“Buy land, they are not making it any more”, said Mark Twain. This quote indicates how real estate investment has been fancied even historically. No wonder, real estate has been one traditional investment class with most of the investors showing trust. Further in a country like India where there has always been a deficit of dwelling units considering the populations and people who are end users, the real estate sector has always been considered as a vibrant space. While the demand has always been outpacing the supply for decades (especially in Urban India), there are many investors who managed to generate significant returns by just investing in real estate. However, on one side physical real estate investment is still considered a safe way to invest, on the other side there is a contrasting view about investing in equity shares of listed entities in the real estate sector. Forget about investing in shares of realty companies, there was a phase when there were no takers of the bonds issued by the realty companies at significant premium to the prevailing interest rates. Just to put it in perspective, few of the real estate companies offered bonds paying 14-18 percent interest rates. However despite such higher rate offerings, there were few takers of such paper.One may wonder, despite having such a long historical background and traditional importance, despite witnessing growth in market size and demand outpacing supply, the organised players hardly enjoy a premium on the bourses. While the other old Economy sector stocks enjoy premium valuations (though cyclical in nature), real estate listed space had never seen a buzz like that. There was a brief period when the realty stocks were providing never seen before returns. However after that period there has been a long lull. It needs to be analysed and thoroughly studied, why a sector which has got all demand drivers in place and policy initiatives are supportive – has never enjoyed premium on the bourses. Let’s take a look at factors that may be the reason behind realty companies not enjoying valuation premium on the bourses.Investors watch - Returns and Consistency of ReturnsIt is a known factor that investments are made to generate returns from it. And when the investment is not risk free, naturally the expectations are on the higher side. Equity as an asset class is considered risky (owing to the risk return trade it offers) and when it is in the companies from the realty sector, the riskiness is considered to be further higher. There is a reason behind the same. Realty companies have been very inconsistent in terms of performance on the bourses. Rather if we take a look at the performance of realty companies for the past one and half decade, it shows they have eroded the wealth most of the time.Nifty Realty Index – PerformanceJust to put things in perspective we would like to put the facts about the Nifty Realty index which was introduced on August 30, 2007 with a base of 1000. Today the same index is trading at 400. This means 600 points of erosion. Yes, after the introduction of the index there was a brief period when the index moved northwards to touch the levels of ~1780 in February 2008. However after that the index has remained under consistent pressure. All in all there is hardly any broader wealth creation that has happened in the Indian real estate sector.Always remember it is the consistency on the returns front that is highly rewarded on the bourses. The players from the other sectors like Banking, IT and even the cyclical sectors like automobile and even metals managed to show consistency. Unlike those sectors, the realty sector has failed to be consistent on financial performance. One may argue that quarterly and yearly financial performance of realty companies is not a right parameter to analyse a realty company. However the realty companies have not only failed to deliver on the smaller periods like quarterly or yearly – the failure is clearly visible for more than a decade.Just imagine, while the benchmark indices like Nifty and Sensex have managed to surpass the respective high made in 2008, Realty index has not even managed to cross the base levels.When we are speaking about the levels of realty index, naturally it is the individual scrip performance that has been very poor. Let’s take a look at the charts of a few of the realty companies.Started With Bang – Soon to Go BurstIf we take a look at the Indian realty sector, there were very few companies in the listed space. That too it was majorly the companies having exposure to the different sectors initially and then eventually turned to become a realty company. It was the listing of India’s largest realty company DFL that created some buzz about the realty as a sector. DLF was one of the few companies that directly got an entry on the listing day to become a part of Sensex. Till that day the realty sector was not part of the leading Benchmark index.While the company started with a bang – the joy was short lived. And just after a few months of listing the scrip witnessed a significant decline.DLF – UnderperformedThe above chart clearly indicates that there has been severe underperformance on the bourses by DLF. We still remember when DLF made and futile effort by going for a Buy Back at Rs 600. This attempt to provide support of attempt to discover value failed and despite the promoters’ efforts, the investors never showed confidence in the scrip.While DLF witnessed such pressures, at least the company ate least managed to avoid fate of getting de-listed or going for liquidation. There are certain others who could not sustain the pressure and eventually went burst. The likes of Unitech, HDIL and even JaiPrakash Associates are some of the examples for the same.Unitech - UnderperformedWhile a few went burst, there story has not been any different for the other players. Though they haven’t gone burst, the underperformance is clearly visible. The following charts and heading show how the scrip has performed.Brigade Enterprises – Relative UnderperformanceGanesh Housing – UnderperformedIndiaBulls Real Estate – UnderperformedKolte Patil Developers – Relative UnderperformerParsvnath Developers – Underperformer (Wealth Destruction)Prestige Estate – Market PerformerPuravankara - UnderperformerSobha – Relative UnderperformerIn the above mentioned charts it is clearly visible that most of the stocks have underperformed. We have segregated them as market performer, underperformer and relative underperformer. And the list shows that there are more underperformers eroding investor wealth. We are just providing a few other names like DS Kulkarni developers, Amrapali and even Nitesh Estates witnessing miserable failures.No wonder, with burnt fingers not many are again ready to take further risk in the realty sector. This is the prime reason why realty players hardly enjoy valuation premium on the bourses.Failure of Large Ambitious Projects – A Major WorryWhile we have already discussed the underperformance of Realty companies, real estate companies have also failed to execute large and ambitious projects. If we take a look at the past few large projects like Lavasa (HCC), Sahara City and few others like large projects from Unitech and Jai Prakash Associates not only created doubt about the execution capabilities but also the ability to sustain severe financial burden created because of large projects. All in all it not only resulted in severe losses to the companies, even the investors lost their confidence. This was despite the fact that Government policy initiatives were favourable for the realty companies. This signifies if the companies are not able to perform even with a policy support, what would happen if the policy support is not available. While large execution has been a challenge, there are certain other factors as well that keep the investors away from the equity instrument of the realty sector.There is historical evidence of failure to deliver on ambitious projects. Just to give an example, In CBD Belapur (Navi Mumbai) a lot of buildings are yet to achieve the price they had in 1996-1998. A few projects are still laying undelivered for over decades.Complex Holding Structure and Complex Accounting PoliciesReal estate companies have a very complex holding structure. There are several subsidiary companies formed through joint ventures or tri-party agreements. To put things in perspective, DLF has more than 100 subsidiary companies. Similarly Unitech has got more than 150 subsidiaries. (List is provided in Excel Sheet). Even companies like Godrej Properties have more than 10 subsidiary companies. This complex structure actually works against the companies. Reason being, while the subsidiaries are formed to adhere to the regulations (Project Wise), there is constant query being raised about the promoters intent. While the consolidated results are available to an investor, to find irregularities from more than 100 subsidiary companies is surely a daunting task. Add to that the complex accounting standards and policies opted by realty companies – it is really a complex process to come out with exact expected numbers and estimates. To be very specific, there is usually a mismatch between proceeds received from the customer and the amount booked by the company in results.Again the quarterly results and yearly results are not a right parameter to analyse realty companies. The net present value of its assets (saleable land bank – all liabilities). However the cash flow is what gets affected and hence the results analysis is important. Over the past few years the realty companies have failed to generate cash flows. In the other sectors the accounting policies are simpler. And as we say simpler things naturally the investor interest is higher.No Real Pan India Presence – Always been a geographical playOne factor we look at before investing is, if the company has a larger presence in the market. Unlike the other sectors where the products can be manufactured at one place and distributed to pan India or even exported, real estate has got a mobility issue. It has been a geographical play since day one. There is no realty player who could be considered to have a Pan India presence. DLF has worked in clusters in NCR, Godrej Properties has a presence in Western India and the rest are also segregated in different clusters. As a result the presence has been limited to a particular region. All in all this has made the realty industry a very fragmented sector dominated by unorganised players. Some amount of consolidation has happened, however it further made the already complex subsidiary kind of structure further more complex. Add to that the factor that real estate has no such standardisation enjoyed by equity markets and gold. As a result there is no parity between the two dwelling units in similar locality. And if there is no such standardisation, it is really difficult to value the underlying asset. As expected this also impacts the valuation matrix of realty companies.No Regulatory BodyWhile many would immediately argue that, there is Real Estate Regulation Act (RERA) present. However we believe, though there is some comfort drawn by the customers or home buyers – there are still many lee ways available. The way there are regulatory bodies in Equity markets (SEBI), Insurance (IRDA) and even PF segments (PFRDA) – there is no regulatory body for the realty sector.as result the complete authenticity of the RERA is questioned. Further not all states come under the RERA and hence can’t be considered as a best regulatory act.Just to put some examples of lee way possible, the RERA is not applicable if the project has got up to 8 dwelling units or the size is 500 sq. mt. In Some cases the loophole is utilized and builders have built 20 units as the area was less than 500 sq. mt.Further the RERA has only added to the cost (ultimately borne by the end users) and there is no speeding up the process. We know few of the projects that can be completed within 24 months, have been given delivery date in 2025-26. This is just like utilising the loop holes. Though the no regulatory body factor is negative for investing in the physical asset class, it also has an impact on the equity instrument as well.Financial Indebtedness – Still lingering Issue We all know that the ambitious projects and debt raised for the same (at exorbitant rates) was a major issue faced by the realty players. After biting something more than what they can chew in 2007-08, the realty companies are still facing debt issues. A lot of restructuring has happened, most of the companies have already got rid of the non-core assets (and in many cases sold core assets to pay for the wrong move to go for non-core Assets), but the debt burden still remains a dragger on its performance.No Right balance between Residential and CommercialReal Estate companies have never been able to strike a right balance between residential and commercial segments. They have been shifting the focus from one segment to another based on the demand parameters. However there has been the right kind of success that any of the companies achieved. It is true that the Real Estate Investment Trust (REIT) has managed to help some of the companies to monetise assets but then the benefits are restricted to the REIT stakeholders, where the minimum investment is on the higher side. And hence has always been a HNI favoured game. Not much of a retail participation is visible out there.Many Promoters Not Considered CleanOne of the most important parameters we consider for analysing a company is management quality or promoter background. Thanks to the various legal processes that run through building a realty business, promoters have lots of litigation pending with them. Hence there is a presumption about real estate promoters not being clean. Add to that the consistent underperformance of the realty companies on the bourses, the management bandwidth is usually questioned.Affordable Housing New Growth Area – But Got Its own ChallengesAffordable housing is one segment that has helped the sector witness some positivity. A lot of developers are growing in this segment as well, however this has got its own challenges as well. The issues like scarcity of land, lack of infrastructure and basic amenities and lengthy statutory clearance & approval process are the three major challenges. Lastly private participation is lower in semi urban and even in few urban areas. There are 30 basic regulatory approvals required for the affordable housing projects. This clearly indicates that the dependency of the developers on the approvals is high. In such cases the sector (higher government interference) does not enjoy premium valuations. We have seen how the sugar sector and even the energy sector have never managed to enjoy premium valuations.While we have spoken about the factors that are affecting the valuations of the realty companies there are few positives emerging as well. The consolidation narrative is driving the sector re-rating. Slowly and steadily the sector valuations have evolved from promised execution to actual execution. Over the period the things are changing, the larger players with strong brand names are enjoying better valuations. The less leveraged balance sheets, transparent management and speedier execution are important parameters to enjoy better valuations. Rather most of the companies would try to monetise the brand and not the land. Luxury and premium segment would mean better valuations going ahead.