Realty: Cash flow challenges

Property stocks have staged a strong comeback in the recent rally with the BSE Realty Index gaining 49 per cent compared with a 31 per cent move for the BSE Sensex. Apart from the fact that they had been been mauled, stocks have bounced back because several companies have managed to get their loans rolled over from banks which means repayments have now been postponed to 2010-11.

However, companies still need to meet recurring cash flow obligations (interest plus the difference between recurring operational costs and income) and according to Motilal Oswal, this could be a challenge. A recent report concludes that while many firms are relying on affordable housing projects will allow them to generate adequate cash flows, they cannot afford to do so.

The report says companies would require contributions from other segments such as commercial or retail space as also from premium housing. The bad news is that the recovery in these segments seems a long time away because the supply of space today far exceeds the demand. That’s one reason why Edelweiss Capital expects a further correction in property prices of 35 per cent over the next three years. Demand from the IT sector, one of the biggest consumers of space, has almost dried up as has the requirement from retailers.

Against this backdrop, real estate firms could have a problem matching their cash flows unless they keep selling their assets.