Cracking Up

The $90-100 billion Indian real estate sector has faced two major challenges over the past four years - unaffordability and slowdown in sales due to lack of trust among customers. Consumers still aren't ready to trust developers due to fear they may not deliver on time. So, while they are avoiding projects under construction, they are comfortable picking up homes that have been built. Still, the demand is largely in the top six-seven cities.

So, while developers struggle due to heavy debt and slow sales, financiers want them to sell inventory. Developers do not have much of an option but to listen to them. The courts have also sent some developers to judicial custody for not adhering to commitments.

Of late, prices have remained flat, with Delhi-NCR even witnessing a correction of 10-15 per cent. But it's a Catch 22 situation for developers. They aren't able to openly bring down prices as this will result in existing customers also demanding a price reduction. According to Knight Frank, the overall inventory levels across the top eight cities fell 3 per cent to 6.71 lakh units in 2016. That's largely due to the Mumbai inventory falling to 1.54 lakh units in 2016 from 1.81 lakh in 2015.

With sales slowing in the residential segment, developers are looking to clear inventory as lenders, financiers and PE players are desperate to exit. In the last three years, exposure to real estate across banks, NBFCs and housing finance companies has surged by 70 per cent to `19.45 lakh crore in March 2016, as against `11.32 lakh crore in March 2013. The available options for developers include lowering prices or selling existing land parcels or bringing in fresh equity. However, poor sales velocity and rising costs have seen developers margins falling from 20-25 per cent to 15-20 per cent in the last 18 months.

Expectations are that the trust deficit will end once states enforce the Real Estate Regulation Act (RERA). The RERA is also expected to remove non-serious players. The introduction of GST is expected to increase prices further. Government initiatives on tax exemption, raising foreign money and industry status to the sector will also help restore confidence. Says Anand Piramal, Executive Director at Piramal Group, "In the last one year, smaller developers have been trying to sell their projects to us. They are still lining up with their proposals at lower prices than last year. We are still negotiating for a better bargain."

Meanwhile, government initiatives on affordable housing have widened the scope for buyers and sellers. The increase in the size of the apartment to qualify for affordable housing benefits is expected to act as a catalyst for the sector with developers finding the sweet spot and targeting homes between `3,000 and `6,000 per square foot. Says Sharad Mittal, Director and Head, Motilal Oswal Real Estate Fund, "Today, for a property to be a hit, developer, price and product & location have to be in place. Execution is the key. For such developers there is no dearth of capital."

Overall sales velocity is down in the residential segment. The pain is at the top of the pyramid -- high-end and luxury segment where most developers are stuck. This segment is now set for M&As.

The Comeback Kid

In a scenario where affordable housing has yet to pick momentum and luxury and high-end homes are not seeing any sales, developers and investors have shifted to commercial real estate. "With vacancy levels in the top six cities falling from 15 per cent in 2015 to 12 per cent in 2016, there has been a shift towards commercial real estate where weighted average rent per square foot has risen 11 per cent in a year.

Investors and developers are finding a silver lining in the commercial real estate segment. The change in FDI regulations in 2015 has encouraged global funds to show interest in the space with PE investments doubling to $2 billion in 2016.