The Hindu Business Line : The brick and mortar of realty stocks

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The brick and mortar of realty stocks

A look at some aspects investors ought to take into account so as to stay on safe ground.

Buying real-estate through stocks.

Vidya Bala

Is there a substitute to owning multiple properties across the country? This question should especially appeal to young investors who cannot afford to buy even a single piece of real estate, forget several across the country. If you are one of those young investors, don’t lose heart, there actually is a substitute– shares of real estate companies!

Realty through equities

For the astute investor community looking at real-estate as an investment opportunity, land and property are not the only options. With lower investment and lesser ordeal you can still hope to receive reasonable returns if you invest in real-estate stocks. Of course, the risk of “no guaranteed return and loss of capital”, typically associated with equity investing, remains.

Unlike a couple of years ago when few quality real-estate companies were listed on the bourses, a good number of realty players chose to shed their ‘family business’ avatar and go the corporate way by listing their stocks on the exchanges. This is reflected by the spate of realty IPOs that were floated over the last one year opening up more opportunities for investors.

Having taken the realty stock route to investing in real-estate, one must, however, act with caution in making an investment decision based on news surrounding these companies. Here’s a look at a few factors that may, on the face of it, appear to have a positive impact on the performance of a real-estate play but could well turn out to be deceptive if not taken with a pinch of salt.

Banking just on land?

With disclosure norms improving by the day, most realty companies have been revealing their “land bank” data, which refers to the land owned by the company or for which it owns development rights. The higher the land bank, the better the earnings visibility, is the general perception. No doubt, locking on to low cost or prime land essentially means assured inputs to feed the company’s projects. However, the location of these properties, the plans that the company has for such land and the gestation periods for the projects may be the key to actually unlocking value for the company rather than the presence of these land banks alone.

Holding land with no clear plans for it is probably akin to buying shoes without knowing your size and later trying to fit your feet into it! Big plans in a location where there is very little potential for demand (especially in case of commercial or retail space) should also be viewed with caution. Similarly, land earmarked for long gestation and experimental projects such as special economic zones (such as Mahindra Gesco’s Mahindra City) can be factored into the earnings expectations only if the company has proven execution skills.

On another note, land bank across various States, although a good diversification move, need not necessarily be superior to regional concentration, especially if the company has a strong brand recognition in that region.

Pseudo plays

All the above is for companies who are in the business of real-estate. There are companies that are not in real-estate but excite investor sentiment with the property that they own. The likes of Century Textiles or Raymond have seen many a rally backed by the property that they held. Non-realty companies holding property gain on two counts. One, the cash flow from selling such property in a boom may well be deployed into expanding their core business. Two, such property may be used to develop the company’s own unit or office or develop and lease such property. Markets try to factor in the impending cash flows from such activities. However, valuing land of such companies may be justified only when the company has serious plans on the land development front and not merely because it holds an otherwise illiquid asset such as land.

Further, if you are serious about investing in a real-estate theme and not looking to make a few quick bucks, then you may be better off avoiding such pseudo realty plays. Additionally, unlike a few years ago, when one had to be content with such proxy plays, there is no dearth of pure realty companies in the listed space now.

Track the record

Are the companies you choose to invest just fledglings hoping to make it big or have a reasonable track record of execution? While the newer ones may do well, you would be better off sticking to companies that have been able to demonstrate reasonable executions skills, overcoming various constraints, starting from buying land to developing and selling the property. Track record, combined with the quality of management, needs to be given substantial weight in your decision making.

Taking stock

Many analysts value land bank by calculating the present value of future cash flows (revenues less costs) arising from developing the property and selling or leasing it. This, again, is possible only if there are concrete plans for developing the land, and the location and demand scenario in the area is known.

For a lay man these may be too many factors to keep track of. Instead, you can consider sticking to the good old metrics such as price earnings ratio, operating and net profit margins and return on capital employed across peers.

Profit per square foot (instead of price per square foot) may also be used to compare regional peers in similar business segments.

As the working capital requirement is also high, one needs to look at the options available to the company to ensure regular cash flows.

For instance, some companies prefer to sell properties rather than lease them out to ensure sufficient capital availability for their other projects. Other established players create a lease portfolio that could generate regular cash flows.

The above are just a few slippery aspects that you may have to view with discretion. If these aspects appear too cumbersome, then you may have to wait for less unwieldy vehicles such as real-estate investment trusts/mutual funds that are set to soon hit our shores.

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