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Real estate developers have suffered from a combination of low demand, high interest rates and over-supply. Most have high levels of debt on their balance sheets and they are finding it difficult to cut leverage
The realty sector is among the worst performing segments of the Indian stock market. The sector index, the CNX Realty, tracks 10 stocks. The index is down 38 per cent in the past year; it was flat over the past two years and down 65 per cent in the past four years. The best performer in the last year is Pheonix, down 10 per cent.
The fundamental reasons are not difficult to find. Real estate developers have suffered from a combination of low demand, high interest rates and over-supply. Most have high levels of debt on their balance sheets and they are finding it difficult to cut leverage. In the home loan market, mortgages are high-interest and demand is soft. The commercial market is worse. Banks are reluctant to make advances to realty developers, so their access to funding is also restricted.
The realty sector has a high correlation with the financial sector because it is extremely rate-sensitive. In fact, it is high-beta with respect to the financial sector index, the Bank Nifty. And there are several realty stocks available in the derivatives segment. These stocks, such as Unitech, IBRE or DLF, are high-beta with respect to the realty index itself.
This means the realty index will move in the same direction as the Bank Nifty but will have an exaggerated movement. Given leverage in the stock futures segment and high beta stock such as DLF, Unitech and IBRE, the sector could offer a high-risk, high-return play on interest rates.
This is why thesector could be interesting for the trader who doesn’t mind gambling for somewhat high stakes. The realty sector in itself, might be fundamentally busted. But it is more or less guaranteed to respond with sharp short-term moves to any changes in interest rates. The chances are quite high that the Reserve Bank of India (RBI) will have to change policy rates in its next policy or even “off-policy” as Raghuram Rajan warned in the December policy update, where the central bank hit the pause button on rates. We will know in another 10 days if inflation has shown signs of abating. If it hasn’t, RBI will probably raise rates. If it does, shorts on realty stocks could generate even more in the way of returns than shorts on bank stocks or on the Bank Nifty. If RBI leaves rates unchanged or it looks as though there could be rate cuts because inflation has eased, the relief rally in realty stocks could be sharper than in the Bank Nifty or in bank stocks.
Given leverage and volatility, this usage of realty stock futures to play interest rates is in no way a safe trading possibility. But the risks can be controlled by use of sensible, disciplined stop-losses. Right now, the Bank Nifty is sliding slowly downhill and this downtrend could accelerate if the inflation numbers are high.
The author is a technical and equity analyst
