The bright spot in the Indian real estate market viz leasing is likely to see an abrupt end to its rental uptick cycle.
The ongoing consolidation of the Indian property sector will get a boost as Covid-19’s disruption further weeds out the weak hands. Stocks are down 44-60% from their 2020 peak pricing in a 20%+ capital value decline. Best in two decades affordability and a seven-year long weak residential cycle set a good base to bounce back. Survivors are set to make disproportionate gains. We initiate with ‘buys’ across our coverage with Godrej Properties as the top pick.
A seven-year long volume downturn and price stagnation in India’s residential property markets puts the cycle on a low base. Even as Covid-19 will take an economic toll, and system inventory is an issue; healing for the sector will ultimately come from much improved affordability. Home loan rates are sub GFC lows, which, along with prolonged weakness in property pricing, sets affordability levels at best in two decades.
Repeated shocks viz demonetisation in 2016, enforcement of the Real Estate Regulatory Act (RERA) in 2017 and then the NBFC funding crunch from late 2018 onwards have driven waves of consolidation in an unorganised sector. Even then, the stocks under coverage are only about 3% of residential market. Funding cost advantage for Grade A listed developer can be as much as 5-10 ppt, which gets amplified in a low-inflation environment. Private Equity, with deals worth c $10-11 billion over 2018-19, is another important capital source but limited to better quality developers. As such, we see Covid-19 as another disruption to the funding environment, which will end up driving consolidation.
The bright spot in the Indian real estate market viz leasing is likely to see an abrupt end to its rental uptick cycle. The virus and ensuing social distancing will impact office demand and likely cause a longer term shift to on-line retail. We estimate spot rentals could settle c.10-20% lower across the board, vacancies higher by 5-10 ppt and cap rates rise by 1-2 ppt against their 8% pre-Covid benchmark. Residential prices could marginally correct too (5-10%, likely more at upper end of market), but best-ever affordability would support affordable and mid-income segments. Weaker pricing and lower demand after the pandemic could thus strengthen the ongoing consolidation wave.
We initiate coverage on Indian property sector with a ‘buy’ across 5 companies. Property market cap at sub 1% of India is a significant under-representation. Industry consolidation offers a structural growth story, similar one such as the shift from state owned banks to private banks. Godrej Properties is our top pick with its nation-wide residential business, consistent execution and multiple funding options making it best placed to benefit from industry consolidation. Our other ‘buy’ ideas are DLF (low gearing, strong asset base), Oberoi Realty (high visibility assets), Prestige Estates (high risk-reward) and Sobha (value pick). Our earnings are much below consensus but we believe that risk reward is fairly attractive on a long term basis.