Real Estate Presents "REAL" Opportunities For Discerning Investors

Real Estate is the second largest employer in India after agriculture and is ranked third in Asia in terms of size. The sector's growth in India is linked with the developments in the field of retail, hospitality and entertainment industries, economic services and IT sectors. The housing sector alone contributes 5-6 per cent to the country's GDP, with the overall industry contributing about 9 per cent. The sector has a robust demand with over ten million people migrating to the cities every year. Due to changing customer preference owing to their global exposure, the customised demands have led to shift from regional players to national real estate players who are in a position to deliver high-end real estate solutions at affordable prices. The real estate players are encouraged by the support from the Central government for affordable housing, be it in terms of interest rate subsidy for the first-time buyers or tax rebates for developers. Due to the introduction of regulations such as RERA, Benami Transaction Prohibition, REITS, and GST, we expect a long-term growth  and transparency in how the industry works.

Over the last five years, the world has witnessed a weaker-than-normal economic growth in the midst of rapid changes, but 2017 is expected to show a stronger growth. The private equity activity looks healthy in 2017, in spite of Brexit and uncertainty around the new US President's outsourcing and visa-related policies. The Asian sub-continent may witness reasonable growth owing to fall in interest rates in most of these economies. The quarterly commercial real estate returns are in a decline phase from 2015, according to NCREIF. The volumes have also declined across all property sectors in 2016. It is expected that the commercial real estate markets will maintain strong fundamentals in years to come and will continue to support prices. Niche sectors such as data centres,  cold storage and last mile facilities  are undergoing rapid changes which would drive real estate sectors in Asian markets.

The industry faced a tough time in the previous year due to stagnant sales and was later hit due to demonetisation. The government in its Union budget 2017-18 announced 'Affordable Housing' to be given infrastructure status, with an intention to increase participation from private players and act as a catalyst to its initiative ‘Housing for All by 2022’. The government also increased its budget for schemes such as Pradhan Mantri Awas Yojana, AMRUT and Smart Cities. Further, steps like introduction of Real Estate Regulatory Act (RERA), Goods and Services Tax (GST) and Real Estate Investment Trusts (REITs), are aimed at improving transparency and enhancing the overall investor sentiment. Impact of GST on real estate Currently, home buyers end up paying a number of taxes, including VAT, service tax, excise duty, stamp duty, registration charges, etc. GST will bring a uniform tax structure into the system. Under the GST, 12 per cent tax will be levied on purchase of new property, excluding stamp duty. The commercial property developers would also be benefited by a smooth credit inflow, along with the availability of construction-related credits. From the developers point of view, GST would bring down the project cost because of the scrapping of the above taxes, but the tax rates for major inputs have been marginally increased. Earlier, the indirect taxes on steel were around 17 per cent, which is now 18 per cent under the GST. Similarly, the taxes in total for cement were 24 per cent, which has now been increased to 28 per cent under the GST regime. Also, the holding cost is likely to go up for the developers. The rental housing market will also be affected post-GST as the government would be looking to tax residential leases.

The real estate sector got its own regulatory body from May 1, 2017. With the implementation of the RERA, the risks of delays, poor quality of construction and title issues which were earlier borne by the customers, are now to be borne by the developer.  Now it is almost a month-and-half since the Real Estate (Regulation and Development) Act, 2016 (RERA) has become effective. The developers and real estate agents now are left with 45 more days to get their ongoing projects registered with RERA i.e. until July 31, 2017. So far, 18 states and Union territories have been notified and 10 states and Union territories are preparing draft rules. Maharashtra and MP are the only states that have a permanent authority in place and have completed their website development. Some banks have already started to disburse loans after RERA registration, but still more clarity is needed on how the amount would be disbursed from an escrow account. Ramesh Nair, CEO & Country Head, JLL India, says, “RERA has been implemented with the purpose of enhancing transparency, mitigating information asymmetry and applying a uniform ‘code of conduct’ for developers across various states. It seeks to reduce the volatility seen in the real estate sector in the past, and eliminate the trust deficit between the two primary industry stakeholders – builders and buyers. However, residential prices are likely to rise in the post-RERA world.”

RERA has also set out new guidelines for regulation and promotion of real estate sector so as to provide more efficiency and transparency. The new policy states that no promoter shall advertise, market, book, sell or offer for sale, invite persons for the purchase in any manner any plot, apartment or building without having the project being registered with Real Estate Regulatory Authority.

REITs will attract institutional and smaller investors alike because of their inherent nature to provide regular dividends at relatively low risk. The development of REITs in India can benefit the commercial office space sector.  As India's stock of Grade A commercial assets increases, REITs can prove to be the growth catalyst for the real estate sector.

In India, the private developers mainly cater to high-end luxury and upper-mid housing segment because of the  low premium being fetched by lowincome housing. Hence, we see a  high supply in luxury segments and a shortage in low-income houses. One crore houses are to be built in rural India by 2019, followed by cheaper sources of finance to give a boost to affordable housing. Many of the institutional players are now looking at affordable housing as their mid-margin and quick turnaround products. This development is being supported by quick and easy government approvals for the developers and incentives to the end-users.

The private equity investments in  real estate increased by 26 per cent in 2016 and reached to Rs.40,000 crore, a nine-year high. From the 30 major real estate giants in India, considering the financials of top 10 based on their market capitalization, we see an upward trend in the sector. The average net sales of the major 10 companies have increased 6.34 per cent quarter-on-quarter, with companies like Oberoi Realty and Indiabulls Real Estate posting a significant increase of more than 50 per cent in their toplines. The margins of these companies were also on an upward trend. Taking the average margins of these companies, we see that the PAT margin of the industry is around 32 per cent, which is likely to grow in the upcoming quarters. On the yearly front, we see that companies like DLF and Indiabulls Real have posted an increase in topline by more than 50 per cent. Taking the average of top 10 companies, we see an increase of 15 per cent in net sales, with total net sales of almost Rs.15,686 crores in FY17.

SEGMENT-WISE REAL ESTATE SCENARIO

Demonetisation had a negative impact on market sentiments across all major markets, with developers delaying new project launches and investors and end-users postponing their investment/ buying decisions,. India's housing market is now expected to shift from pure price play mechanism towards a market driven by commitment because of developers coming up with attractive schemes/payment plans to offload their unsold inventory.  Postdemonetisation, banks being flush with cash, a rationalisation in mortgage rates has also been witnessed, thereby improving the appetite of the end-user to buy new homes. By mid-2017, it is expected that the impact of demonetisation on the macro-economic sentiment would substantially reduce  and the reduced mortgage rates, along with other policies by the government, are likely to revive the home-buyers' sentiments. Also, with greater transparency in place for the sector and aided by government's efforts to revive housing sales, it can now be expected that the developers with a strong track record will be be encouraged to launch new projects across markets. The creation of a national housing regulatory authority is another positive for the residential sector.

Retail

The Indian retail real estate witnessed a greater penetration of international brands, completion of retail developments and robust demand during 2016. The organised retail segment expanded by about 3.4 million sq. ft., out of which the majority of supply-approx. 40 per cent-was concentrated in Delhi NCR followed by Bangalore and Pune.

With further penetration expected in cities such as Hyderabad, Bangalore, Chennai, among others, we are likely to see global and national brands executing their entry and expansion strategies in these cities, leading to a more developed scenario of retail space across India. The key for demand revival in retail space is the steady footfalls from captive catchment, competitive rentals and availability of high visibility locations.

Also, now with the increasing government’s focus on establishing new airports in Tier II and Tier III cities, airport retail as a segment is expected to gain more prominence over the coming years.

The steady lease rentals and higher absorption levels, along with global investor interest, make commercial office market in India attractive. In 2016, Bangalore and Delhi NCR

Dominated the office leasing activity, followed by Hyderabad and Mumbai. While talking about the overall space take-up, Delhi NCR, Mumbai and Bangalore continue to be the leaders. However, the share of cities likes

Hyderabad, Chennai and Pune is  also expected to rise. Increased participation is likely to be seen from institutional players, as the operating environment becomes more transparent.

CONCLUSION

The Indian real estate sector is currently under a transformation phase with GST and RERA around the corner. The real estate developers are already gearing up to cope up with the changes and for compliance with the act. The developers now are likely to keep a strong check on space utilisation ratios and innovations in workplace strategies, while implementing their expansion plans. Also, they will now be more professional in managing their projects and hiring more qualified project managers, engineers and architects. It would be interesting if RBI lowers its repo rate post-monsoon and thus bring in more benefits for both developers and customers. The industry is currently in the recovery  phase post-demonetisation. We expect the industry to perform better in this financial year. India stands fourth among the top destinations for FDI in Asia as per World Investment Report 2016, and more transparency in the real estate sector will bring in more investments into the country. The government’s objective of Housing for all by 2022' would take a step forward towards the goal.

We will also witness the downfall of fly-by-night operators masquerading as real estate developers with the ushering in of more transparency in the sector and also expect large players to do well in the coming years. All the above factors will take India's real estate sector in an upward trajectory and we will see more and more people making a beeline to invest in the sector.

Initially, the demonetization move appeared to have taken all the remaining steam of our Indian real estate's sails. Sales in the significantly cash-driven resale homes market nosedived and prices in this segment declined by as much as 20-25%. They were already trailing primary sales prices by 25-30% in the investor-driven residential corridors before demonetization. The luxury housing sector took a big hit, because a notinsignificant number of transactions in this category had cash components. In the luxury sector, such transactions were largely by speculators and people hoping to hide their unaccounted wealth in real estate - not genuine end-users.

The real estate market has now recovered from the demonetization shock and, in fact, looks primed for a rebound on the back of the transparency and regulated market practices that RERA is likely to bring in its wake.

Has implementation of RERA really put the ball in customers' court? What will be the impact of RERA on real estate prices in India?

This very critical Act literally holds the key to the future growth of the Indian real estate sector. Because it has the potential to clean up the sector at all levels, RERA saw a lot of opposition from both government and industry stakeholders with vested interests in the past. It was only with the arrival of the Modi government that it received the determined forward impetus it needed to overcome all objections and clear every hurdle. The current government understands that RERA's implementation will not only help revive end-user sentiment, but help further open up the Indian housing sector to foreign investments. There are no significant added costs of RERA compliance to developers. However, supply has definitely reduced as developers rush to become RERA compliant and ensure that their ongoing projects get completed according to the RERA-stipulated timelines. Reduced supply can have a bearing on property prices going forward. Also, the fact that pre-launches can no longer be used to draw capital from the market will cause funding issues for some players, meaning that they will have to raise capital via debt and equity. The added expense can also reflect on prices going forward. However, for now, developers cannot afford to raise rates as the market will not support any escalations.

The government has rolled out various incentives to boost affordable housing To begin with, the Government of India designated this vital sector as a favoured segment under its 'Housing for All by 2022' initiative. This led to affordable housing graduating from being the poor second cousin of Indian real estate to a highly influential sector. The most recent Union Budget provided direct tax relaxation to the lowest income  earners, along with much-needed  clarity on the designated beneficiaries under the Pradhan Mantri Awas  Yojana (PMAY).

The government also brought in a new Credit Linked Subsidy Scheme (CLSS) for the middle-income group, with a provision of Rs.1,000 crore. Additionally, the extension of tenure for loans under the CLSS of Pradhan Mantri Awas Yojana (PMAY) was increased from 15 to 20 years. Finally, affordable housing has also been accorded the very important infrastructure status, ensuring that developers in this segment have access to cheaper loans and various other incentives to encourage them to pitch in and drive supply.

Having emerged as a preferred segment for housing finance institutes, affordable housing is now also attracting the interest of more developers who had previously shunned it because of its 'down-market' image. Today, affordable housing has become a respectable segment and with the government's determined push towards creating it across the country in sufficient numbers, it now plays a very important role in the housing finance sector.

That said, whether the government's vision for Housing for All by 2022 is realistic and implementable to its intended extent is still a big question mark. Definitely, it seems impossible if enough land is not released for the creation of affordable housing. Various government agencies such as the Indian Railways do, in fact, hold sizeable land parcels which could logically be deployed for this purpose.

 Land is a very price-sensitive commodity, and its current shortage in major city-centric areas prevents the development of affordable housing in areas where it is most direly needed. The cost of land currently accounts for as much as 30-50% of the cost of a project within city limits. However, RBI regulations do not allow banks to fund land purchase. Developers, therefore, are left with only a few options. They can either form a joint venture (JV) with the land owner, or get funded through NBFCs - usually a very expensive route, which again precludes the prospect of developing affordable housing on the acquired land.

There is limitless demand for residential properties in India - demand which will sustain for several decades, until the huge housing gap is bridged. However, there is currently considerable investment potential for office spaces - especially Grade A properties in the larger cities - as there is massive demand for such spaces from entering or expanding domestic and international corporates. From an investment perspective and for investors with sufficient funds, commercial real estate is a good play right now.

Residential prices will remain flat for now, but will definitely show appreciation over the mid-term. Residential is still the most logical choice for smaller investors with a long-term horizon and an added focus on rental income.

❝ Mutual fund managers have historically been underweight on real estate stocks for many years now. As on May31, 2017, the MF industry had an aggregate exposure of ~Rs2000 crore to real estate stocks, which represents a meagre 0.3 per cent of the overall equity exposure held by funds. Over the last one year, the value of this exposure has almost doubled from Rs.1100 crore in March 2016, which is primarily due to rise in the underlying stock prices and also some selective buying in certain stocks. The top stocks held by MFs are – Brigade Enterprises, Prestige Estates, Godrej Properties, Sobha Ltd.& DLF. Amongst these, Brigade, Godrej Properties and Sobha have seen additions in the last one year, and especially in 2017 after the stocks corrected post demonetisation. DLF has witnessed fund managers reducing positions. Overall, the manager sentiment towards real estate stocks still remains muted, barring a few names. That said, managers have been adding positions to ancillary stocks like housing finance and cement. ❞