Is Equity Returning To Residential Real Estate?

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The storied tale of the Indian residential sector is likely to be a subject of fables.

How an unregulated sector which went from being a villain despite is social moorings to being held in the throes of a sector-shaking regulation that is likely to change the face of this asset class and how business is conducted by development players.

The compliances and reporting under RERA are going to separate the chaff from the wheat. A cleaner sector will bring out the moneybags.

The last 3 to 4 years have not been the best for the residential sector. Rising inventories, falling sales, consumer disputes, massive delays amid major media coverage – the sector was a much-maligned one.

The risk associated with litigations and the resultant downside drove equity away from this asset class and the money found safe shelter in the steadily growing commercial sector.

Despite this, money continued to be pumped into the residential sector, though most of it was going to the Tier I cities where the bigger, established and branded developers were present and most of this money was in the form of debt structures.

In fact, in the last two years, all of the investment flow into residential has been in the top three cities of Bangalore, Delhi NCR and Mumbai.

Also notable was the fact that while residential sector continued to receive a lion’s share of investments, equity structures made up a minuscule percentage (~4 – 5%) of these inflows over the past 4 years or so.

What is heartening to see is that within six months of RERA, most of the residential markets are sprouting green shoots of recovery. While supply has whittled down, sales momentum found some uptick in the last quarter of 2017 and prices have settled to a rational level.

More than ever, we are witnessing examples of smaller developers tying up with national players through Joint Development/Development Management agreements as the former face liquidity issues, no having the financial muscle to undertake residential projects under the current RERA mechanism.

The rising presence of established developers who are actually the most active during this period, sewing up land deals at attractive valuations bodes well for institutional participation. In fact, it is a good trend as these players have established credentials and have the ability to attract equity back to the fold of this asset class.

With the high levels of debt funding over the past four years, developers are over-leveraged and during these times of slow sales are missing out on making the interest repayments. They do not have the ability to take on more debt.

While such players may have to offload the project to a larger developer, investors would find greater comfort with established development entities and may be willing to explore structured equity transactions going forward.

We believe these times are still some time away, but the rising transparency levels and better corporate governance and regulatory oversight may pave the way for the return of equity to the residential asset class as money are now chasing quality rather than returns.

And do not forget, this sector has the ability to fulfil an almost unquenchable thirst for home ownership in the country with a significant shortage in the larger cities.

The right development partner and the optimal product in the current regulatory environment may just have investors breaking the bank again!

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