Builders are piling on debt while residential inventory is at a 7-year high

Media reports suggest that the coming Diwali may mark the revival of real estate sales, but a close look at hard data shows that there is simply too much inventory waiting to be sold for there to be a real uptick.

A new report by UBS shows that on an average pre-sales are down 50 percent in 2014 while residential inventory is at a seven-year high on an average. Now take a look at city specific data and you will see why the real estate market is rigged in favour of builders and politicians rather than the aam aadmi.

The National Capital Region (NCR), which is the largest investor-driven market, has seenpre-sales drop a whopping 73 percent; Gurgaon is even worse at 74 percent! Mumbai, another market largely driven by investors, has seen pre-sales drop 49 percent in the last year. All major metros, including Bangalore, Mumbai Metropolitan Region (MMR), Hyderabad, Pune and Chennai have seen a drop in pre-sales. But when it comes to prices, there has been no visible correction.

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[caption id=“attachment_98638” align=“alignleft” width=“376”]  Source:UBS[/caption]

As Firstbiz pointed out earlier, many “real estate companies are (often) fronts for politicians. What makes this very clear is the fact that even though there are thousands of real estate companies operating across India, there is not a single pan India real estate company.” ( Read more here )

Now here’s another set of data that does not justify the prices commanded by builders today.

Amid affordability concerns, property prices are up 13-30 percent in key cities over the last two years but inventory (the time it takes to sell these flats) is almost at an all-time high.Data by PropEquity shows Mumbai has the highest inventory of 50 months, followed by Gurgaon at 30 months, Hyderabad at 27 months, Bangalore at 22 months, Chennai at 20 months and Pune at 21 months! Nowadd to thisapproval delays and cash flow constraints, whichhave furtherslowed construction progress. This in turn is putting pressure on the balance-sheets of builders and as such the net debt levels of most listed real estate players has risen. The data below shows how debt levels have risen for builders in the last one year.

[caption id=“attachment_98630” align=“aligncenter” width=“600”]  Debt/Equity for major real estate developers. Source: UBS[/caption]

When you analyse the two data points together, the logical conclusion is that there should be at least a 25 percent correction in prices across the board. But builders have devised another wayof fooling the common man: reduce the size of anapartment in order to match affordability.

For example, data by property consultancy firm Liases Foras show that the average size of a Mumbai apartment in the last five years has shrunk by 31 percent. NCR, in the same time frame, saw a drop of 14 percent in apartment sizes while Pune saw an increase in apartment sizes by 23 percent. Thane and Navi Mumbai witnessed apartment size reductions of 17 percent and 18 percent respectively.

“In 2008, apartment sizes in Greater Mumbai were, on average, 20 percent larger than those observed on a pan-India level. The median size of apartments across the country at that time was close to 1,600 sq ft. While this number continues to remain more or less the same in most other cities, unit sizes in Mumbai have drastically reduced and are currently at least 15 percent lower than the national median size,” the report had said.

According to Pankaj Kapoor, MD of Liases Foras, carpet area may have reduced but not the super built-up area.

Carpet area is the total usable area within the four walls of a building. The super built-up area includes other spaces such as corridors, lift rooms, motor rooms, meeting halls, lobby areas and staircases. Loading charges is the difference between super built-up area and carpet area.

Let’s say you are purchasing a 1,250 sq ft flat with a 25 percent loading. This means the actual area you consume is 1,000 sq ft only. Loading includes common areas like lift lobby, staircase etc.

“Earlier the difference between carpet area and super built-up area was 25 percent. This gap has now doubled to 50 percent in almost all the new project launches and this is how builders are fooling buyers,” he says.

So even if several reports by brokerages suggest newer projects are being launched at cheaper rates today, the size of the apartment you get is also half of what you would get a decade ago.

In cities like NCR and Mumabi, builders are hard-selling existing inventory and the loading strategy is one of the biggest gimmicks employed by realtors.

The second strategy, more prevalent in the NCR and Gurgaon markets, is the buyback scheme whereina developer offers to buy back the flat after a fixed period at an appreciated price. Such properties usually have a lock-in period of three to five years. At the end of the lock-in period, the home owner can retain the property or sell it to the builder at the predetermined rate. However, these schemes are riddled with risks and there are no guarantees with regard to the usage of the cash for the same project at hand. The buyer cannot do anything if the developer does not use his/her cash for the project in question. As such these schemes have not done well which is why launches in the NCR market have fallen a whopping 37 percent in the first six months of 2014.