Listed players on shaky foundations

The real estate sector saw phenomenal growth in the last two decades, as the market went from primarily Government-sponsored housing to large private townships.

The housing boom enabled rapid growth for many developers that led to a spate of high profile IPOs during 2007 to 2010.

While those who invested in a home saw their capital appreciation go through the roof, investors who bought stocks of listed developers were on shaky ground, with a negative return of around 20 per cent from the BSE Realty index in the last five years.

Listed developers saw their fortunes slide, with the market capitalisation of top ten listed developers cut in half in the last three years. A host of factors - high debt burden, long delays that cut into profitability, poor cash flows, slowing volumes, cyclical nature of the business – led to the huge divergence between the performance of the real estate asset class and that of the developers.

Last millennia

Housing was traditionally unorganised and fragmented for individual homes and most of the large housing development projects handled by the Government. “Twenty years ago, majority of the housing projects were under the purview of Karnataka Housing Board (KHB) and Bangalore Development Authority (BDA), which allotted plots to the developers” says J.C. Sharma, Vice-Chairman and Managing Director, Sobha Developers.

The number of buyers was relatively less and there was limited access to home loans until the 1980s when the government accorded priority status to housing finance. The urban growth that followed the liberalisation in 1990s led to a boom in apartment developments in cities.

IPO frenzy

The housing market grew tremendously in the 2000s, thanks to better availability of loan, policy changes that opened up new funding sources for developers and growth in the economy. Foreign Direct Investment in real estate sector was permitted in 2005 and global funds started investing.

Other regulatory changes such as modification of Rent Control Act, repealing of Urban Land Ceiling Act, computerisation of land records helped accelerate growth, says Shrinivas Rao, CEO-Asia Pacific, Vestian, a real estate consultant.

There was a flurry of public listing from real estate developers starting around November 2006. Public interest was high, as witnessed by Sobha’s IPO in December which was oversubscribed over 100 times and had a first day gain of around 50 per cent.

Listing blues

The party was short lived as SEBI raised many issues. For instance, many developers used the money raised for land acquisition, rather than development. They also took on huge leverage. For instance, debt of DLF increased by over 60 per cent – from around Rs 10,000 crore in 2007 to Rs 16,000 crore in 2009. The liquidity crisis after the global financial crisis also added to the woes and DLF’s stock, which listed at around Rs 570 in July 2007 and had soared to Rs 1,176 in early 2008, plunged to a low of around Rs 150 in early 2009.

Optimism returned to the market and companies such as Indiabulls Real Estate were able to raise over Rs 2,500 crores in May 2009 through Qualified Institutional Placement. A second wave of IPOs in 2010 saw listings by companies such as Godrej Properties, Oberoi Realty and Prestige Estates. However, the housing loan scam involving LIC Housing Finance and a number of PSU banks along with developers such as DB Realty, rattled investors in early 2011 and the second honeymoon was also short lived. Developers focused on the commercial segment were not immune to trouble. The government imposed a Minimum Alternate Tax (MAT) in 2011 on Special Economic Zone (SEZ), souring the initial enthusiasm of most developers such as Mahindra and Parsvnath. Still, overall growth in the sector averaged more than 8 per cent during 2007 to 2012. Real estate’s share of GDP increased to 10.8 per cent in FY12, up from 8.7 per cent in 2000.

Valuation metrics

The market was learning how to value real estate companies. Developers were initially valued based on their land bank holdings but later companies such as Godrej Properties, which entered into joint venture with owners instead of buying land, commanded higher valuation multiple due to their asset-light model.

Changes in accounting rules were introduced to have more uniform revenue recognition standards. Earlier, revenue was not based on actual sales or customer receipts and investors could not gauge the real performance. These issues were somewhat solved by the new accounting guidelines introduced in 2012 with revenue reporting rules to include sales and cash realisation.

Even if the quarterly expectations of the market are difficult to manage for listed developers due to the lumpy nature of sales and expenses, listing has been beneficial. “Listing puts pressure on us to maintain a good valuation, which enables us to tap some non-conventional avenues of raising capital like GDRs or placement of shares or tapping hedge funds, who typically only invest in listed companies,” says Hariprakash Pandey, Vice-President – Finance and Investor Relations, HDIL.

Net positive

That said investors had to pay a heavy price as the realty industry had growing pains. Developers expanded into non-core sectors or entered new geographies they did not understand. They were also highly leveraged and interest rates climbed. Project delays led to fall in cash flow which made it difficult to service debt. Regulatory approval delays also hit profitability.

The sector is interest rate sensitive. Currently, most markets are witnessing excess inventory and home price appreciation has also cooled down. The past was not perfect, the present is tense and yet, there is yet hope for the future. In the last few quarters, listed developers have seen their debts stabilising or reducing through sale of non-core assets or land and raising funds through QIPs. Cash flows are also improving, with HDIL and Sobha Developers reporting 20 per cent increase compared to last year.

“Developers are strengthening their cash-flow position, thereby reducing exposure to debt financing,” says Jackbastian Nazareth, Group CEO, Puravankara Projects Ltd.

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