The size in terms of total economic value of real estate development activity of the Indian real estate market is currently US$40-45bn (5-6% of GDP) of which residential forms the major chunk with 90-95% of the market, commercial segment is distant second with 4-5% of the market and organized retail with 1% of the market. Over next five years, Indian real estate market is expected to grow at a CAGR of 20%, driven by 18-19% growth in residential real estate, 55-60% in retail real estate, and 20-22% in commercial real estate.
Long term industry outlook remains attractive: We believe that long term industry outlook remains attractive, on account of increasing urbanization, growing nuclear families and the increasing number of Indian middle class. Fundamentally, strong GDP growth, increasing tourism traffic and increase in per capita income coupled with lower interest rates shall improve the outlook of the sector in the medium to long term.
The real-estate sector offers a US$80bn-100bn opportunity over the next three years.
o Tier I cities- Mumbai, Delhi and Bangalore
o Tier II cities- Kolkata, Hyderabad, Pune
o Tier III cities- Nagpur, Ahmedabad, Indore, Lucknow, Jaipur
The affordability index, although at a reasonable 40% (EMI/net monthly disposable income), has risen about 50% over the past two years, suggesting a price run-up faster than income growth. The affordability is also affected by mortgage rates, which has risen by 400bp during the same period. Lending institutions managed to limit the EMI increase to a certain extent by adjusting the loan tenure, thereby controlling the affordability as well. Currently, the domestic real estate market has an affordability levels (Property costs / Annual Income) of 4.5 to 5.0x compared to global level of 3.5x
Cap Rate = Annual Cash Flow / Value of property
From an IRR perspective, the residential segment is the highest return earner. This is possible due to the unique way in which the payment for residential properties is structured, where the buyer pays some upfront money and the balance by way of installments, which allows the builder to block less capital in the project. IRRs for residential projects range between 30% and 35%.
The return from commercial property is always lower compared with the residential project due to the following reasons.
As a result, the developer must invest far greater capital of his own before he sees any cash inflow, and due to lease rentals, his payback period increases, in turn reducing his returns from the project compared with the residential project.
Real estate investment trusts (REITs) are companies that own and often actively manage income-generating commercial real estate, such as shopping centers, apartments, offices and warehouses.
DCF-based NAV methodology to value the company’s current land bank: The process involves the following.
All the above helps us forecast cash flows and lease rentals, which are then discounted or capitalized based on our discount rate and capitalization rate assumptions. This gives us the NAV for the land bank. Premium to NAV is a more subjective analysis in our view, directed by factors such as land bank quality and execution and financial strength.
o Asset-Turnover ratio
o Annual GFA delivered
o Backward integration
o Initiatives such as partnerships with construction companies, centralized sourcing of raw materials, investment in high-end equipments etc
On the basis of our evaluation of the companies on the above four factors, we assign a premium or discount to the NAV if needed.
Before I proceed I would like to know whether it is a vacant land or land with some improvements.
Sales Comparison Approach
How do you estimate land value when there have been no vacant land sales?
It is a typical problem in urban and built-up areas. The solution is to select comparable improved sales and subtract the value of the improvements- extract the depreciated replacement cost of the improvements.
Impact on NAV in a declining property price scenario: A 30% price correction in residential price can lead to 50% erosion in NAV. In a few cases where margins are not high enough, there could be little value creation. Hence, valuation assumption for big land banks would need to be re-looked at in the current scenario (high interest rates and declining price).
Each square feet of IT space generates demand for 5 to 6 square feet of other real estate segments, namely residential, retail, hospitality, etc.
The supply would still be more than demand and the rentals for all would get impacted since most retailers are not making money. India too would move more towards revenue sharing followed in many developed markets rather than the fixed rental concept. This forces the developer to maintain the mall and create value for the shoppers. This forces the developer to maintain the mall and create value for the shoppers. Same-stores sales in most markets have been facing pressure owing to increased mall density.
Most of the companies are facing execution delays. Regulatory approvals and physical execution are the main challenges. Companies are trying to overcome this challenge by having in-house construction and forming joint ventures with international construction majors (DLF and Liang O’Rourke).
It doesn’t matter. What matters is the economics of individual projects. Focus should be on the quality (location, demographics/demand drivers of the micro-market) of land bank, cost of the land and execution skills. Similarly, a pan-India or a regional player who has bid aggressively to purchase land recently is worse-off than a player with existing low-cost land-bank.
Reasonable expansion plans, quality of the management, low leverage etc are the key to spot the winners, apart from the quality of land bank.
Historically, higher than anticipated inflation has had negative consequences for financial assets (both bonds and stocks being adversely impacted by unexpected inflation). In contrast, unanticipated inflation seems to have a positive impact on real assets. Why is real estate a potential hedge against inflation? There are a variety of reasons, ranging from more favorable tax treatment when it comes to depreciation to the possibility that investors lose faith in financial assets when inflation runs out of control and prefer to hold real assets.
Demand in 2008 (1st half) = 7million sq ft compared to 6.6 million sq ft in the same period last year.
It includes areas near MG Road, Vittal Mallaya Road, Residency Road and Richmond Road. sCBD remains the most attractive and suitable micro-markets for new companies entering Bangalore. The central locations offer ease of accessibility and visibility for these new companies and allow established companies to retain brand equity by being in the heart of the city. There is less supply of office space.
It includes Indira nagar, Old Madras Road, Airport Road, CV Raman nagar, Inner ring road, Koramangala. The Non CBD area is being observed as the most preferred location for setting up office for high end engineering companies for setting up R&D centers/labs as well as high end support functions. High levels of absorption activity continued to be witnessed even in the Non CBD areas of the city where many corporates chose to relocate/expand due to availability of quality options offering adequate infrastructure and lower rental values compared to CBD. However, land bank is limited in these regions, which might put upward pressure on the real estate in near future.
This includes Whitefield, Outer ring road, Electronic city, Bannerghatta road and North Bangalore. The Suburban micro market is another zone that has witnessed high level of space intake by corporate over the year. Scarcity of space in the Non CBD area is furthering the case for location of corporate in the micro markets. The Peripheral areas remain preferred by the corporate for building their campus style facilities. Consequently these locations have witnessed frenzied construction activity from both developers and also individuals possessing large land banks.
Whitefield is now gaining favor as a viable micro market due to decongestion of the airport road, completion of the Marathahalli flyoverand availability of mid to low end housing infrastructure.
The area between Marathalli and Sarjapur on the outer ring road has a fair amount of STP, SEZ and grade-A office supply. The excess supply along with low occupancy has put downward pressure on the prices.
With development of BIA and coming up of Peripheral Ring Road (PPR), properties prices in north Bangalore look to go up in the near future. PPR will connect Tumkur road, Magadi road, Mysore road, Bellary road, Old Madras road, Hosur road and Kanakapura road. This region has seen interests from leading IT firms, property developers for residential areas and hospitality sectors to set up star hotels.
There has been a noticeable demand for prime residential properties and developers are targeting residential areas in the outskirts of Bangalore such as Whitefield, Sarjapur road, Banerghatta Road and Kanakpura Road. Demand is also high for leased apartments in prime areas of central Bangalore by company executives, due to limited supply there is upward pressure on rentals.
New developments are shifting away from the central Bangalore due to close proximity to IT and ITES areas and availability of land for lifestyle projects. Nearly six mega townships promoted by reputed developers are on the anvil in Bangalore. The proposed mega townships will have thousands of housing units and will be a mix of apartments, row houses and villas. Moreover the townships will include educational, commercial, retail and medical facilities.
Capital values for apartments in prime residential areas of Bangalore are in between INR 3000-4000 / Sq. Ft while rental values are in the range of INR 25-30/sq ft. p.m. Absorption rates for prime and quality residential apartments is very high thus demand is exceeding the supply in the areas of Outer ring road, Whitefield and Airport road. There is scarcity of luxury apartments thus in last one year capita; values in suburbs have increased around 35-50% due to high demand. Yield on Residential property in Bangalore is ranging between 6-7%.
To check the trend in the residential properties find out from the local authorities on the trend in stamp duty and registration fees.
Improved connectivity between Bangalore and Mysore has led to gradual development of residential properties in and around Bidadi (southwest of Bangalore)
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