Taking ‘stock’ of the real estate market

Steps in the right direction, but the market still remains cautious of the real estate index.

Business is booming, with many developers putting their balance sheets in order, and completions and deliveries being the order of the day. However, experts are still unwilling to declare this as an investable sector, as many policy loopholes exist. Land aggregation norms appear to be a significant hurdle, which some address through joint venture developments. The larger players are cornering a substantial share of the market. The question remains: Is Indian real estate a stable asset on Indian stock markets? E Jayashree Kurup and Pratap Padode find out.

Godrej Properties' sales bookings rose 56 per cent in the last fiscal year to an all-time high of Rs 122.32 billion, while Lodha's sales bookings increased by 34 per cent to a record Rs 120.64 billion. DLF Ltd achieved record sales bookings of Rs 150.58 billion for FY 2023. Gurgaon-based privately held realty firm M3M India reported that its sales bookings more than doubled to a record Rs 130 billion in FY23. Prestige Estates' sales bookings increased by 25 per cent year-on-year to a record Rs 129.31 billion in FY23. Despite these impressive figures, the actual results of real estate companies do not align, and here's why...

Many leading real estate players recorded pre-sales of about Rs 100 billion in 2021-2022, driven by substantial housing demand during the pandemic and beyond. Demand for luxury housing has persisted, and this demand has positively impacted balance sheets. Real estate is a business that sells today but delivers four to five years later. Construction cycles are lengthy, drivers are diverse and unpredictable, and receivables from current sales are deferred until completion when recoveries occur. Yet, realty is a well-tracked index, and investment in this index has yielded returns as well.

In our analysis, a total of 10 listed companies in the above Rs 10 billion bracket are profitable. About 16 companies in the below Rs 10 billion segment are profit-making. Currently, there are 39 companies with less than Rs 10 billion in losses. These are the broad trends. (Disclaimer: Our research is limited to listed entities).

With declared profits of Rs 13.3535 billion in 2022 and Rs 23.1082 billion in 2023, DLF is a standout winner in the Indian market in terms of profits. In second place in terms of profits is Embassy Office Parks REIT Ltd, with profits of Rs 13.3974 billion in 2022 and Rs 12.7915 billion in 2023. Mindspace Business Parks REIT Ltd, with declared profits of Rs 13.3974 billion in 2022 and Rs 12.7915 billion in 2023, has consistently achieved profits above Rs 1,000 billion in consecutive years.

However, profit-makers are not necessarily the ones with the highest revenues. Macrotech Developers Ltd (previously Lodha Developers) reported revenues of Rs 83.6591 billion in 2022 and Rs 87.346 billion in 2023. As luxury demand remains high, especially in the MMR region, companies like Macrotech have achieved significant sales. In fact, the top real estate developers are expected to consolidate their market share from 17 per cent in 2020 to 30 per cent in 2023.

With luxury sales peaking in the Mumbai Metropolitan Region (MMR), developers from the South, such as Prestige, have entered and already recorded robust pre-sales numbers of over Rs 27 billion in the MMR out of the total projected Rs 120 billion. Mahaveer Shankarlal, Director, India Ratings & Research, says, "The strength of the balance sheets has improved due to both high sales velocity and realizations over the last eighteen months. Execution and turnaround time are critical as the collections are linked to construction milestones and handover."

Debt Reduction: Many real estate companies have focused on reducing debt on their balance sheets. A significant portion of the revenue of high-debt companies goes toward servicing debt. Debt was not always seen as negative; it was largely incurred for acquiring new lands, a classic stock-in-trade. Greater land banks meant greater worth as lands appreciated in value. However, as profitability was impacted, the value of land as an asset is now being questioned. Today, Dhirendra Kumar of Value Research says, "Many developers have chosen to use earnings to reduce debt. It also helped that rent-earning commercial assets could now be sold to aggregators such as Brookfield and Blackstone, and the cash used to reduce debt and launch new projects and achieve better sales." For instance, DLF has reduced its net debt to a historic low of Rs 570 million, increasing profitability's chances.

Shankarlal of India Ratings agrees. "The inventory levels were high pre-Covid at quarter-to-sales of 14x. Now it is reduced to 11 or 12x. So some of the ready inventory enabled the players to generate good cash flows and use it to reduce debt and also build launch pipelines. Since the implementation of RERA, also IND-AS requirement of FCM of accounting and Covid in 2021-22, the sector's reported PnL sales plummeted during FY17 to FY22. Now we are seeing pent-up demand as well as the base effect."

So, what makes these companies successful, and how do stock markets assess them? Both Kumar of Value Research and Dhiraj Mittal of Prime Capital say that the realty index has a long way to go before it is taken seriously by stock market investors. While investments are being made, the industry's size and the number of listed players are still relatively small to make a significant impact. Today, investments in real estate stocks are largely based on sentiment, driven by news items or other publicly shared information, says Mittal. Kumar says that returns from real estate stocks still cannot be assessed on many parameters, and there is considerable flexibility in reporting the purchase of land. He echoes Mittal's observation that current investors are short-term speculators looking to book quick profits. Detailed balance sheet analysis is only available for Real Estate Investment Trusts (REITs), and Mittal believes that a significant infusion of funds and stakes by large REIT players would be required to make a significant change in the industry.

REITs in India primarily own Grade A commercial properties that yield regular rental returns of over 8 per cent. Having aggregated Grade A office properties in prime locations of select cities, these REITs have contributed to reducing the debt portfolios of many leading developers. Many listed developers, like DLF, still have significant commercial and retail properties that yield rental income. Today, primarily residential players like Macrotech have announced their foray into new segments, such as commercial and new geographies like Bengaluru, following a 100 per cent acquisition of G Corp Homes. This trend of acquisition and joint ventures with land bankers is the new formula for increasing attractiveness as a good investment.

So, the jury is still out on whether real estate has become an investment-friendly category. Prof. Prashant Kumar Das, Associate Professor, Finance & Accounting, IIM Ahmedabad, says, "I hesitate to consider the landscape of listed real estate in India as an asset category for two reasons: 1. The firms in this space still seem to be in flux, and far from offering significant patterns to adequately inform the investor community. Beta of realty stocks (index) has fallen during the recent decade from 1.8 to 1.5.

While 2022 saw a record trading volume of the decade, the overall liquidity in this space, too, has been falling, and the share of market capitalization has nearly halved compared to a decade ago. The Price Earning (PE) ratio has been more volatile than the Price to Book value (PB) ratio, both of which nearly doubled in the last decade. Nifty500 has a PE ratio of around 25, realty firms of over 40, that too doubling in a decade. 2. Companies within the segment present a heterogeneous set with substantial variations in Return on Equity (RoE), PE and PB ratios. Brigade, Oberoi, DLF, Prestige, and Macrotech saw a substantial decline in sales in Q2. Sobha and NBCC saw improvements. In other words, the jury is out on whether fundamental analysis of financials is meaningful for longer-term investment strategies. However, unlike a decade ago, this space is no longer dominated by a selected few. Therefore, the pursuit of identifying more desirable companies, however heterogeneous, is a pertinent endeavour."

Real Value: Prashant Thakur, Regional Director & Head Research, Anarock Group, puts the real estate value on the stock market into perspective. "Real value comes from three elements - the ability to aggregate land at reasonable rates, the most competitive launch-to-completion time because of good execution, and an ability to secure financing at the most reasonable rates."

The perception of land as a value creator for real estate promoters has undergone a sea change in the minds of investors. For instance, a purchase like Rajpushpa's in Hyderabad at Rs 1 billion per acre is not designed to increase the profitability of the purchase. But when Lodha bought 17 acres of mill land from DLF for Rs 27 billion in 2012, with liabilities, it did not immediately try to unlock the value all at once. The project began in 2013 with a 76-floor tower, and the final tower of Lodha Park is being sold at Rs 40 - Rs 130 million in 2023. By unlocking the value of this prime land over almost 10 years, it was able to recover the cost. A boom cycle also helped. As Shankarlal puts it, "Profitability depends on conceiving the right product for the micro-market, land costs, approval timelines, execution & handover timelines, realizations, and demand-supply in the micro market for the product segment."

Land bank creation at one time occurred when developers ventured further and further from the city along newly evolving corridors, betting on their future prospects. At the time of purchase, the land was valued very low, and the development added significant value to it. When the purchase value itself is very high, the chances of generating a profit on the development erode. Today, land is sold at values that factor in future development.

Predictability of Land Pricing: Thakur feels that maturity in Indian real estate stocks will only come when there is some predictability in land pricing. However, there is a bifurcation of responsibilities when it comes to land banking. Today, joint ventures with land bankers who have acquired land from farmers and traditional owners are favored by investors. The risk is taken by the land bankers, and the promoter brings development acumen to enhance the land's value. The promoter's books do not get eroded, and the projects are ready to take off once the joint ventures are signed off. Joint ventures went through a messy period in the past decade, but now, with the Real Estate Regulation and Development Act (RERA) in place, things are getting streamlined, with base norms for operation in place. "Corporate players such as Godrej, Mahindras, and Tata have resorted to this format, where they enter only once the land is available for development," says Kumar of Value Research.

Today, money collected from buyers for projects has to go into escrow accounts and has to be used for construction. Since banks do not fund land purchases, separating that risk from the balance sheets of promoters works. This gives promoters a chance to launch, build, and generate value from the land as quickly as possible. In an age of adopting modern construction technologies, the reduction of launch to completion dates of real estate companies adds significant value in the stock market. Project execution capabilities are now under scrutiny.

With both these risks covered, the promoter's ability to raise funds from banks for project execution at reasonable rates goes up. And the third check box is ticked as far as investors are concerned. "From a lending perspective, things that positively impact credibility are maintaining projected pre-sales growth, collections, timely handover, profitability, balance strength, etc.," explains Shankarlal of India Research.

Diverse Footprint: At one time, real estate was believed to be a regional business. DLF was concentrated in Gurugram, Lodha in Mumbai and Pune, and Prestige and Sobha in Bengaluru. However, from an investor's perspective, this concentration makes the investment risky. Today, most big groups are in diverse geographies. A significant presence in the Mumbai Metropolitan Region, the National Capital Region, and Bengaluru, which together account for 70-75 per cent of the real estate sold in the top seven cities, according to Thakur of Anarock, is critical to entering the big league. However, wealth creation capabilities are now calculated based on the number of micro-markets the company has a presence in. Thakur draws attention to the fact that promoter companies now call out the number of ongoing or proposed projects in investor presentations. With delivery capabilities significantly enhanced through mechanized building, pre-cast technologies, and enhanced finishing skills, there is merit in announcing robust project pipelines that can translate into wealth creation.

Commercial and retail real estate development attract institutional finance and equity money. However, residential real estate largely attracts structured debt. Commercial properties can borrow against assured leases, while residential properties only secure construction finance. Since commercial real estate has pre-commitments even before the project is up, there is a promise of return. Also, since the project is not for sale, these returns are assured to come in for the long term. As a result, having commercial portfolios offers certainty of cash flows, which translates into stable performance on stock markets. Thakur recommends at least a 60:40 ratio of residential to commercial properties in the portfolio for better stock market performance. As pure commercial office space begins to slow down after meeting pent-up demand after the pandemic, new formats such as logistics and warehousing, data centers, etc., which all promise rental annuity income, have started entering promoter portfolios.

Institutional rental housing, such as student housing and retirement homes, is still in its nascent form, largely due to a lack of regulation. With an active mobile professional population, these formats hold promise but suffer from a lack of regulation. Even in senior living, small pockets of development have begun, but with no real policy definition, they are yet to become a mass-market product, with acceptability as value in stock markets.

Realty Index: The realty index has underperformed for a long time but has outperformed in the past year, and there has been an upsurge of listed developers. Smaller developers who are profitable benefit from small-cap funds picking up these portfolios to balance their investments. Individual shareholder buys are largely based on announcements and therefore raised sentiment.

From diversifying product mix/geographic exposure to lifecycle quality control, some companies have acted more strategically than others. In the relatively longer term, firms that diversify away from a sole focus on homebuilding will see a clear advantage.

Slowdown in home price appreciation may be more real than perceived by optimists, given an increasing proportion of households turning disillusioned about homeownership. Besides, we have seen numerous homebuilders close their shops after failing to deliver on some projects, as reputation is a critical factor for success. The long-term sustainability of firms will also depend on how seriously they incorporate climate-change related transparency in their project deliveries.

Real estate as an industry is moving towards structured operations. However, the pace of growth is not uniform, and there are still many regulatory issues to fix. The fact that stocks of the top developers are withstanding investor scrutiny is a step in the right direction. A few policy tweaks should get this industry operating more transparently and be seen as a force to reckon with in stock indices.

Here are the executive summary bullet points for the longer story prior to the table:

  • Indian real estate is experiencing a surge in business, with developers focusing on improving financial stability, completing projects, and delivering properties.
  • Despite this growth, experts remain cautious about categorizing the real estate sector as a solid investment due to existing policy loopholes and challenges.
  • Land aggregation norms pose a significant obstacle, often mitigated through joint venture developments.
  • Major players in the market are dominating the sector, raising questions about the stability of real estate as an asset in Indian stock markets.
  • The long construction cycles, uncertain drivers, and deferred receivables from sales until project completion contribute to the sector's complexity.
  • However, India's real estate sector has been closely tracked and has provided returns for investors.
  • An analysis reveals that several listed companies in the above Rs 10 billion bracket are profitable, while many in the below Rs 10 billion segment are also profitable.
  • Yet, 39 companies with less than Rs 10 billion in revenue are currently operating at a loss.
  • DLF stands out with substantial profits in recent years, followed by Embassy Office Parks REIT Ltd and Mindspace Business Parks REIT Ltd.
  • The top real estate developers are expected to increase their market share from 17% in 2020 to 30% in 2023.
  • Developers from the South, like Prestige, have entered the lucrative Mumbai Metropolitan Region (MMR) market, recording robust pre-sales numbers.
  • Many real estate companies are focusing on reducing debt on their balance sheets, with the aim of enhancing profitability.
  • The perception of land as a value creator for real estate promoters has evolved, emphasizing the importance of unlocking land value over time.
  • Predictability of land pricing remains a challenge, but joint ventures with land bankers have gained investor approval.
  • Investors are currently evaluating real estate stocks primarily based on sentiment, news items, and other public information.
  • The realty index has underperformed for some time but showed improvement over the past year, attracting more listed developers.
  • Real estate diversification, institutional finance, and equity investments are seen as potential avenues for industry growth.
  • The real value in real estate comes from factors such as land aggregation, competitive project timelines, and favourable financing rates.
  • The industry's transition toward structured operations is underway, but regulatory issues still need addressing.
  • While the sector faces ongoing challenges, the ability of top developers' stocks to withstand scrutiny indicates positive momentum.
  • Continued policy improvements may solidify the real estate industry's position in stock indices and attract more investors.
  • E Jayashree Kurup is Director, Wordmeister Editorial Services and Senior Editor, Construction World.

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