The bad news just doesn't seem to stop for the beleaguered realty sector. Of late, the sector has been hitting the headlines, but for all the wrong reasons. A burst of land-related scams and more recently, a Rs 630-crore fine on DLF, the country's largest realty company, for "abusing its monopoly position" and treating home buyers unfairly, are just the latest in a string of sticky issues that have plagued the industry.
As the Competition Commission of India turns its scanner on the practices of other real estate companies, the industry finds itself under attack from several sides.
Weighed down by debt
One of the biggest problems afflicting the real estate industry is its high level of debt. After gorging on debt in the go-go years before 2008, today, realty companies are struggling to shed the weight of excess debt repayments. According to a recent Edelweiss report, the debt load of 11 listed real estate companies climbed by 15 percent, or by Rs 5,000 crore, to Rs 38,500 crore in the 12 months to June.
DLF, India’s largest real estate company, accounted for a large proportion of that debt – Rs 21,520 crore, which is itself up by nearly 17 percent from a year ago. The top six developers account for 60-70 percent of the total debt burden the sector is reeling under, according to one report. The cost of servicing that debt is about 18 percent, according to one estimate.
DLF recently announced that it plans to cut debt by Rs 3,000 crore by selling non-core assets such as hotels and plots of land that do not have the potential to be developed over the next five years. Most analysts, however, remain sceptical of whether the company will actually be able to stick to that plan, given that similar earlier estimates have missed their targets. Nevertheless, the trend is being replicated across the industry. “Many of the larger developers are already in the process of liquidating their land holdings and projects across cities,” a note from property research consultancy Jones Lang Lasalle stated recently.
Yet, the ability of such sales, and other tactics, to bring down overall debt levels remains uncertain. “There may be many attempts at restructuring of debt, though it remains to be seen how successful these will be,” Jones Lang Lasalle added.
Even before the central bank’s 50 basis-point rate hike in July, the cost of funds of real estate companies was high — 14-16 percent — depending on the credibility of the borrower. Because of RBI regulations, banks have been wary of lending to real estate companies for some time now. The strict due diligence standards and provisioning requirements for real estate loans has put off banks from lending and delayed loan sanctions.
A string of scams involving the sector in the recent past have added to the 'pariah' status of realty. No surprise then, developers are gasping for funds. Several realty companies have been forced to turn to alternative methods of financing such as non-banking finance companies (NBFCs), which charge higher rates of interest than banks – as high as 36-38 percent. For unlisted companies, the cost is very likely higher.
Even borrowing from overseas markets in the medium term isn’t an option, given the turbulence in global financial markets. “Raising money overseas would get difficult because investor appetite is low and they are reluctant to commit to long-term investments,” Sunil Rohokale, executive director, ASK Investment Holdings, told Mint newspaper.
In addition, companies have also been grappling with higher construction costs: prices of key inputs such as steel, cement, bricks and labour have been rising. For instance, steel and cement and labour costs account for about 70 percent of total costs for DLF. Higher commodity prices, higher transport costs — because of an increase in fuel prices — have pushed up costs in recent times. If crude oil prices drop, transport costs could decline, but that is still uncertain. That, along with high interest costs, has caused margins to decline, and delays in old projects.
Passing on costs to customers is possible for some companies, but that could lower sales, already suffering from a decline.
Indeed, it’s a double whammy for developers: on the one hand, they’re struggling to raise funds, on the other, they’re finding it tough to generate revenues. In the past 12 months, the central bank has hiked interest rates 11 times, pushing up rates on home loans higher by more than 200 basis points. That has curbed demand from home buyers.
Meanwhile, property prices have climbed. Mumbai, India’s most expensive property market, has seen a 27 percent year-on-year rise in property prices to Rs 9,716 per square feet, in turn resulting in a 33 percent fall in sales to about eight million square feet a month, according to research agency Liases Foras.
Judging by the results of the quarter ended June, realtors based out of Bangalore fared better than companies based in any other region. Nevertheless, unsold residential stock is expected to go up further. “Going forward, while we expect Bengaluru-based players to sustain sales volumes in the near term driven by new launches, NCR-based players could see an incremental slowdown,” noted the Edelweiss report. “Recovery in Mumbai volumes is contingent on reduction in prices and movement in project approvals over the next two quarters.”
Commercial property demand, meanwhile, also faces the prospect of a sharp demand drop, given the possibility of a global double-dip recession. That's because the information technology sector accounts for 50 percent of the demand for office space in India. Currently, the outlook for tech companies, which export software primarily to the US and Europe — the two markets threatened by recession — is gloomy and uncertain, which is likely to impact commercial property demand, according to industry experts.
“We are looking at a potential reduction in the expected levels of demand for IT-centric office spaces by next year. In the current year, we will not see a significant reduction in demand since it will continue to be driven by existing contracts,” noted Jones Lang Lasalle.
Entangled in corporate governance issues
And finally, the real estate sector, drowning in scams of late, is not exactly a favourite among large institutional investors. While some property companies are rated a 'buy' by foreign brokerages, by and large, most brokerages take a dim view of real estate stocks, primarily because of the lack of any corporate governance standards. “Investors have become sceptical of the extent to which the reported accounts of real estate firms are a true reflection of the underlying operating performance of these firms and also the extent to which businesses are being run in an ethical manner,” a recent Ambit Capital report noted.
A lack of investor confidence has caused most real estate stocks to languish below their initial public offer prices. The BSE realty index has plunged more than 50 percent in the past 12 months, while the Sensex has shed about 12 percent.
Indeed, India's biggest domestic institutional investor, Life Insurance Corporation of India (LIC), recently said it would predominantly invest in companies with good corporate governance, which means that investing in real estate stocks are out of the question. “Although LIC does not have any sector-specific preference, it has decided to stay away from realty," said S Bandhopadhay, the chief equity investment chief of LIC. "Apart from realty, we are investing in all sectors. We have stayed away from realty for last two years."