms, who are the biggest consumers of commercial properties, have reduced hiring by over 50% and not looking for newer properties. I believe there would be lower consumption of both residential and commercial properties in the next couple of years, much below the estimate of developers. This has already led to a miss match between demand and supply. Hence, prices has to come down if developers do not want to hold on to their properties (inventories) forever.

I spoke to several Tier-2 &3 developers at Bangalore Expo who admitted to reducing rates by Rs. 200-300 per sq. ft. on their properties in South Bangalore. Same was true with those who were launching projects in other areas of Bangalore. Many developers are offering freebies such as cars, plasma TV, and wood work. One developer was offering Honda Civic on his 1 crore+ property in Electronic City! Big boys like Mantri Realty and Brigade haven't lowered the prices till date. I spoke with an analyst in Mumbai who said property prices have already come down by 5% in some areas but not everwhere. He said the market should see many distressed assets in near future as many of youngsters are fully leveraged and if they see any cut in salary or loose job, it would be difficult for them to servive. This will be another harsh reality if there is slowdown in our economy or corporates trim employees in future.

Another important factor that I would like to discuss is the financial condition of real estate developers. Most of them are over leveraged i.e. have huge amount of debt that they raised to fund their aggressive growth. Nobody even in his wildest dream would have imagined of this bleak scenario a year back, when our developers were busy planning and launching projects after projects. With the slowdown in the demand, developers will face severe pressure to honor their interest payments on debt. They have to trigger the demand by lowering prices in this higher interest rate environment, if they do not want to default on the payments. However, big firms so far have resisted the idea of lowering prices. I find this strategy quite strange because this might aggravate the situation even further. They are willing to hold on to inventories with high cost debts , hoping markets to improve further. But once they start defaulting on debt payouts they will have to offload or dump the inventory in the markets leading to chain reaction and a overall loss of confidence.

Banks to cut rates

Yesterday I wrote about the effect of RBI rates cut. I was wondering whether banks will cut rates or not. Today after the meeting between FM and bankers, public sector units have decided to reduce rates by up to 75bp. Moreover, FM promised to provide adequate liquidity to the real estate sector. RBI would soon take a decision on extending a line of credit of Rs 10,000 crore to the National Housing Bank to ensure that adequate funds were available for the housing sector. Privates banks such as ICICI and HDFC have hinted on lowering rates as well. This might has brought some smile on the faces of Mr. K.P. Singh and Mr. Chnadra who were active lobbying for the same.

These development gave positive news to the market. Investors showed interests in beleaguered real estate companies. The BSE Realty index turned best performer among sectoral indices, with a hefty rise of 12.14%. The next thing to ponder over is whether banks will lower risk aversion for developers.

Alternate funding for developers

Due to the ongoing crisis, the real estate sector has seen a 60% fall in the demand for properties. Banks are quite reluctant to lend loans to firms even for ongoing projects. Hence, developers are looking at alternative instruments of funding such as lease discounting for completing ongoing projects, especially the commercial ones.

Under a lease or rent discounting agreement, banks lend to developers for new projects against rents they directly realize for completed projects, which also is mortgaged with the bank. Thus, banks are assured of guaranteed cash flows and also have physical assets in case of defaults. Lease discounting is a much safer mode of lending, as the entire loan amount is covered through the rent agreement, and the banks are cushioned against defaults. The risk averse banks are more willing to lend under this arrangement as it is safe. Also, the rate of interest charged by banks for loan against rent, generally for a tenure of five-six years, is generally 1-2 per cent lower than the benchmark lending rate.

But the question remains how many banks are willing to lend to developers? Most of the bankers say that they have limited headroom for real estate sector and have already exhausted the stipulated limit for real estate lending.

RBI reduces rates - Lifeline for developers?

On Saturday, November 1st, RBI slashed CRR by 100bp and repo rate by 50bp. Will it help the developers or buyers? Lets examine this.

Real estate developers are struggling with a number of factors such as low demand, high interest rates and credit crunch. RBI's recent move to lower CRR and Repo rate may inject more than Rs. 60,000 crores in the market. But this may not percolate into a lower interest rates either for buyer or corporate. This is because of "risk aversion" attitude adopted by the banks. The yeild spread (difference between govt bond and AAA corporate bonds rating) is around 400bp, which is extremely high. This shows that banks are still wary of lending to corporates. Situation is worse for real estate companies which do not come under AAA rating. For example DLF's credit rating is AA, Omaxe's is A- whil other developers'ratings are BBB or less. This put them in extremely risky category pushing corporate borrowing rates of moe than 16%. Developers such as Unitech, HDIL, Omaxe, Orbit Corporation and Sobha Developers have borrowed aggressively in the last three years to support their ambitious expansion plans. Now they are facing a slowdown in the demand for the properties, which would serioussly affect their cash flows in the coming month. They are now over-leveraged; thus have limited option to raise debt.

So unless the risks aversion reduces, I see little chances of interest rates or corporate borrowing rates to come down. Moreover, banks have not decided on the lending rates yet. So RBI's recent move may or may not lower housing loans.

Real Estate - What next?

This is a terrible time for real estate developers, who have excess inventory, are short of capital and very low demand, but a great time for buyers with cash at their disposal. In a bearish market, where there is a poor demand for products, customer is the king! The same is true for property buyers. Remember the time when developers were asking exorbitant (ridiculous is the right word!) high prices for their properties. Their greed is over now but it is the time for YOU, the buyers, to be greedy.

This sector has already seen price corrections and will see another correction soon. Developers are in deep trouble because not only funds have dried up but also demand has gone down. People who booked properties this year are delaying or canceling their orders. These firms are facing acute problem of servicing their debt obligations (They raised huge capitals to fund their ambitious pan-India projects). There is some fear in the market that even big developers are on the verge of defaulting loan payments.

Bangalore Real Estate Expo-2008
I went to attend Real Estate Expo in Bangalore on October 25th and 26th. Mantri Developer was the only big developer out there while rests were Tier-2 and -3 developers, which had only couple of projects to their credit. As expected I found very few people compared to last year. It appeared to me that things are not going great for the big as well as local developers. Most of their completed projects are yet to be sold. If you remember the scene in the last few years, projects used to get sold the day it was launched! Alas, those days are over. When I spoke to these developers, however, none of them was willing to accept it. They appeared confident, at least were pretending to be, and optimistic about their new projects, which they were planning to launch soon. But, one thing was clear that most of their projects were behind schedule, at least by six months.

Do’s and Don’ts in the market
Ask for heavy discount on finished apartment. You could ask for up to 30% discount. Real estate developers are in deep red and will want to sell off all the finished products as soon as possible. However, buy ready to handover properties only. If you can delay your plan, wait for another 4 to 5 months. Prices would come down by another 15-20% over this period.

Do not buy any under construction property because the chances are high these developers may not have enough fund to complete these projects. Mid-tier developers are the worst affected because they may not have enough resources to fund their projects. Expect to see a delay of 2 to 3 years on most of the projects that were announced this year. “Over the night flyers” have quit the market and this is a great news for the consumers.

Employment scenario in the sector
Diwali sales are down amid the ongoing financial crisis. Buyers have adopted wait and watch approach which I believe is the right thing to do in the bear market. Some analysts believe the sector would see layoffs in the coming years. In the current scenario, developers can not sustain a huge workforce that was created during the boom time. So top realtors like DLF and Unitech might be forced to reduce their workforce by 5-10% to cut costs while mid-tier developers may layoff around 15-20% of their manpower. Moreover, executives at these firms got huge salary increments previous years which may now be reduced. There will be some effect on ancillary businesses as well. Consulting or Investment Banks or Private Equity firms which specialize in providing real estate specific advisory services would face the heat as well. So we will see lesser recruitment by these firms.

However, some analysts believe that there won’t be many layoffs in this sector because there is a scarcity of real estate professionals (compared to mature markets) in India. Second, new areas to work for especially for real estate i-banking people (REITS and real estate derivatives, the latter will take perhaps some more time). Third, fundamentals of Indian economy are still strong that will lead to higher growth, create more people with high disposable income, retail revolution, etc.

Outlook
The next couple of years would be slow for the industry. There is a genuine excess supply in the market which needs to be absorbed quickly to match it with the demand. This will lead to further price correction. Interest rates have started coming down which might ease some pressure on buyers’ shoulders to borrow from banks. This would give some boost to the demand for the residential properties. However, as long as there is a negative sentiment among buyers, both domestics and internationals, the demand would grow slowly, forcing speculators out of the market. The demand for commercial properties will depend on the outlook of US and European countries. If they go into deep recession, IT/ITES companies (which consumes 75% of commercial real estates) will have lesser growth and hence less demand for commercial space. Hence, both global as well as domestic factors will decide the future of industry.