While investing in realty stocks, here are a few things that you should look at.
Despite real estate companies being the most profitable among the listed entities, some in the investment world are wary of them. Take the example of Rajat Jain, chief investment officer at Principal PNB Asset Management Company. He says he does not hold real estate stocks in any of his equity funds. “The companies are too complicated to make an investment decision,” says Jain.
This is despite the listed entities in the sector giving an annual net profit-to-sales ratio of 36 per cent till September-end even in the face of an economic slowdown.
At the same time, the sector is a trader’s delight, and they swear by it. The stocks are sensitive and react sharply to every small bit of news – good or bad. Take Housing Development and Infrastructure (HDIL). At the month-beginning (November 3), it was trading at Rs 291.75. A week later it went up to Rs 374.75 (28.44 per cent rise). Last week, on Friday, it closed at Rs 308.9 (down 17.57 per cent from November 11 price).
“Due to this sharp volatility of price, it makes sense for investors to buy good companies when they dip and book profits regularly,” said Ajay Parmar, head of research – institution equities, Emkay Global Financial Services.
For an investor in real estate stocks, here are some unique features they should be looking at besides the two macro factors – economy and the Reserve Bank of India’s policy measures. The former is critical because if the economic growth rate slows down, there are fears of job losses and as a result, few people or companies are willing to purchase real estate.
For instance, in December 2007, DLF’s share price was quoting at a whopping Rs 1,073.80 because the economy was buoyant. After recessions fears emerged, the company’ stock price plummeted almost 86 percent to Rs 151.70 within three months. Also, some developers can get more impacted than the others, depending on their presence in various segments. Orbit Corporation’s business, for instance, suffered more than diversified developers last year as it only builds luxury projects.
Then, the hardening of interest rate affects the demand for houses, which in turn impacts companies’ profitability. Lower rates induces buyers to purchase houses.
“A clear example is the last six months. As interest rates bottomed out, the demand for houses started picking up,” said Param Desai, who looks after the industry as a research analyst at Angel Broking. The central bank also cautions banks time and again on lending to developers. In some quarterly reviews, RBI has also increased risk weights for the sector. This makes it difficult for banks to lend to builders.
COMPANY MODEL: When an investor looks at a real estate company, the first thing to observe should be the diversification of business. Check if the company has presence in verticals such as residential, commercial, retail and hotels. This ensures that the business is diversified to the extent that if one segment is not doing well, the other one will.
For instance, analysts say that revenues of listed entities in Bangalore, such as Sobha Developers and Purvankara, come purely from residential properties. As a result, when information technology (IT) companies suffered due to the global economic slowdown last year, these companies were hit.
ACCOUNTING & FINANCIALS: Companies in property business have two methods of accounting—project completion method and percentage completion method. Most of the companies follow the latter model. In percentage completion, the companies book revenues as and when the project is completed and sold. Some companies, such as HDIL follows project completion method, wherein the income is realised when the project is completed. “Since the revenues of realty compnies are erratic, the percentage calculation method is preferable,” adds Parmar. Importantly, quarterly financials are of little importance. Investors should rather look at sequential completion of projects on quarterly basis and average realisation or average rent per square feet. “Keeping a track of increase in volumes gives a better picture of what the company is up to,” said an analyst.
LAND BANK: In 2007, companies raised huge amounts through public offers, based on their land bank. DLF, for example, managed one of the biggest initial public offers of the country because it had a land bank of over 10,000 acres. But, this has changed over the past two years.
Analysts say that it’s not just the acreage of land that is important but the quality as well. The company having land reserves in better locations should be preferred than one who may have large reserves, but at regions where development has not yet started. For instance, in Mumbai, there is always shortage of land. “This means even if the real estate markets crash, developers in Mumbai will not see huge corrections,” said Desai.
If a company has its land bank in locations where they are heavily banking on some future development to increase their value, analysts suggest that these reserves can be ignored. For instance, some companies in the South hold land at Shamshabad, near Hyderabad. These developers are banking on the upcoming international airport and infrastructure developments around the area. Similarly, investors can also discount agricultural land. “Converting such parcels to non-agricultural land is a time consuming process and involves a lot of money,” said an analyst.
Further, the cost of acquiring the bank is also very important because it gives an idea whether the company has been able to acquire land cheap to make huge profits when properties hit the market.
NAV: The earnings of developers are inconsistent due to the changing price of their assets. So, the analysts do not consider price-to-earnings as the right parameter to gauge the performance. Instead, they look at net asset value (NAV). Simply said, NAV shows the future cash-flow of the company. This is calculated by assuming the money that the company will generate in the future and then, discounting it to the present value.
DEBT: Most of the listed entities in the sector have a high debt burden. This is because of their build-and-sell model. Real estate companies are always starved of money as they first need to deploy money and build projects. Revenues follow later. But a high debt-to-equity ratio also decreases the ability of the company to borrow more for further construction. This can result in project delays, or even stalling of projects.
This was widely seen last year when banks stopped lending to them around October. According to realty research firm PropEquity, over 1,089 projects in four metros and cities such as Bangalore, Pune, Kochi and National Capital Region were delayed. These were scheduled for completion in 2008 and onwards.
Transparency Issues: Many investors do not prefer to invest in realty companies as they have high cash component that developers cannot account for. To top it, all listed companies have several hundred subsidiaries. Even analysts find it tedious to track the financials of each of these subsidiaries. Also, many promoters privately hold stake in such subsidiaries that help them to garner profits from projects.
Most feel that real estate companies are not yet fit as a long-term investment. “They sector is cyclical and stocks are high beta. It makes sense to keep booking-profits in them regularly,” Parmar says.
