'These are the sins of a typical bull run'

Q&A/ Gaurav Dalmia

Nothing seems to be going right for the country's real estate developers: Consumers have started shying away from the market with the rising interest rates on home loans and developers are unable to tap funds.

Though developers are still putting up a brave front, they know the ground under their feet is shaky. Gaurav Dalmia, the chairman of Landmark Land Holdings Pvt Ltd, which has invested in more than eighteen projects in the past five years, tells Bhupesh Bhandari what went wrong.

Isn't Indian real estate facing its worst ever crisis?

There is nothing called the Indian real estate market. It's a myth. There are local markets with local demand and supply. Indore or Kochi could be different from Delhi. However, the offtake of the end product today is lower than what it was six months ago in most markets.

The slowdown is driven by the sales of the last three years a lot of which went into the hands of speculators. This is now coming back to the market. The rise in interest rates is not the cause of the problem, it has only amplified it. So, this is one thing we can't blame Finance Minister P Chidambaram for.

Many investors are not paying their instalments. Mortgage rates were variable, not fixed. Genuine buyers with old assets are feeling the pinch and will opt out of the market. There is trading pressure from them.

What was the extent of speculative buying?

In housing, half the sales in north India would be to speculators. It would be lesser in the south. Delhi would be the highest.

How badly has commercial real estate been hit?

The rise in interest rates will hurt office space and retail even more. Each rupee of lease income is worth less now because the interest rates have gone up. So, buildings will be valued at less. There will be a dramatic fall in the borrowing capacity of developers against these assets. Developers who were looking at returns from these assets on a fully leased basis will be hit the hardest.

In which markets do you thing the correction in prices will be more severe?

In some tier two cities, the assets were priced outside the purchasing power of the local population because of huge investments by speculators. There will be a severe price correction in these markets. Again, it has less to do with interest rates than simple affordability.

The tap of funds seems to have been turned off for real estate developers. How bad is the situation on the ground?

I know that developers with billions of dollars in market capitalisation are borrowing at 18-19 per cent interest. Some equity deals have been done with a put option, guaranteeing returns of 18-20 per cent.

But I don't think this will lead to a catastrophe. The pain will be felt by those who have behaved like fly-by-night operators. Unfortunately, most developers fall in that category. Better developers will be able to sell products. It's a matter of pricing. For such developers, there will be a lot of struck projects available. Weeding out is round the corner.

At much lower valuations than six months ago?

Yes.

Will international capital help sustain the industry?

Most of this capital is going to what is familiar to it. Show one of these people a decent project in Bangalore with decent returns and an extraordinary project in Mysore, the general tendency would be to go for the Bangalore project. They might be savvy investors but Mysore is unfamiliar territory. So, there is excess foreign capital chasing deals in some markets and very little foreign capital in other markets.

So what are the funding options left for real estate developers?

Private equity is the solution. And there are players who are looking at all sorts of things. Like any other market activity, it is about matching your project with the right private equity source.

What went wrong? What is it that the developers did not understand?

Instead of maximising returns from one project, developers were looking at moving from one project to the other. As cash was constantly required, many of them sold their projects too early. I am not sure if the developers believe in their own projects as they should.

If you look at the development of the Indian real estate market, DLF made its money in Gurgaon working there patiently for 20 years. The Hiranandanis made their money in one suburb of Mumbai over 15-20 years. They maximised the value of each project before moving on to another one.

You can make a couple of billion dollars by working at just a few projects. Large projects take time and require solid project management skills. If you are doing large projects, you must be prepared to go through a downturn. The 20 million square feet Canary Wharf project in London was conceptualised in 1987 and is still being done. Developers in India think such projects are easy. They aren't.

Historically, real estate has been one of the largest wealth creators in the world. Housing is the single largest industry in the world, though it is cyclical.

So, are we at the beginning of the down cycle?

In certain pockets, yes. Some developers are putting up a brave face and others are in denial. But the pain is self-inflicted. The correction also lies within the strategies of the developers.

Is the primary market dead for real estate developers?

There are two issues here. One, 75 per cent of all IPOs are trading below their issue price. Not that these companies are not doing well. But these IPOs were over-priced. So, the general perception is down. Two, in real estate, there is this esoteric phenomenon called land bank which is equated with profitability. This is a bizarre correlation. It is just land which you can develop, take the risk and possibly make money. I won't be surprised if real estate companies fail to live up to the expectations of investors. Welcome back to the dotcom days, though it is not so bad. These are the sins of a typical bull run. I have seen it in other sectors also.

Going forward, do you see returns on your real estate investments coming down?

Returns have been extraordinary in the last few years. We are still expecting 45 per cent returns, down from 60-70 per cent in the last 4-5 years. But we are in no hurry to invest all our money "" we can sit and watch television.