Why are property prices rising but realty stocks falling?

Housing prices in India have witnessed the biggest increase in the world over the last 10years by a staggering 284 percent, according to a new research by Lloyds TSB International Global Housing Market Review. However, the BSE Realty index has fallen 19 percent in the last one year and by more than half (55.8 percent) in the last five years.

Is it not odd that realty prices are consistently rising but stock prices of realty firms are falling? Higher prices and profits in real estate are obviously not accruing to investors.

Higher prices and profits in real estate are obviously not accruing to investors. Reuters

According to real estate research firm Liasas Foras, between Q4 of 2010-11 and Q4 of 2011-12, property prices in the National Capital Region (NCR) have increased by 33 percent and in the Mumbai Metropolitan Region (MMR) by 17 percent. Bangalore, Chennai and Pune have seen a modest increase of around 8 and 5 percent respectively in the period , but the demand in India’s top six real estate markets of Mumbai, Delhi, Kolkata, Chennai, Pune and Bangalore – has fallen around 40 percent on an average. This is a situation of low volumes and high prices.

The sector’s prospects are looking bleak due to a series of interest rate increases since March 2010 affecting demand for real estate, along with rising input costs and mounting debt. Builder claim the rise in construction costs along with tight liquidity is the prime cause of their debt build-up. But the truth is the rising debt levels are more the result of an investor-driven demand.

Total debt of India's realty firms have gradually increased in the last five years. It wa sonly in 2012 that it dipped a bit as realty firms began selling non-core assets to pay off debt. Chart:Sanjit Oberoi/Firstpost

A builder’s cost in constructing a property is not significant. Purchase of the land is actually done with private equity investors’ money who are looking for at least 20-30 percent returns. Since the builder does not want to share his returns with investors, they jack up the prices of property instead. As per a report titled “Capital-driven real estate and its consequences“, property prices are raised by as much as 43 percent to accommodate the interest of the private equity investor.

With the increase in prices, velocity drops, slow sales result in delayed construction and also impact the returns of the private equity (PE) investor. So if the end-consumer is suffering from unaffordable prices and the PE investor is at a loss due to poor returns, who is actually gaining? The builder and the retail/trading investor, says Pankaj Kapoor, MD at Liasas Foras.

The builder easily benefits by roping in investors with surplus money. Citing bad economic conditions and rising interest rates and property prices, the builder dupes the PE guys but ends up doubling his profits by adding the PE margins to the selling price of property. Over the last four years the amount of stock being picked up by investors has surged from 45 percent in 2008 percent to 52 percent in 2011.This means more than half of today’s realty market is only used for investment purposes and not for actual consumption.

Secondly, the problem of piling debt arises because of trading investors. ” DLF can claim that all flats are sold by taking a token amount of Rs 2 lakh from each investor for a property worth Rs 10 crore. But the numbers cannot lie in the company’s books and hence the rising debt”, explained Kapoor.

So where does that leave investors? Industry experts say investor holdings should be limited to companies with low or zero debt, strong cash holds and high governance standards. Meanwhile, investment in residential property should only be done for appreciation and not yields. “Rental yields do not even cover 5 percent of the actual cost of buying a property. Invest in property only from a long-term point of view,” Pankaj Kapoor told Firstpost.

Investors are looking to book profits and then exit, which is why 31 percent of of projects launched in the past 12 months have already witnessed deferred possession dates compared to their earlier made commitments. And this can be seen in the falling stock prices of India’s real estate companies.

Hence the crux of rising property prices and falling stock prices is the capital-driven realty market which caters only to investors and struggles due to inefficient policies.

According to Kapoor, there are only three ways of regulating the sector.

1. Private equity capital should be restricted to capital-intensive assets such as commercial properties, hospitality, etc.

2. Residential development based on bookings and sales proceeds can take care of the entire development of the project. PE capital is only creating unaffordability.

3. Like China, India too should strictly formulate regional property purchase policies and local residents with two homes should be banned from further purchase. Moreover, transaction and additional tax should be levied in cities with overheated prices.

Among the steps taken by China to curb investor activity are increasing down payments for second homes to 60 percent from 50 percent, and charging second homes much higher interest rates. Local governments has been asked to set price targets on new properties based on regional disposable incomes.

Source:www.firstpost.com