A real-estate feature, cover story

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COVER STORY
The
Heais on!
t
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The growing whispers of a slowdown
in the realty market in the country are
increasingly becoming louder. And,
now, with the banks tightening their
cash belts, the real estate market seems
headed for a slump. Shashidhar V &
Remona Divekar find out.
ith the inflation rate breaking the 12
percent barrier, Indian economy is
staring at a phase that could spell
disaster. All sectors of the Indian
economy are facing tough times, the
real estate sector being one of them. Real estate
players are, currently, grappling with dwindling sales,
correction in land prices, tepid demand, and a rising
input cost, even as they face a liquidity squeeze.To
make matters worse, banks have tightened their
positions and hiked the interest rates on home loans
further hitting the property and real estate market.
The Reserve Bank of India’s (RBI) decision to raise
Repo Rate and cash reserve ratio is expected to
only add to the woes of the real estate sector.
Harsh situations do, at times, call for harsh
measures. But, this sustained series of Repo Rate
hikes by the RBI has definitely pushed up the cost of
funding a home by a substantial percentage.The real
estate companies, developers, both big and small, are
in dire need for credit and other sources of capital
to complete projects at hand and also to sustain
their expansion plans.These are visible signs that the
global liquidity crunch has started to impact real
estate companies in India making it difficult for both
small and large realty companies to organise
financing.
Currently, the lending rate of banks is between 18
and 20 percent.The top notch real estate
developers, like DLF, MGF-Emaar, Shobha
Developers, Unitech, Omaxe, Parsvnath Developers,
Hiranandani Group, Ansal API, BPTP Developers and
TDI Group are facing severe cash crunch, as
W
reported in The Economic Times. In fact, the situation
is so bad that most of them have reported a 50-70
percent cash shortfall.
Says Pranay Vakil, chairman, Knight Frank (India)
Pvt Ltd., one of the leading realty consultants in the
country, “You have to be clear about the finance bit.
Banks have not stopped financing projects per se.
What they have done is stopped providing easy
finance for the purchase of land for housing projects.
The cost of land is currently inflated and not realistic.
And, that forms the major cost of the project. So,
those developers who are amidst a project are
caught between the devil on the one side and the
deep sea on the other. On the one hand, developer
who have sold some properties at a particular rate,
cannot now reduce it to sell off the rest of the
properties, while on the other hand, there is no
demand for the rest of the properties at the current
rate. And, that’s why you feel that the real estate
market is facing a tough time.”
Some industry experts aver the liquidity crunch is
artificial, to force developers to pick up cash from
the unorganised market at interest rates as high as
35 percent to 50 percent annually. Says Ajoy Kapoor,
managing director, Saffron Asset Advisors, “The
property markets in India have been witnessing a
downturn in the last six to seven months. Not across
the board but, in several micro markets, property
prices have been going down by 15-30 percent. We
expect this downturn to last at least for the next 1824 months. Having said that, I would add that there is
still demand for property that is correctly priced, in
both residential and commercial segments.”
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COVER STORY
phenomenon. “The credit
profiles of the companies are
not affected by the current
situation as credit profiles are
usually individual matters,” he
says.
Correction in prices
“Not releasing funds to the developers may be
specific to an individual company. But, I would like to
mention that banks have stopped financing for
purchase of land but construction finance is still
available,” notes R S Ajmera, MD, Ajmera Realty &
Infra India Ltd., and President, CREDAI. Explaining
further, he says, “Financial institutions usually keep
substantial security margin before lending to any
project. India has robust financial infrastructure like
any developed economy and many alternate means
are available today to raise project finance, like PE
Funds, Mezzanine Finance, Realty funds, etc.” Adds
Anshuman Magazine, chairman and managing
director, CB Richard Ellis, South Asia, “The property
“The market is,
currently, in a state of
extreme flux because of
a liquidity crunch and
muted sentiments.”
Anuj Puri, chairman and country head,
Jones Lang Lasalle Meghraj
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market is slowing down and it’s happening all across
the country. From the developer’s point of view, they
have stock of flats as their source of income, but
even that is witnessing stagnation.The debt market,
on which most of the developers were surviving, is
also stagnating. However, this phase will last for a few
months only.”
Agrees Ajmera, who says that this is a short-term
According to a recent Fitch
report, large development
plans and aggressive land
purchases have led to a
considerable increase in the
financial leverage
(debt/EBITDA) of most
developers, with the smaller
players now being exposed to
liquidity pressures for project execution as well as a
general slowdown in property sales. Says Kishore
Gotety, country head of RREEF India Advisors Private
Ltd., “No business would be able to grow through
aggressive leverage if underlying earnings do not
support such borrowing.Thus, financial discipline
would be important here.”
Some companies are able to access capital, albeit
at very high cost, which, in the long run, may not be
a sustainable solution, especially given the size of the
market and consequent need for large chunks of
capital.The rising inflation and interest rates is leading
to a slackening in property demand; 1-1.5 percent
increase in interest rates could further impact the
real estate sector. A
slowdown in new
project launches
could also delay
refinancing, as debt is
taken as project debt.
India’s monetary
policy, together with
slowing demand and
growing liquidity
concerns possibly has
a negative impact on
the credit profiles of
real estate
companies, notes
Fitch.
Says Anuj Puri, chairman and country head, Jones
Lang Lasalle Meghraj, “The market is currently in a
state of extreme flux because of a liquidity crunch
and muted sentiments. A correction, if any, will take
four to six months to happen, depending on the
market trends in a particular location and the
holding capacity of the developers there. Certain
over-heated micro markets in Gurgaon, Noida, Pune,

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Bangalore and other places will,
in all probability, see a 5-15
percent price decline. An
approximate correction of up
to 10 percent is also expected
in places like South Mumbai,
some locations in Mumbai’s
suburbs and certain areas of
New Delhi that have seen
unrealistic price trends.”
Adds Vakil, “The realty
market in India changed
forever on January 20th. And,
as developers would hope, the
market will see a correction in
the next couple of months, if
inflation level comes down.The
issue to be noted is that the market is over-priced
currently.There is minimal demand while there is
enough supply. So, who’s going to blink first – will it
be the consumers, keeping the festive season, go
ahead and invest in the project at the prevailing rate,
or will the developers be forced to bring down the
rates to reflect the real price?”
Very generally, there will be a period of
stagnation, followed by a fall of prices in certain
sectors and locations.The market will then
consolidate itself and rates will once again rise in
tandem with increased demand brought on by a
revitalised economy, renewed purchasing power and
also, market drivers, etc. “The slackening in demand,
coupled with liquidity
crunch, could lead to
consolidation in the
realty sector as
smaller players will
find it difficult to
survive.The current
trend of drop in
demand would
continue for another
18-24 months as
there is no sign of
inflation cooling
down and high
chance of interest
rates becoming harder,” notes Puri.
The government is walking a tightrope in trying to
arrest inflation as well as deal with the liquidity
crunch. Notes Magazine, “The priority of the
government should be to control inflation along with
high interest rates on home loans. So, hopefully, with
the decrease in residential prices and lowering of
interest rates, I hope we will have enough of demand
along with the supply.”
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Realty Risks
A slowdown in new project launches could also
delay refinancing, as debt is taken as project debt.
The risks would be higher for real estate companies
with a limited track record and limited cushion for
debt financing. While banks have taken a restrained
approach to funding real estate developers, Fitch
expects some of the more established developers to
continue to enjoy access to the loan market. Fitch
also notes that only large players with an attractive
portfolio of ongoing development and an established
track record are in a position to attract capital
through the private equity route.The sharp rise in
construction costs, driven by steel and cement costs,
“The issue is that the
market is over-priced
currently. There is
minimal demand while
there is enough supply.”
Pranay Vakil, Chairman,
Knight Frank (India) Pvt. Ltd.
could impact margins and, hence, liquidity.
Vakil, though, feels that the main reason for the
high cost is due to the rise in the cost of land, on
account of the high demand, and not due to the rise
in the prices of cement of steel. “The rise in the
prices of steel or cement is only marginal when
compared to the cost of the land at which it has
been acquired. For example, the cost of land in a
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COVER STORY
“The priority of the
government should be
to control inflation
along with high interest
rates on home loans.”
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AUGUST 08
the coming months.
“We believe this is a
temporary
phenomenon, I think
by this year-end, the
situation will stabilise,”
he says.
Testing Times
“These are testing
times for any
Anshuman Magazine, Chairman and MD,
economy and, at the
CB Richard Ellis, South Asia same time, occasions
that serve to set
Tier-II city like Jaipur has gone up nearly 300 percent
apart the more focussed professional organisations
in the past two years. Compared to that, the rise in
from the ones that probably are still trying to get
cost of cement or steel is only marginal.”
there. Any professional organisation is quite
Many in the industry feel
circumspect and careful while
that, notwithstanding the final
predicting the future scenarios
verdict on the extent of global
and the market conditions,”
economic slowdown and
states, Anand Sundaram, COO
recovery of financial institutions,
Operations, Market City
real estate players in India may
Management Pvt. Ltd.
continue to face liquidity
Fitch Ratings also notes that
problems in the near future as
the slowdown in the sector
well due to global credit crunch
and the growing liquidity
and unfavourable stock market
concerns have forced some of
the developers to back out of
conditions for raising capital.
land deals, which had been
Slowing demand and product
agreed upon.The sharp
off-take in the residential sector
increase in construction costs –
that is still the largest
driven by increased steel and
component of the Indian real
cement costs – could also
estate sector will put pressure
on developers, especially on
impact margins – and, hence,
smaller developers. Says
liquidity.The rise in the cost of
Kapoor, “On the commercial
raw materials, such as cement
and retail properties fronts,
and steel that constitute a
price points may not hold up as
significant portion of a project’s
construction cost, combined with the fall in the endexpected and may result in pain for the developers.”
product pricing will squeeze developers’ margins.
Some, like Sushil Mohta, managing director, Merlin
“This, in turn will impact liquidity adversely, and
Group, are hopeful that the situation will stabilise in
combined with
restrained lending by
banks, is likely to
result in delayed
project take-offs,”
adds Kapoor.
Property
developers hit by
falling sales and
liquidity issues would
need to reduce list
prices to enhance
Ajoy Kapoor, MD,
demand. But, many
still seem to be
Saffron Asset Advisors
“On the property front,
price points may not
hold up as expected and
may result in pain for
the developers.”

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holding on to the
asking price. Sales
have gone a little
slow but the scenario
is not the same
everywhere.The
negative impact will
be only in those
areas where the
supply is very high
compared to the
demand, say industry
observers. Kolkata,
for instance, has not
seen such high supply. “The prices will not come
down because construction costs have gone up and,
in last year alone, it has gone up by 20 percent,”
argues Mohta.
Volumes are expected to
further decline if the
developers persist in holding
on to their current prices –
and buyers anticipate a further
fall with current rates being
beyond reach, with affordability
having significantly declined
with rising interest rates.
Though the sector has already
factored some of the news
impact, there is scope for
further correction. However, as
quoted in Realty Times, many
developers are holding onto
prices and even operating as a
cartel in some prime pockets
like Mumbai.Therefore, say
industry observers, postponing
purchase decisions may not
really be a solution. Despite the fact that volumes
have fallen sharply, established developers are clearly
unwilling to drop prices.
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“We believe this is a
temporary phenomenon,
I think by this year-end,
the situation will
stabilise.”
Sushil Mohta, MD,
Merlin Group
The tightening bias of India’s monetary policy,
together with slowing demand and growing liquidity
concerns could have a negative impact on the credit
profiles of real estate
companies.The slowdown will
also aid the process of weeding
out some of the weaker entities
within the sector, and increasing
the relative strength of some of
the larger, more established
developers.
PE Please!
While the primary market for
real estate has virtually dried
up, private equity players are
also following a very cautious
approach. Only those
developers who have internal
cash flows and have not gone
for recent land acquisitions will
be able to sustain these tough
times. Earlier, they were seeking
mortgage against property but,
now, credit requirement has forced them to pledge
their own shares for securing mortgage, industry
officials say. Bankers say they may now get more
cautious towards
lending to real estate
developers. Also,
banks need to
maintain their reach
among their clients.
However, it is
possible that all
banks may sanction
loans to only those
developers with
whom they have had
Anand Sundaram, COO – Operations, Market a long and profitable
City Management Pvt. Ltd. relationship.
“These occasions set
apart the professional
ones from those that
probably are still trying
to get there.”
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Real estate companies have many projects at
hand and the sales have been constantly dwindling.
The persistence of inflationary pressure in the
market will further affect the recovery in the real
estate sector. However, larger, established and wellcapitalised companies with access to banks/financial
institutions would remain better positioned to
manage this risk slowing demand.
Says Gotety, “We would agree to the extent that
companies, who expanded their scale of operations
through aggressive land acquisitions, etc., by overleveraging and generally accessing high cost capital,
will see some strain on their cash flows.This is also
because some of their revenues (on account of
“Banks have stopped
financing for purchase
of land but construction
finance is still
available.”
R S AJMERA, MD, AJMERA REALTY & INFRA
INDIA LTD., AND PRESIDENT, CREDAI
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AUGUST 08
sales) would have been pushed further in the
timelines. However, companies who have operated
with restrain, got into calculated, planned expansion
programme and have a strong culture of financial
discipline are still well-positioned in this market and
should be able to tide over the current low-liquidity
phase effortlessly.”
He further stresses that banks are definitely more
selective now in lending to real estate
companies than earlier. Also, owing to
higher provisioning and capital
adequacy norms, the cost of lending to
real estate has gone up. As a result,
developers have had to consider
alternative providers of capital, such as
mezzanine and private equity investors.
There will be a slowdown as the
market goes through a correction
phase.
Says Ajmera, “Credit is still available
from banks for construction, if the
project is viable. India has a robust
financial infrastructure like any
developed economy and many
alternate means are available today to
raise project finance, such as PE Funds, Mezzanine
Finance, Realty Funds, etc.”
However, a prolonged slowdown could also
reduce the appetite of private equity. According to
Fitch Ratings, the liquidity risks on account of
significant bullet repayments falling due during the
course of 2008 remain a key challenge across the
board. With access to capital markets likely to remain
limited at the parent level by attracting private equity
participation would remain a key for managing
overall funding and liquidity requirements. But Gotety
feels that committing to purchase large land banks,
without necessarily having a financing plan in place
will be the single biggest factor that will see
developers facing
liquidity pressures.
Second, given the
present slow down in
demand, however
short-term it may be,
will cause cash flow
mismatches in
companies who will
have committed on
expenses (for
expansions,
construction,
marketing, etc.) and
would not see
matching revenues
flow in as expected.They will have to resort to some
short-term borrowings.
Says Puri, “Concerns about liquidity will continue
to plague the market since debt will not be easily
available. Real estate players had traditionally raised
money from debt funds via corporate deposits and
commercial paper. However, debt funds are currently
not eager for more exposure in real estate and are

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continuously rolling over the debt advanced to these
players.The primary source for institutional funding
will, therefore, now is private equity.”
The road ahead
Healthy and sustained economic growth, a strong
currency, favourable demographic profile and rising
incomes certainly positions India amongst the world’s
most attractive investment destinations in the real
estate sector. However, it is companies who have
operated with restrain, got into calculated, planned
expansion programme and who have a strong
culture of financial discipline are still well positioned
in this market and should be able to tide over the
current low-liquidity phase effortlessly.
Having said that, though, the real estate sector, like
all other sectors of the economy, will be affected by
inflation, higher interests rates, an uncertain global
macro environment and consequently, reducing
demand in the medium- to long-term.The extent
that companies who expanded their scale of
operations through aggressive land acquisitions, etc.,
by over-leveraging and generally accessing high cost
capital, will see some strain on their cash flows.This
is also because some of their revenues, on account
of sales, would have been pushed further in
the timelines.
Given India’s performance in the last few years,
there are many investors who are still willing to fund
real estate development in the country.These could
take the form of private equity placements, listing on
exchanges, REITS and others. “This is especially true
for the more ‘professionally’ developed assets with a
sound understanding of the business continuum,”
states Sundaram.
(WITH INPUTS FROM RAHUL KAMAT)