Rising raw material costs make analysts cautious on realty stocks

Analysts are turning cautious on stocks of real estate companies, which have been hit by a double whammy of rising input costs that may push them to pass on this surge to the consumers and a possible rise in interest / home loan rates over the next few months that can slow their sales.

At the bourses, the Nifty Realty index has been an underperformer, slipping nearly 7 per cent thus far in calendar year 2022 (CY22) as compared to around 1 per cent dip in the Nifty50 index. Indiabulls Real Estate, Sobha, Godrej Properties, Macrotech Developers and Sunteck Realty have cracked 8 per cent to 36 per cent during this period.

According to A K Prabhakar, head of research at IDBI Securities, most realty stocks are trading at a reasonable valuation. The markets, he said, have recovered from the recent lows, but realty stocks have not rallied much due to the rising cost hangover.

"It will be very difficult for the developers to pass on the rise in costs to the consumers. Costs of steel, cement etc. have risen sharply. Gas price increase has also seen costs of tiles also rise. The demand in the real estate sector had been strong due to low rates and affordability, which is now likely to taper off. Pune, Bengaluru, Chennai and Hyderabad are IT hubs where the salaries have gone up sharply over the last two years. So, these areas may still see demand sustain. Someone with 1-2 year’s investment horizon should avoid real estate stocks," Prabhakar said.

Cost escalation

Over the last one year, developers' average cost of construction has risen 10 – 12 per cent, owing to higher input cost due to supply-side constraints. This surge in cost comes at a time when developers have been under pressure due to higher debt and liquidity concerns over the last few years.

The cost of key materials like cement and steel have risen over 20 per cent year-on-year (YoY) as of March 2022 and constitute a predominant share in the total cost of construction, analysts said. So far, developers have been cautious about increasing prices as the market was recovering from the aftermath of Covid-19. However, they have now started feeling the pinch of rising cost and started reviewing their pricing strategy.
 

"With rising material cost, developers will be compelled to increase prices as construction materials account for about two-third share in the total cost of construction. Developers are operating on thin margins. The rising cost will impact developers in the affordable and mid-market segments relatively more as they are already operating on lower margins. With wholesale price index (WPI) and material cost, both seeing a double-digit rise, the cost of construction can rise by a further 8 – 9 per cent by December 2022,” said Ramesh Nair, CEO, India & Managing Director – Market Development for Asia at Colliers.

Residential projects in the affordable and mid-income segments carry relatively lower margins and are price sensitive, Colliers said. Any major increase in input cost can, therefore, put pressure on developers to pass it on to the end-users.

Those at Jefferies say the construction costs are 25-40 per cent of the selling price of the unit, and around 50 per cent of them are stickier labour costs. A 10 per cent selling price appreciation, they said, can absorb the recent construction commodity price spike. Among the lot, DLF, Lodha, and Sobha are their preferred picks from a one-year horizon.

=============================

Twitter: @Pun_ditry