By Abhishek Anand, JM Financial Institutional Securities
Real estate is a key sector of the Indian economy, contributing 6-7 per cent of Indias GDP. In addition, the sector employs a 52 million workforce and is expected to generate over 15 million jobs over the next five years.
The importance of the real estate sector is well acknowledged by the central and the state governments and the introduction of affordable/mid-income and rural housing schemes are aimed at improving real estate activity. While inventory overhang is expected to continue in 2019, we will see developers provide value propositions for the end-users benefit, as the market consolidates. Funding will remain the lynchpin for the sector. We expect moderation in prices, if current liquidity trends continue in 2019. While this disruption will lead to uncertainty in the short term, improving affordability and higher transparency will result in better economics over the medium term.
The sector is expected to witness significant transformation with the implementation of RERA, GST and IBC, leading to higher transparency and accountability, going forward.
The residential market has seen more prudent launches by players, resulting in a 13-15 per cent decline in inventory. With asset valuations remaining flat in last five years, affordability has improved significantly over time.
The commercial office space has reported rising rentals and improving occupancies across cities. Key demand drivers have been the technology sector, manufacturing/engineering and financial services. Rentals have gone up 5-10 per cent annually across regions over the last five years, driven by high demand for Grade A office space.
The residential sector awaits recovery as buyers remain cautious. The underperformance of the asset class has been a key reason for deferral of purchase decisions. In addition, the cap on property loss provisions has further impacted investor demand.
Cost of funding remains high as land financing is available only from NBFC leading due to materially high cost of capital. With NBFC funding cost rising, we see an increase in developers funding cost, leading to low returns, especially in a weak pricing environment.
Affordable housing: This remains a key opportunity for players, as 90 per cent of housing shortfall is in the economically weak and low-income segments. Buyers are likely to benefit from the availability of low-cost home loans and lower GST rate, while developers will enjoy the advantage of favourable tax rates. Affordable housing will remain key driver for residential segment in 2019.
Consolidation in the sector: With stringent regulatory requirement and rising funding cost, we expect market share gains for organised developers and developers who adapt their business models to the new norms. For instance, our analysis suggests top 10 developers market share to increase to 40 per cent in Mumbai from 20 per cent three years back.
REITs – Unlocking capital: With 550msf of Grade A office space, India provides a significant opportunity to investors and developers looking to tap the REIT market. The total office space market size is about $75 billion; and out of this $30 billion could be available to tap through the REIT channel. Apart from the commercial office market, India has 77msf in retail malls valued at $16 billion, of which $5 billion would be available to tap through the REIT channel.
In addition, REITs would allow other sectors to unlock commercial real estate by partial liquidation of portfolios.
Funding risks: NBFC funding to developers posted a 35 per cent CAGR over FY16-18 as companies faced operating cash deficits. With an increase in funding costs and fewer refinancing lines, developers would need to increase collections to meet the shortfall. As a result, we expect prices to rationalise in the near term. However, a delayed demand recovery despite price rationalisation could lead to defaults in the interim period.
RERA implementation: RERA norms implementation has been lagging in most states. Delayed implementation with diluted norms will result in further delay in project execution with no improvement in customer sentiments.
(Abhishek Anand is Vice President for Institutional Equity Research at JM Financial Institutional Securities. Views are his own)