Effect of global financial crisis

Stock market and real estate
Most of the real estate developers are publicly listed companies and trade on stock exchanges. This is because real estate development is capital intensive business and developers need cash to develop properties which is then sold or rented to customers. The investors in the stock market provide these developers cash for their projects. Hence, if the market is going down, these companies would get affected as well.

A large number of financial institutions (Banks, Mutual Funds and Hedge Funds) buy or sell these companies’ securities on the exchange. If these FIs start heavily selling their investments for one reason or other, it will negatively affect companies’ stock price, which is an attractive currency for the firms in the bull market. Firms may sell (issue) these stocks in the market to raise capital to fund their expansion plan without the headache of interest payments that accompany debt. So any downward movement in the stock market might decrease the stock price of these firms and hence reduce their ability to raise sufficient capital.

Some macroeconomic factors such as inflation and recession also affect these companies and their stock prices. As we know inflation in India is around 11.5% which is quite high compared to last year’s figure of 3-4%. RBI and Banks had to increase interest rates to counter high inflation. For real estate companies higher interest rates environment is not suitable because customers avoid taking home loans (higher EMI) which decreases the demand for properties. A bad prospect of growth in the earnings of the firms gets reflected in their stock prices.

Are blockbuster deals over?
Indian real estate sector was darling of foreign investors until six months back. Did you ever hear about mega real estate deals that happened in Mumbai in 2008? If not here they are: London-based banking major Barclays Bank created history in May when it took space at Cee Jay House, a landmark office complex in Worli, for Rs. 725 a square foot (sq ft) per month. Yesteryear movie star Vinod Khanna and his wife set a reality record in Mumbai by buying an apartment in Malabar Hills for Rs. 30 crore after paying a mind boggling Rs. 1,20,000 per square foot. But those days are over now. The sub-prime crisis has taken its heavy toll on the sector.

As we know real estate is a capital intensive industry. Firms need to buy land, which is extremely expensive these days, raw materials such as cement and steel, and hire manpower for the construction activities. All of these require huge amount of money. Developers generally raise capital either by borrowing or issuing stocks. RBI has made extremely difficult for the firms to raise debt in domestic market and through external commercial borrowing (ECB). Hence, the best way for them was to go to stock market or private funding. Unfortunately, the global financial crisis has taken a heavy toll on not only the Indian stock market but also global financial market, which was the major source of funding for the last 3-4 years for developers. In less than a year Sensex has gone down from 21,000 to 10,000 levels. Most of the real estate stocks are down by over 70% w.r.t to their 52-weeks high. This is because of higher interest rates, global slowdown and heavy selling by financial institutions, seriously cutting down these companies expansion plans. They are stuck with their existing projects while investors have pulled out. Lehman had around $1.3Billion of investments in Indian real estate market. Several developers such as Unitech had planned to raise money through Special Purpose Vehicle (SPV) to fund their projects. Even REITs traded on Singaapore exchange are not funding any major projects in India. This caused DLF to postpone its plan of raising capital in Singapore. Now, after the bust of Lehman, firms may seek PEs help to raise capital. But, how many global funds would be interested to invest these days is the million dollar question!

Company Current Price (Rs.)* 52-weeks high(Rs.) % drop
DLF 304.65 1225 75
UNITECH 86.8 546.8 84
PURAVANKARA 123.95 535 77
SOBHA 132 1060 88

* As of October 16th 2008

Outlook
From the above table we can derive the outlook for these companies is not so good. Over 70% of their market value has been wiped out in less than a year; thus, putting brakes on their expansion plans. They might have to look for alternative source of capital or delay their projects. The global financial crisis and impending US recession have severely affected a large of industries such as IT/ITES and Financial Services. Both these industries were creating huge demand for A-grade commercial properties in Metros and Tier-1 cities. Now, that demand has been reduced by over 50% and it may decrease further if the US goes into deep recession. So the next one year would not bring good news for the firms in the realty sector.

However, the consumers have great opportunities even in this bear market and higher interest rate environment. With the decrease in demand for both commercial and residential properties, prices/rentals have come down. We have already seen a correction in the range of 5-10% across the properties and believe prices may go down further by another 3-5% in the next 2 to 3 months. Also, the prices in the secondary market have fallen more compared to that in the primary market. We believe inflation might cool off by June 2009 which might push the demand for residential properties. Though the long term outlook looks good, the short-term outlook is very bad for the industry. So if you plan to buy a house, either buy now or wait for couple of months but definitely before inflation falls below double digit and banks gradually start rolling off hike in rates.