Opportunity’ in realty chaos

Opportunity’ in realty chaos
The Hindu Business Line, April 12, 2009, Page 13

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Even if property prices and interest rates fall, ‘sentimental recession’ in the buyer’s mind may put off purchase.

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Mr SUNIL ROHAKALE, EXECUTIVE DIRECTOR, ASK INVESTMENT HOLDINGS

Suresh Parthasarathy Vidya Bala

Unless interest rates drop to a compelling level of 7 per cent, there may not be a significant pickup in residential demand, says Mr Sunil Rohakale, Executive Director, ASK Investment Holdings. This Wealth Advisor has nevertheless chosen to launch a real estate private equity for Indian investors. Mr Rohakale explains as to why this fund, which will predominantly invest in residential units, was chosen to be launched during a downturn. He also explains the reasons for the slowdown in demand and how a realty fund may be a superior option for investing in real estate.

Excerpts from the interview:

How does investing through realty fund score over direct investing in realty or buying realty shares?

For one, there is concentration risk of buying a property as against the diversification that a fund offers. Two, investing in a realty fund amounts to stepping into the developer’s shoes instead of buying from the developer. In other words, one can benefit from the extra margin enjoyed by a developer. Three, direct investing in realty has additional costs such as stamp duty and registration and recurring costs such as property taxes. Four, the question of when one should exit and who should moot such an exit would arise in direct investing. Five, maintaining a building/flat and leasing and managing it is a hassle.

In investing in realty through stocks, one loses control of money and cannot have much say in the capital efficiency. A private equity fund keeps full watch over money flowing in and out of the project and ensures that there are no diversions. Risks attached to a project – including those related to reputation, completion and title – are evaluated by experts in the fund. A private equity fund with a clear-cut strategy and which is not open ended can, therefore, score over the other options of investing in real estate.

With realty sector being overshadowed by various concerns, would investors not view your fund as a high-risk investment?

Historically, real estate, whether land or house or office space, would have grown to 3-5 times the cost. With GDP growing from 5 per cent to 9 per cent, the home buyer’s profile too has changed. So if one sees the changing profile of a customer (from a lender’s perspective) the average age of a borrower was 47 in 1998 and he was looking for a Rs 3.5-lakh home loan and was happy with a 70 per cent loan to value ratio. In 2004, the average age of the borrower was 38 who wanted Rs 7 lakh of home loan and the loan to value was 80 per cent. In 2008, this profile changed to a 32 years, wanting a Rs 15-lakh loan, with a 90 per cent loan to value ratio.

The point that I am trying to make is that the customer has moved from being a risk-averse Indian to a risk-taking Indian; from a low-income individual – whether government or bank employee or working in a private company – to a higher income individual, with higher surplus income.

When did the home buyer’s demand wane?

Housing became unaffordable for many, as developers began to make luxurious houses. When this happened, interest rates too went up from 7 per cent to 12 per cent between 2004 and 2008. This also reduced affordability. Property price hikes also added to the fuel.

A 0.5 per cent increase in interest rate means an increase of Rs 30 per lakh of EMI. Interest rates have gone up by almost 500-600 basis points. Where the individual EMIs was Rs 50,000, a 6 percentage point increase in interest rate leads to EMI becoming Rs 65,000. Now, where am I going to pay that additional Rs 15,000 from? Initially banks were kind to increase the term… but you can’t be an 80 years when the loan matures.

You were talking about the sharp hike in interest rates. Was this not accompanied by a huge jump in income levels as well, especially in the last 10 years?

Correct. If you see HDFC’s data it says that 22 times of your annual income was needed to buy a house sometime in 1995-96. Today, you need six times your annual income to buy a house. But worldwide this figure is 3-4 times. So there is still scope for either incomes to rise or property prices to decline.

Our observation is that in India, the income of government employees has risen 6-7 per cent CAGR in the last 10 years. Private sector employees earn 12-15 per cent more. The knowledge economy – primarily IT and IT-enabled services, banking and insurance and telecom – which has been the driver of growth for quite some time now, has seen a salary increase of 15-20 per cent CAGR in the last 6-7 years. So an average Indian has seen a 12-13 per cent increase. Property price in the same period has increased by more than 13 per cent, affecting affordability. If you take the property price index of NHB, a property in Bangalore priced at Rs 100 in 2001 had gone to something like Rs 230 in 2007 (this works out to a CAGR of 15 per cent). This growth is definitely far more than the rise in income. The quality of houses and amenities offered have also changed between 2001 and now, thus putting additional burden on affordability.

Now that interest rates are declining, would housing demand pick up?

Unless interest rates drop to a compelling level of 7 per cent from the 10.5 per cent, there may not be a significant pickup. In our country, 6.5 per cent mortgage rates have happened. This will bring EMIs to a reasonable level; the original level where the borrower will once again have his surplus.

Even if this happens and property prices comes down, the ‘sentimental recession’ in the buyer’s mind may put off his purchase. He is today worried about the economic uncertainties, his job, whether the factory would work three days or five days and so on.

So what is the opportunity that you see in real estate today?

In any private equity investment, the investor is more concerned about the entry point. We do not see an opportunity to enter at the land stage because land has already been aggregated in the last two to three years. So entry has to be in the development stage. The opportunity for us is to get into those residential projects, where the plan approvals are already in place and the construction is about to start; or where construction has been started but there is no financial closure.

Secondly, there is opportunity for investment at the asset level rather than at the holding company level. The latter needs exit opportunities such as IPOs; this makes it more uncertain. We do not want to be a builder but a facilitator of the asset development so that we have control over the execution.

The third point is that SEZs and townships have longer gestation period, are decade-old projects and are not meant for an investor with a horizon of five to seven years.

Similarly, the current rentals in malls have become so unaffordable to the tenant that his business is no longer viable. Tenants have started re-negotiating fixed rents. So we feel that these segments are ahead of times, although there will be opportunities for long-term players.

We were looking at a five-year period, and therefore these did not fit our bill.

As the first three years have already been given for the developer to acquire land, the question here is how much time would be required to build a three-lakh-sq.ft or a 100-flat residential project? Architecturally, 30-36 months is a reasonable time for a 100-flat project when the plans are approved.

So, do you expect the demand to revive by the time the projects you enter into are completed?

A revival may take another 18 months. By then some amount of interest rate decline and price correction is likely to happen. I do not rule out another 25-30 per cent correction. So, a total correction of 50-60 per cent from the peak prices is very much possible. While we would reach a neutral stage in the December quarter, with a stable Government, clarity on jobs and income and improvement in global economy, transactions will start happening from the September quarter of 2010 onwards. The current journey of developers launching projects, at lower rates and lower sizes is a step towards liquidity and affordability for various segments. So we will use the next 24 months to deploy our funds.

We will collect 20 per cent of the application money and the rest over 24 months to provide value proposition to investors.