Getting real on realty

Getting real on realty
Business Standard, February 13, 2009, Page 9

Thanks to the realty sector crying hoarse and the fact that an economy in a serious downturn does call for government action, India’s real estate majors have got some respite. They will now be able to reschedule the loans that were to be repaid by March 2009, and some restructuring can also be expected, now that banks don’t have to classify the loans as NPAs. And at least home loan rates from the State Bank of India have been slashed — you can finance a home at 8 per cent. Whether or not it can afford to do so given that 1,000-day money still fetches a depositor 9 per cent is another question. The problem, however, is that if the real estate majors don’t get real, they could soon be in line for another bailout next year, or even earlier. Much of the problem, as is evident, is of their own making. They didn’t see the writing on the wall and so, while cashing in on the boom on the way up, didn’t lower prices quickly enough as the economy started slowing. Or perhaps they didn’t want to?

One would have thought that in return for the government’s generosity, the industry would return the favour. After all, they’re using up scarce capital. Also, construction costs are down now that prices of steel have fallen nearly 50 per cent. But even though the signs of trouble are pretty apparent to everyone now, you still don’t find too many cuts in prices by real estate majors. Sure, there are the usual discounts of 10-20 per cent being offered, but these aren’t really serious offers. If you look closely enough, builders aren’t really offering to slash costs in existing locations—for instance, DLF is selling apartments in Hyderabad at 20 per cent below the market price. But most are holding on to inventory in the posh areas, and are converting larger flats into smaller ones; the prices per sq ft aren’t really lower.

This sounds counter-productive. For, with construction costs collapsing, you’d expect that, even at lower prices for completed flats, the margin structure of the majors wouldn’t get affected too badly — for the older players like DLF where the land banks are so old, the incremental costs are only those of raw materials and labour. So, if they lowered prices and attracted more buyers (it’s a myth that, with job uncertainty, the middle classes will not buy property even if priced correctly), the builders would see their cash flows improve. Also, builders were ostensibly bailed out so that they could create jobs for construction workers. But most developers are postponing or stalling projects, so where are the jobs for construction workers?

One reason why builders are not really making sharp cuts in prices, is possibly because they’re underestimating the slump. So, they’re willing to lose some income now for capital appreciation later. A look at some analyst reports suggests this is unlikely to happen. If sales volumes collapse like they’re expected to—CLSA expects DLF’s top line to fall from Rs 14,438 crore in 2007- 08 to Rs 9,907 crore in 2008-09 and Rs 5,079 crore in 2010, and Merrill Lynch reckons Unitech’s revenues will slide from Rs 2,998 crore in 2008-09 to Rs 2,557crore in 2009-10 —the debt overhang will get killing. In the December 2008 quarter, by the way, industry revenues were down anywhere between 60-90 per cent. The reported net debt, however, is huge. DLF’s is close to Rs 14,000 crore, Unitech’s is Rs 9,000 crore and Sobha’s Rs 1,800 crore. A Deutsche Bank report says a spike in debtors and debtor days, across the sector, implies either that customers are delaying payments or have stopped paying. Now combine the two to see how potent the combination is. According to CLSA, DLF’s interest bill in 2009-10 will be in the region of Rs 1,800 crore on revenues of just over Rs 5,000 crore. In 2010-11, the bill is expected to be only slightly smaller at Rs1,680 crore. The story is not much better for Unitech; interest payments are estimated to rise from Rs 264 crore in 2008-09 to Rs 423 crore in 200910. Given this, isn’t it a better idea to simply slash prices in a few projects and get cash flows going? Unless, of course, the real estate majors are confident they’re too big to fail, and another bailout is around the corner. That, after all, is the real lesson from the US financial crisis — you don’t pay for your sins, we do!