Realty Check on the real estate front: Unitech, Garnet Construction, Lok Housing, D S Kulkarni, Era Construction,Mehendra Gesco and BSEL Infrastructure Realty Ltd could be bought in a staggered way in this market: The next trigger for the markets is the Q4 results of most of the companies: Premier Explosives will complete the due deligence of the sale of the assets of the mushroom division in this month:Keep holding Zigma Software, Vishal Exports, and Soma Textiles with appropriate stop lossses for the short term. For the long term one do not have to worry as the long term India Growth story is intact:The sensex will touch 40, 000 by 2015 A.D. Indian Real estate sector is set for an exponential growth in the next few years, driven by favourable demographics( an ever growing population of young high income group), improving regulatory environmenet, rapid urbnisation, shorage of land, and robust support from the financial sector. Indian real estate revenues are estimated to be in the range of $ 15-16 billion for FY06-07 and which is rising at an annualized rate or more than 25%. But since the sector is fragmented with small and big players, it is very difficult to quantify the earning potential of the sector in the next few years. However, according to the research report from some of the brokers/analysts it has been found that its revenues is expected to cross $40 billion by FY08. Residential housing accounts for more than 70% of the sector. Long term drivers: This sector has been registering a phenomenal growth on the back of: a) Rising income of the of the middle class b) Increase in urbanization and concentration of the masses in the metros c) Healthy growth in the housing finance spurred by the low interest rates. Falling interest rates, coupled with aggressive marketing by the banks and NBFC’s have given a rapid rise to the mortgage finance d) Improving regulatory environment: i) Repeal of Urban Land ceiling act in some states: The urban land ceiling act, put limits to the Urban areas that can be acquired by any entity. This act was a major impediment in for smooth land acquisition in some states for big projects. Till now it has been repealed in 9(nine) states and some other states are soon going to do the same. (ii) FDI Rules Eased: IN 2005, the government eased the rules for foreign participation in the real estate sector. FDI is now allowed under automatic route for new projects meeting specific criterion. (iii) Tax breaks on housing mortgage payments: Interest payments on housing loans availed by the individuals have been made tax deductable, thus encouraging home ownership. e) Increasing consolidation in the industry: Real estate scene has traditionally been dominated by the unorganized players, who account for 70-80% of the total revenues from the sector. The primary reasons for this fragmentation are: (i) Restrive law and slow legal system makes it difficult to consolidate land holdings (ii) Lack of access to organized finance (iii) Spate of government clearance required for each project imply that that the relation with the local authorities are essential (iii) A sizeable portion of the financial transactions in this sector are unaccounted for(this is cash component which is used often used to “bribe” officials or to buy land from farmers. The industry has experienced some consolidation over the past few years driven by: ## Increasing prominence in organized finance via banks, FDI, and real estate funds, which is available for large players. ## Rationalisation of law( This includes repeal of ULC RA in many states) ## Increasing popularity of large townships with modern amenities, which can be developed only by large scale developers ## A decline in the cash component caused by increase in mortgage-financed transactions ## A surge in construction activities, which has stretched human resources thin, especially for small developers ## Increase in allocation of infrastructure funds in the successive bugets by the Finance Ministry. However the consolidation process will be slow going forward and the unorganized sector will continue to dominate the industry for the next few years. Key Charasteristic of Real Estate business: ## Industry is characterized by enormous operating leverage: Construction costs are fairly constant across regions and are primarily influenced by commodity prices. Construction costs are around Rs.800—Rs.1200 for mid range residential apartments and is Rs.1, 200 –2, 500 for commercial and retailing space. As the construction costs are more or less constant, the margins of real estate developers depend primarily on sales realization—any rise in realizations flows directly to the bottomline. The greatest implication of this cost structure is that the greatest value of Real estate, comes not from construction, but from prudent acquisition of “Cheap Land”, obtaining clearance in a timely manner, and design of the construction to get the maximum monetary from the said land. Monetary policies have a great bearing on the sector: Interest rate and credit growth have great impact on the real estate sector as mortgages have come to play an increasing role. Anecdotal evidence suggests that 80—90 % of all incremental buyers avail of mortgage finance. Project roll out time: While ‘Cheap” land acquisistion is one part of the story, duration of the project also can have a significant impact on the project’s net present value( NPV), as many real estate projects takes months to be completed; during which time the price of raw materials could have increased significantly ballooning the project cost and shrinking margins. Thus, it is found that land banks enable developers to develop townships complete with commercials and retail component. But the trade offs is that they entail longer incubation time which could translate into lower per-acre NPVs than those standalone buildings. Real Estate prices: In India it is difficult to get precise data on demand and supply of housing stock, hence forming a view on real estate prices is rather an Art than a science. Also the real estate valuations are sensataive to location and can vary significantly across Indian cities and even across areas in the same city. My conclusion is that the real estate prices are either going to stabilize or increase substantially in the days to come as land is a scarce commodity and population pressure is likely to increase the cost of housing. Besides this a number of Foreign companies setting up shops in Metro and TierI and Tier II cities would also escalate the price of land. The shift of Indian population to the big cities would also make the cost of housing rise exponentially. Since SBI, which is one of the major contributors to the loan portfolio in Urban and rural masses has kept the rates of housing loans unchanged, it will act as a positive trigger for the people who want house at affordable prices. Indirect triggers from other sectors: Retailing: I expect retailing to be a major boost for the real estate sectors. Some companies like gravity(I) Ltd which are venturing into retailing could post ample opportunities to the real estate developers for the development of the shopping malls etc. There are at present 100 shopping malls in India and by 2008 it is expected that this figure could be TRIPLE. Thus there might be some pressure on the rental income from the shopping malls since supply could outstrip demand. Hospitality: The rise in the flow of tourist across India could give a spurt to the real estate activities. Already some companies like BSEL Infrastructure Realty Ltd which are already in the hospitality sector could gain significantly. Mature Areas hardly provides great returns: Typically a city evolves it changes from “monocentric” to “polycentric”. New centres of such evolving cities, are usually satellite towns that offer better residential accommodation and also attract business development enterprises to develop the lands there as they offer better margins. In India the growth in IT/ITES has fuelled the development of new business centres –Gurgaon, Noida, Salt Lake( Kolkata), Hosur near Bangalore, OMR Road in Chennai, Gachibowli in Hyderabad. Super normal returns are obtained in real estate when in periods when business centres attains critical mass in terms of people, civic amenities, office space etc. Once the areas develop, the returns tend to drop significantly. Hence considering all the factors, I find the real estate sector a bit attractive for investment, though it has some negative effect of the removal of Section 80 I(A) snd 80 I (B) of the Indian IT Act. But, this will have not have significant effect as the growth in the companies will offset the negativity due to this act. Some companies which look attractive at this price are: Unitech( which has the largest land bank among the Indian real estate companies), Mahendra Gesco, BSEL Infrastructure Realty, Garnet Construction Ltd( Preference issue at Rs.150 is the prime trigger) , Lok Housing, D S Kulkarni, Era Construction ltd Etc. The real estate story is to continue in the next fiscal also.[An adoptation from an old report of a brokerage house]