real estate industry building wealth with bricks and mortar
Real estate as a sector is the 2nd largest employer after agriculture and constitutes almost 6% of our GDP. Urbanization is one of the biggest growth drivers for Real Estate in India, which is in turn fueled by a growing business climate. Every year, around 10-12 million people become urbanized. In this blog, we will decode the real estate sector and look at the potential opportunities in this space.
Until 2008: The real estate sector in India was largely unregulated until 2008, with a fragmented and inefficient market. There was a lack of transparency and accountability, and the sector was highly localized, with each region having its own unique set of rules and regulations
2008-2015: During this time the sector was still unregulated, fragmented, highly
Inefficient. But during this period, many corporate houses entered the space.
2016-2020: The year 2008 marked a turning point for the real estate sector in India, with the introduction of the Real Estate Regulatory Authority (RERA). RERA was established to bring regulation and transparency to the sector and to protect the interests of buyers. The period from 2016 to 2020 was one of consolidation and improvement in efficiency for the real estate sector, but it was also disrupted by a series of events, including demonetization, RERA, GST, the NBFC liquidity crisis, and COVID-19.
Beyond 2020: After COVID, the sector has become highly regulated and has seen stability. Due to RERA and other measures taken by the government, transparency has increased and the sector has become more efficient. Weak players folded their hands and the real estate sector has seen accelerated consolidation.
Indian Real Estate expects Grade 1 players to continue winning. They are gaining market share and are expected to do so as Grade 2 players have been finding it difficult to
find financing. Buyers have also become increasingly wary of the latter’s ability to deliver projects on time.
Real estate is a cyclical sector. Real estate markets tend to follow economic cycles, which are influenced by factors such as interest rates, economic growth, supply and demand dynamics, and investor sentiment. Just look at the below chart of the Nifty Realty Index to see the cyclical nature of the sector.
Real estate companies can be divided into two primary categories.
Residential real estate refers to properties used for living purposes, such as single-family homes, apartment buildings, and townhouses. This segment encompasses the development, sale, purchase, and management of residential properties where people reside. About 80% of the contribution comes from this segment in the real estate sector. Some of the most prominent listed players in this space include DLF Limited, Godrej Properties Limited, Macrotech Developers Limited, Oberoi Realty Limited, etc.
Commercial real estate refers to properties that are used for business or investment purposes. This segment encompasses various property types, including office buildings, retail spaces, industrial properties, and hospitality properties like hotels and resorts. Commercial real estate serves as a crucial component of the business environment and includes properties used for offices, retail stores, manufacturing, warehousing, and more.
Some of the key players in this segment are Prestige Estates Projects Limited, Embassy Office Parks REIT, Phoenix Mills Limited, Mindspace Business Parks REIT, etc.
Accounting of a real estate company involves some degree of subjectivity and is slightly complex. For example, long-term contracts can be recognized using the completed contract method and the percentage of completion method.
On top of that, you should not use P/E to gauge the valuation of the company. This is because revenue recognition occurs upon project delivery to the customer, while expenses are recognized when incurred. This discrepancy leads to a misalignment between the recognition of revenue and the timing of incurred expenses. Additionally, advances collected from customers are categorized as part of other current liabilities, reflecting that the company has yet to fulfill its obligations. So, below are the key metrics that you should track and compare while analyzing any real estate companies.
Pre-Sales: Sales that are made before the project is completed. This shows the demand for the projects. High pre-sales points towards a better future for the company.
Collections and Collection Efficiency: Collection refers to the money received for the sales made. Collection efficiency is simply calculated by dividing the collection numbers by the pre-sales number.
EV/Pre-sales: As the P/E value becomes less effective in this space, Enterprise Value/Pre-sales can be a good proxy for valuation and comparison among peers. Higher pre-sales mean higher demand and better future prospects for the company.
Debt/Equity: The D/E ratio is another important metric for realty companies. You should look at the historical values along with comparing the same with peers. This will give you an in-depth idea about how the company is financing its projects. You should also compare the cost of debt among peers.
Inventory/Sales: This metric will give you an idea about how much inventory the company has. If the company has a large inventory and yet it starts new projects in the same location then it can be a bad sign. You should always analyze the reason when you see an abnormal change in this ratio.
Apart from this, you should also look at the land banks the company is holding along with its geographical presence. A geographically concentrated company can be a good bet for someone looking to benefit from strong demand in a specific region (e.g. Sunteck Realty for Mumbai). You should also analyze near-term growth triggers for the company.
The S&P BSE Realty Index has been a top-performing sector, delivering more than 40% return over the past six months (Apr 2023 - Sep 2023). The sector is set to fire on all the cylinders as there are multiple factors acting as tailwinds.
The three leading players in the sector have significantly increased investor wealth by 43-70% during this period. The strong bookings trend for larger players in the real estate market is expected to continue based on the Q2 2023-24 updates from Macrotech Developers and Sobha, along with industry data.
Macrotech achieved its best-ever quarterly bookings of approximately 3,530 crore in Q2FY24 and is on track to meet its FY24 booking target of around 14,500 crore. Despite no new launches in the first half of FY24, the company plans to introduce projects in seven new locations and has reduced its debt by about 540 crore. Sobha also saw its highest sales by value in a quarter at around 1,724 crore.
Bengaluru-based developer Prestige Estates Projects is expected to report its highest-ever quarterly pre-sales of around 5,000 crore, a 41% YoY increase, attributed to positive responses to new launches in Bengaluru and Hyderabad.
The Gurugram housing market is performing well due to a shortage of inventory from Grade A developers, with DLF being the dominant player. Real estate consultancy Knight Frank notes a significant increase in residential demand, with sales volumes at a nearly six-year high despite escalating prices and increased interest rates.
Mumbai's registration data shows a 24% YoY growth in homeownership, particularly in the luxury segment. Real estate developers in the Mumbai Metropolitan Region (MMR), including companies like Godrej Properties, Oberoi Realty, Mahindra Lifespaces, and Macrotech Developers, are well-positioned to capitalize on the MMR real estate market's growth.
On the technical front, many names have given a fresh breakout and some have hit new ATHs in the past month. However, our proprietary stock score suggests that most of the names do not have valuation comfort at the moment.
The real estate sector is at a very interesting point at the moment. The sector has become more regulated and efficient since 2016 and is now dominated by large players after accelerated consolidation. At the moment this sector is showing strong momentum because of the robust demand and favourable supply environment. Even the promotors are also upbeat at the moment. However this is a cyclical sector, so investors should limit their exposure to this sector.
