India Real Estate 2020

This article has been contributed by Mr. Rohit Malhotra, CEO, Realtech. Realtech (www.realtechgroup.in) is a leading North India based Real Estate developer promoted by a team of young, dynamic entrpreneurs. Since founding the company just over 3 years ago, Realtech has undertaken projects across office, retail, residential and hospitality verticals.

India’s progress over the next 20 years will be intimately linked to events within the region and around the world. The World Bank estimates that India will become the third or fourth largest economy in the world by 2020, with the GDP per capita to double by 2020. Thus, India is viewed as a key element in the "Chindia" and the "BRIC" economies, which are seen as key emerging markets playing an expanding role in the global economies. The scale of development might end up a lot larger in India than even China. India is a two-speed market with small medium and large players. Since India's political system is more defined, investor appetite in India is longer term -- 6-10 years.
India’s urban population is expected to rise to around 40 per cent by 2020. The face of urban poverty in 2020 is unlikely to be very different from what it is today, given that the largest indicator of poverty in cities is not so much lack of income, as lack of decent housing and civic amenities. While improving infrastructure in existing cities/towns is not to be ignored, in the next two decades there will be need to encourage growth of new townships and take up regional urban development plans where growth corridors can be identified and public-private partnerships promoted for investment in alternative nodes of development. Such centres will have considerable impact in improving the urban profile of the country.

The Indian real estate sector has witnessed an equivalent growth, driven by the booming economy, favorable demographics and liberalized foreign direct investment (FDI) regime. Growing at a scorching 30 per cent p.a., it has emerged as one of the most appealing investment sectors for domestic as well as foreign investors. India has 10 of the 30 fastest-growing urban areas in the world. Based on current trends, a massive 700 million people (roughly equivalent to the current population of Europe) will move to cities by 2050. This will have significant implications for demand for urban infrastructure, real estate, and services.

This is no fast burn as a 700% increase is forecast in the Indian property market. India is already achieving GDP of US $1.50 trillion. Currently, the overall property market in India is estimated to be worth about $12 billion. Policies to enhance financial sector growth, openness to trade, rural-urban migration, capital formation, education, and environment — together labelled the `FORCE' factors — will be critical to sustaining growth.

There is now an air of certainty of significant inflow of funds in infrastructure, increase in production capacity and creation of new employment opportunities but how to make this a reality is the enormity of the challenge before us.

Is the NCR real estate market in a bubble?

Maybe, this should have been the very first topic I should have addressed on this blog. Better late than never. Over the last 6 months, the media has written a lot about the high RE prices across major metros in India. Infact, there have been several people in the media and industry who have described the Indian RE market as a bubble. I will try and examine this assertion through this writing. I will focus on the NCR for the purposes of this blog.

There may be some truth to the assertion that the NCR RE market is overpriced. However, it would be unfair to characterize the entire market (which is infact a summation of several micro markets) with one broad brush. Having said that, I guess the question I may have raised in your mind is -which micro markets in the NCR are overpriced? This is a difficult question to answer but I will try and attempt it. I am going to begin by examining some micro markets:

1. Apartments in Delhi suburbs (Noida and Gurgaon in particular) where the aptts. are priced over Rs.5500 psf, are still under construction and more than 12 months from handing over possession, I feel, are overpriced eg. Unitech Grande (Noida), Jaypee Greens (Noida), Karma Lakelands (Gurgaon), Magnolias (Gurgaon), Palm Springs (Gurgaon). Use this criteria to determine if the project of your interest is priced right.

2. As I have already indicated in one of my earlier blogs, I believe, there is limited absorption capacity for aptts. which are larger than average (see my first blog). Ofcourse, there is room for a few such projects but I feel the current supply far exceeds demand. Aptts. where the TCO (total cost of ownership) is more than Rs.1.50 crores (in Delhi suburbs such as Noida and Gurgaon) will have limited absorption capacity. TCO for an aptt. can go up either because of high PSF rate or because the apartment size is too large -eg. 4000, 5000 and even 10,000 sq ft apartments !!

3. It may come as a surprise to some of you reading this blog, but I feel that the Delhi market, in most parts, is not overpriced. However, I feel aptt. sizes will need to get smaller to maintain affordability in Delhi. With increasing nuclearisation of families, I feel, there is a demand for studio, 1BR and 2BR aptts. This, however, is not happening as of now. If this doesn't happen, the TCO will have a negative bearing on demand for large aptts eg. a 2000 sq ft 3BR in Vasant Vihat can cost you Rs.5 cr ($1.25 Mi)! As an investor, it is important to "emotionally disassociate" yourself from the buying decision. Just because you can afford to buy a Rs.5 cr aptt. does not suddenly mean that the markets buying power as a whole has moved up. In other words, resist the temptation of extrapolating your riches to that of the market!

In summary, I feel, NCR prices have risen very fast over the last 4 years and that is what gives the impression of an all around bubble. However, if one looks closely, there are enough affordable investment opportunities still available (Gurgaon, Faridabad and even Delhi-read my previous blogs). I feel the pent up demand (built up over several decades!) has been met in the short term through the significant supply that has been created. From here onwards, the price rise will be more orderly and much in line with other economic indicators such as GDP growth rates and inflation. In addition, developers need to address the need for smaller, functional apartments at high end addresses (if you find one at the right price.....just grab it!).

In my next blog, I will write about how new supply in Delhi (is there land still available in Delhi !?!) will impact the RE map of the city.

Later,
Ashish

Leverage - the new cocaine !

Have you ever wondered how private equity (PE) funds, hedge funds and other such private pools of capital, are able to generate extraordinary returns in markets that appear to be behaving quite ordinarily !?! Besides the genuine genius of some managers who manage these funds, they use a weapon which in normal circumstances is not available in large quantities to individuals and that is called Leverage. In keeping with the spirit of this blog which is to democratise access to "intelligent analysis", I would like to share in this particular writing how individuals can maximize returns in RE investing by using leverage.

Leverage (or gearing) can be loosely defined as, using given resources in such a way that the potential positive or negative outcome is magnified. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity. I feel the best way to illustrate its affects on returns would be through a few examples. By the end of it, you will appreciate why leverage is often called the cocaine of financial markets! Just like the real thing, its consumption can take you to great heights and its misuse can destroy you.

Example 1:
(A)Purchase price of apartment = Rs.1,00,00,000
Self funding (15%) = Rs. 15,00,000
Home loan (85%) = Rs.85,00,000
Rate of interest (ROI) on loan = 11%
Period of loan = 15 years
Equated monthly instalment (EMI)= Rs.96,610
Expected price appreciation in property =12% p.a. (with a GDP growth rate of 8% p.a., I believe, this is a realistic assumption for the 5 year period in this example)
Period of holding property before reselling =5 years
(B)Property price at end of 5 years (assumed 12% compounded growth) = Rs.1,76,00,000
(C)Interest paid over this 5 year period = Rs.43,10,092
Therefore, profit from transaction = (B)-(A)-(C) =Rs.32,89,908

The important point to be noted here is obviously the effect of leverage. As an investor, your equity in the transaction was a mere Rs.15,00,000 and you made a profit of Rs.32,89,908 in the 5 year period. Therefore, as an investor, you tripled your investment in 5 years. Ofcourse, the one big assumption in the example is that you are able to get a loan sanctioned and can afford to pay the EMI of Rs.96,610 for 5 years. If you get regular income either in a job or are self employed, most banks would be willing to extend this loan to you.

The above example was to show you the effect of leverage. Ofcourse, the amount you borrow can be increased or decreased based on your repayment capacity. Keep in mind that the more you borrow (based on assumptions in example above), the more your returns will be accentuated. Ofcourse, if some of the assumptions change, the outcome could be painfully different as I will illustrate in example 3.

Example 2 (No leverage):
Let's assume the identical secnario as described in example 1 except without leverage.
Investors equity =Rs.1,00,00,000
Profit at end of 5 years =Rs.76,00,000

Therefore, in this scenario, the investor made Rs.76,00,000 on an investment of Rs.1,00,00,000. This means the investor failed to even double his or her money as opposed to tripling the investment with use of leverage as in example 1!!

Example 3:
Let's assume all things remain same as in example 1 except for 2 things-rate of interest on loan and expected rate of appreciation of property.
(A)Purchase price of apartment = Rs.1,00,00,000
Self funding (15%) = Rs. 15,00,000
Home loan (85%) = Rs.85,00,000
Rate of interest (ROI) on loan = 12%
Period of loan = 15 years
Equated monthly instalment (EMI)= Rs.1,02,014
Expected price appreciation in property =7% p.a. (you may have assumed a higher growth but your assumption could be wrong and you may end up with only a 7% growth or even lower)
Period of holding property before reselling =5 years
(B)Property price at end of 5 years (assumed 7% compounded growth) = Rs.1,40,25,517
(C)Interest paid over this 5 year period = Rs.47,31,306
Therefore, profit/loss from transaction = (B)-(A)-(C) = (-) 7,05,789

Now, that's what is a bad outcome of using leverage. As an investor, you could actually lose money by using leverage. In this scenario, if you had not used leverage, as an investor you would still have made a profit of Rs.40,25,517 or 40% on your investment of Rs.1,00,00,000. By using leverage, the investor could lose Rs.7,05,789 due to the cost of interest! Careful-learn to consume cocaine before you do.

This is a fascinating subject and almost perfected to a science by the financial engineers working at large banks and funds. Suffice to say, as an investor you can use the use same principles and magnify your returns.

What are you waiting for ?

more later,
Ashish