Building castles in the air?

SECTOR REPORT

While developers may have built up valuable land banks, it is difficult to value them given the lack of transparency.

February 2005: Government allows FDI in real estate under the automatic route

April 2005: ICICI Bank and Tishman Speyer set up $300 mn real estate fund, raised later to $1 bn

February 2006: SEZ Act notified, proposals for 150,000 acres follow

March 2006: The Supreme Court clears sale of 240 acres of mill land in Mumbai

May 2006: DLF announces a Rs 13,000 crore IPO

May 2006: Unitech clinches a 345 acre deal in Noida for Rs 1,582 crore

May 2006: Property stocks go through the roof

June 2006: SEBI announces guidelines for real estate mutual funds

You can't beat the real estate sector for action. And if inflation in commodities has left us gaping, so has it been with real estate prices. With demand from all segments be it housing or retail, as robust as ever, property prices have only been moving one way. Skywards.

Consider: In north Bangalore, land prices have risen five-fold in the last 18 months: from Rs 25 lakh per acre, they are now anywhere between Rs 1.5-2 crore per acre.

Over the same time, rents in the central business district of the garden city rose by about ten per cent""they are now Rs 45 per sq ft per month.

In mid-town Parel in Mumbai city, the rise in the last four years has been over 100 per cent, while prices in the Mumbai suburb of Kanjurmarg have shot up from Rs 2000 per sq ft two years back to Rs 4,000 per sq ft.

Property stocks have more than kept with prices, giving returns of between 75-85 per cent to 3000 per cent over the last one year. While there is no doubt that the land banks of many of the companies do have tremendous value, investing in the sector can be a leap of faith, given that there is very little transparency in terms of prices.

Real estate and money management firm Jones Lang La Salle rates the Indian property market transparency as low in its international transparency survey." It is difficult to get reliable information on the property market particularly because prices tend to be very localised and dependent on a host of factors," explains Kishore Gotety, director, investments, ICICI Venture Funds.

It doesn't help that many real estate deals are believed to involve "unaccounted money". Moreover, managements are reluctant to reveal the cost at which they have acquired land, or even at what price they have sold it.

Typically, companies would be valued at a 15-25 per cent discount to their land banks, with better companies""in terms of credibility and management quality""getting a lower discount. While internal rates of return (IRRs) for developers can be as high as 25-30 per cent, the risks are also high.

Again, profit margins can differ from project to project""depending on whether it is a housing complex or a mall"" though gross margins (before fixed costs) of 25-30 per cent are achievable.

The poor transparency is also probably one reason why, not too much foreign money has come into the sector.

According to Rajeev Piramal, executive-vice chairman, Peninsula Land, which is planning two real estate funds""Rs 1,000 crore domestic fund and a $250 mn off shore fund, "No real money has come in as yet, because foreign investors are still trying to figure out how things work." 

HOW THEY COMPARE
(Rs Crore)	NS06	NS05	OP06	OP05	NP06	NP05	OPM%06	OPM%05
Ansal Housing & Construction	125.42	84.96	39.16	18.07	20.59	6.09	31.22	21.27
Ansal Properties	344.56	209.11	82.62	37.28	50.85	13.62	23.98	17.83
Bombay Dyeing	1013.01	1025.60	87.30	60.92	61.34	26.56	8.62	5.94
D S Kulkarni Developers	16.60	35.06	17.11	6.90	12.61	3.68	103.07	19.68
Mahindra Gesco Developers	121.14	91.46	22.98	20.10	11.00	7.85	18.97	21.98
Penland Ltd	163.95	62.23	104.63	-9.25	77.18	-9.52	63.82	0.00
Unitech	653.13	509.76	143.75	63.27	69.65	29.91	22.01	12.41

Are prices likely to rise at the same pace as they have in the last two years. "Unlikely," says Gotety, observing that while demand continues to be strong from the housing sector, the demand will be there only at a price. Again, if one looks at the IT and ITES sectors, there too the idea is to keep costs down, which means that beyond a point, demand will tend to taper off." But as of now, prices have not come off significantly.

Says Pranab Datta, MD&CEO, Mahindra Gesco, "We have not dropped prices and we don't know of other developers who have. However, the pace of deals in the housing space may have slowed down with buyers waiting for prices to cool off."

Demand, however, is unlikely to flag, given the buoyant economy and growing disposable incomes. And it will be driven by :

Huge demand for housing, which constitutes nearly 70 per cent of total demand for real estate, given the shortage of 20 mn dwelling units and shrinking household sizes

Growth in organised retail from three per cent today to 10 per cent by 2010. The need for office space, especially from the IT and ITES, financial services, pharmaceutical and other sectors, which will require 55 mn sq feet of space every year

Companies wanting quality commercial space in SEZs, given the attractive tax benefits.

Thus, demand for real estate will, without doubt, remain strong. In the last few years, prices have risen higher than rents, in Tier I cities, and this trend is likely to continue. Therefore, rent yields could fall further. Given the price increases in the bigger cities, demand may spill over to Tier II and Tier III cities. 

MALLS AND MORE Number and mall space in 2006
	No. of malls	Gross leasable area (m sf.)
Delhi	96	23.5
Mumbai	55	16.20
Bangalore	14	8.00
Chennai	6	2.50
Kolkata	10	3.20
Hyderabad	12	4.20
Pune	19	5.60
Ahmedbad	7	2.70

In 2005, the volume of new development of office space was around 6.5 mn square feet, while the net absorption was around 7 mn sqft.

For developers, Special Economic Zones (SEZs), are also an attractive proposition, given the throwaway prices at which governments are allocating land and the various tax sops. So, despite the fact that the cost of construction materials has escalated, several developers are venturing into SEZs.

Unitech builds both residential and commercial complexes. It has already built 8-9 mn sq feet of residential property and 2.5 mn sq ft of commercial property.

The company plans to scale up its business and move into cities other than the National Capital Region (NCR). It proposes to club property together with hotels, amusement parks so as to enhance value and also plans to set up SEZs. It has a target to complete 9 mn sq ft and 15 mn sq ft of saleable property in FY07 and FY08 respectively.

Over the next one and a half years, the company plans to initiate projects involving an area of 70 mn sqft. Of this, residential properties would account for around 75 per cent. It is reported to be building up a land bank of around 8,000 acres, across cities.

Mahindra Gesco's focus will continue to be residential projects, though it will increase the scale of projects. The share of commercial projects is likely to go up to about 10 per cent from five per cent currently. The company has ventured into smaller towns like Pune.

Having completed its first SEZ in Chennai (1,400 acres), it is now taking up two more in Jaipur (3,000 acres) and Karla, near Pune (3,000 acres). The company has managed to sell space in the Chennai SEZ in the range of Rs 12-30 lakh per acre. The company is planning to raise funds to the tune of Rs 500-600 crore.

Peninsula Land operates across asset classes""residential, commercial, retail""and has set up residential and commercial complexes mainly in Mumbai. The company has three major projects on hand, involving an area of 2.5 mn sq ft, which it plans to complete over the next two years. It recently acquired Dawn Mills, with 0.5 mn sq ft of land, which will be merged with the company.

Peninsula also plans to set up three SEZs in Goa across 250-300 acres and also one in Pune (60 acres). The company has disposed off its Crossroads property in Mumbai. Says Piramal, "There is demand for residential properties, especially at the high end and this should continue since supply is not imminent."

DS Kulkarni focuses on low cost housing in Pune but is also entering other cities such as Mumbai and Bangalore. Besides, it is also foraying into IT Parks and malls.

The company currently has approximately three mn sq ft of area under construction. One of its projects is a 10,000 flat housing complex which is expected to be complete by 2010. The company is also undertaking an overseas project involving Rs 100 crore, in the US through a 100 per cent subsidiary.