Amid consolidation, gains for realty index may continue in the near term

Ongoing consolidation to help residential players expand their market share further

There is consolidation in the real estate market, resulting in speculative trading action in the stocks of listed developers. Over the past two fiscals, the market share of the top 10 listed realtors has risen to about 22 per cent of the real estate market, up from around 16 per cent in 2018-19. 

In addition, the low interest rate regime has created demand while allowing companies to deleverage. The balance sheets of the larger developers have improved, with aggregate net debt coming down by over 25 per cent in 2020-21. Low interest rates also translate into lower EMIs for mortgages, and this has created some demand. 

There has been inventory liquidation and also consolidation, with larger developers taking over projects initiated by smaller realtors who have suffered distress. There are high levels of bookings and pre-selling in units expected to be delivered between 2021 and calendar 2024, indicating that supply overhang is limited.

The base effect of the poor Q1 in FY21 due to the lockdowns last year, is expected to push up sales growth in Q1FY22. Estimates suggest that this could lead to around 90-95 per cent revenue growth in Q1FY22 on an annual basis.  Residential sales were at around 50 per cent of pre-Covid levels in June 2021, and volumes may recover to pre-Covid levels from the second half of 2021-22.

The recovery is in a nascent stage. Surveys indicate developers are facing labour shortages; the under-capitalised developers are facing issues in servicing existing loans; construction costs (such as cost of materials like cement and steel) have increased. 

Demand for long-term, big-ticket assets cannot be driven purely by lower EMIs, given a situation of high unemployment and low growth. This demand would not be sustainable unless there’s a strong growth recovery over the next two–three fiscals. 

As of now, GDP is expected to grow quickly over the next two fiscals. But that growth must come hand-in-hand with reemployment. By analogy with the US housing boom, there may be a “K-shaped” demand curve, where high-end real estate continues to see demand, but there’s less interest in lower-end affordable housing. 

Mortgages are long-term instruments and sooner or later, interest rates will rise. Then, realtors could see demand tapering off, and we may even experience mortgage defaults, unless growth recovery takes place along the expected lines. 

Another factor suggests investors should exercise some caution: Demand for commercial real estate has been affected by the enforced work from home (WFH) paradigm shift. Although there are signs of recovery, this segment is likely to see a long-term down-shift in demand. Many corporates will cut back on space occupancy given that WFH has helped in cost-cutting, without commensurate loss of productivity in many industries. 

Chances are, the consolidation will continue, giving the upper hand to listed developers who have better balance sheets with lower debt:equity ratios. They may take over more market share as the under-capitalised are forced out. The NSE Realty Index has returned 80 per cent in the past year, and 2.9 per cent in the past month, beating the Nifty which has returned 46.5 per cent and 0.3 per cent in the respective timeframes. The sector certainly looks like a good momentum trade.