Real estate is turning again

By Jharna Mazumdar

The real estate in India has been in a slump over the last half a decade. The cash-crunch in the sector is evident from the falling sales and shrinking margins, which has translated into real estate developers having to cut their ad spends. Data indicates that ad spends by real estate developers have more than halved as focus has turned to clearing existing inventories rather than launching new projects.

Earlier developers were enjoying high margins -of more than 50% -but these have dropped by more than half since 2014, as demand for residential and commercial properties had declined sharply. Developers mostly advertised in newspapers, and on hoardings. “In the last few years real estate advertisements have dropped drastically. Earlier there used to be many full page real estate ads in newspapers and also several big hoardings across the city displaying ads of real estate projects, but as sales slowed down the ad budgets shrunk with developers focusing on cost cutting,” said Ramesh Nair, chief executive officer and country head, Jones Lang LaSalle India.

This Industry consolidation had been triggered by disruptions since 2017, such as demonetisation, Real Estate Regulatory Authority (RERA) implementation, GST rollout and the implementation of the bankruptcy code. Ad spends are aggressive on new projects for customer awareness and popularity, and developers have been focused on focused on clearing existing stocks rather than launching new projects. A senior official from Kumar Urban Development, said, “As a cost cutting measure we have drastically reduced our ad spends. We are focusing on reducing our existing stocks rather than launching new projects. It is the same scenario with most of the developers as the sector has witnessed significant slowdown in sales over the last few years. Margins have shrunk by more than half for the sector and so did the ad budgets.”

A JP Morgan report further highlights that, sustained working capital increase on under-construction inventory and lower margins have impacted the financials of real estate developers. “Margin headwinds look to be receding, and the sell-down of completed inventory acts as an additional offset. However, positive working capital, debt on under-construction projects now looks to be the new normal, given industry dynamics. Our base view that a seven-year down-cycle in residential sales ended in 2018 stands,” said Saurabh Kumar, analyst, JP Morgan.

Read Also: To discover local places, Google Maps brings three new features for Indian users

The historical model of excess pre-sales to fund construction, land payments is over. End users are more wary of buying under-construction properties, and investors have realised that returns on real estate investment at present don’t justify the risks. Sales pattern are far more skewed with lower sales during the project launches and increased sales towards the end (after occupancy certificate release). Industry experts say that sales pattern of even some top developers shows that ongoing sales are limited post launch and accelerate only towards the end of the project life. Project construction then needs to rely on construction financing. Higher working capital requirements will be more than offset by higher margins on project sales, as prices do tend to rise post-completion as risks get reduced and end users move in occupancy increases. However, there will be liquidity issues in the initial phase impacting ad budgets.

It seems the worst is over for the sector and demand is expected to revive from the second half of this financial year. Strong pre-sales reported by listed developers in FY19 suggest that market share improvement is now becoming structural. With financing conditions tightening for Tier 2 developers, these gains will continue in 2019 for the listed players.

Rajeev Talwar, chief executive officer of country’s largest real estate company, DLF, highlighted that ad spends depends on individual company strategy. “Our inventory in 2017 was around Rs 15,000 crore which we have managed to reduce it to Rs 11,500 crore, but still it is on the higher side and to clear the stocks we will have to spend aggressively on ads.”

Read Also: Gautam Adani woos Amazon and Google with Indian data hubs

Fast normalising pre-sales were reported by listed developers in FY19, giving confidence that this may continue in the remaining half of this financial year if no major disruptions happen. “Listed Mumbai developers have also been registering improvements in pre-sales over the last few quarters. Notably, Lodha, Oberoi and Godrej have all seen an improvement in sales levels in the market and clearly have been registering sales trends that are better than other developers, implying some level of market consolidation. Launches, which were down to a trickle early last year, have increased markedly by almost all developers in the city. New launches are being planned with lower unit configurations to address affordability. However, the market is becoming sharply two-faced. We see mid-income, affordable parts of the market doing reasonably well compared to high-end luxury projects. We believe in FY20-21 the real estate companies are likely to see strong profits based on back book sales completion and inventory monetisation. New accounting standards for project completions will make book value and earnings per share real numbers and showing the real profitability of a company’s margin across the project cycle.”

Further, within specific markets, Gurgaon’s residential market has now been falling consecutively for six years, so there is a case for stabilisation in 2019. Mumbai’s residential recovery, on the other hand, has already started and, if not for market dislocation in 2017, would have likely continued last year, as well. Bangalore’s residential downturn has now lasted four years. Cycles in that market are typically shorter than in rest of the country, so the market will recover strongly in 2019, said the report.