'Realty prices may fall on slack volumes'

Q&A/ Pranay Vakil, Chairman, Knight Frank

There is a lot of debate over valuation of land with the Sebi coming out with guidelines on the subject. What is your view?

Valuation, in most cases, actually means evaluation of land at its future saleable price. This creates artificially hyped values. Generally, valuation in the real estate market is done on an as-is-where-is basis. It has to be in the present tense and not the future tense. Whatever valuation is done should be realisable and comparison, if any, should be made between the likes.

In all other methods of valuation, one has to make many assumptions such as what is built on the land, as each entity will give different returns. In many cases related to SEZs, agricultural land is shown as land bank. But, it cannot be developed unless it is converted into non-agricultural land. Such valuations of costs and returns are based on assumptions. The more the assumptions, the more artificial the valuations become. From this perspective, the Sebi guidelines are welcome.

How can one decide on the true value of land bank?

The quality of titles is one of the most important issues. To decide this in a simple manner, ask three questions to a developer: Does he own the land? Has he paid for the land? and Can he build whatever he wants to on the land? If answers to all these questions are yes, then valuations can be more realistic.

What should an investor look at when evaluating real estate equities?

A developer will always try to finance his project with debt. In the case of debt funding, after deducting the interest burden, which is also deductible expense, whatever is left is his profit. If he dilutes equity, his profit gets shared. Besides, he has to pay a higher dividend distribution tax. Whenever a developer opts for dilution of equity, it means that he has exhausted all the means of getting debt.

How are the rising interest rates affecting the real estate sector?

Banks are not giving loans for land unless it is part of the whole construction project. The rising rates do not affect those who already own low-price land. However, those who have recently purchased high-cost land through auctions or from National Textile Corporation, whose purchase has been financed by banks, will be under pressure to complete the project quickly, as the interest meter is rising fast. They have to control the damage by completing the project and selling it off as soon as possible.

How will the real estate prices be impacted?

The next two months are crucial for the market. The volumes have almost dried up in recent times. Mid-April to mid-June is traditionally a period for real estate purchases and all developers are anxiously waiting for the buying to begin this season. If it does not happen, see how prices will start falling. They may not fall directly. Developers may give freebies such as free parking space, paying stamp duties on behalf of purchasers, even paying a part of the EMI. They will not directly reduce the prices, as it may encourage customers, who had purchased earlier, to stop paying further.