The real estate sector has had to adapt to a rapidly-changing regulatory environment and a conceptually different market in the last couple of years.
The Chinese saying “May you live in interesting times” certainly held true for the Real Estate industry in 2019 – in many more ways than could be imagined. Not too many would disagree that the real estate industry has had to adapt to a rapidly-changing regulatory environment and a conceptually different market in the last couple of years. Demonetization, RERA, GST implementation, and the new ICBC guidelines have all added to the challenges that the industry has faced. While most participants in the industry have acknowledged the positive impact the regulatory changes would have in the medium to long term, there were coping challenges in the short term.
Added to this, a slackening residential segment in the last 2-3 years and the daily bad press on issues involving the likes of Amrapali, Jaypee, Unitech, project delays, etc. all added to the sombre mood. The industry seemed to be getting out of the black clouds with silver linings in the form of residential offtake in some markets when the final straw – the NBFC crisis – struck another massive blow. It sucked out liquidity and has brought disbursals – existing, new to a grinding halt which has, in turn, impacted the pace of construction of projects and hit liquidity hard. In the last 4 years, NBFCs and housing finance companies started contributing to 60%-65% of developer funding with the rest coming from banks. A slowdown of this 60%-65% would mean a virtual drying up of funding with a lot of public sector banks already having gone slow on RE funding in the last couple of years.
The major trends of 2018 (and in no particular order of preference) can be summed up as below:
1. The pareto principle or 80:20 rule is getting accelerated in the industry. While the residential market has shrunk (new launches, new sales) between 2018 compared to 2015 or 2016, the fall has been more dramatic for a large number of developers – while the stronger ones (who had a good track record of project completion, good customer feedback perception, are well funded and less stretched) are gaining a disproportionate percentage of sales and have seen increased market share.
2. The GST impact on under construction residential sales impacted the market severely. While moderately priced projects of good developers bucked the trend, most buyers are preferring to wait for the project to be completed and OC to be obtained before buying the unit to save on the GST cost.
3. New residential launches fell to a trickle. The developers are concentrating on completing their projects and hoping to see sell their unsold stock as the project nears completion/is completed rather than thinking of launching new projects.
4. Commercial is the new mantra – Many developers have started focusing on commercial (office) development as they believe the scope and potential for this are far better in the next couple of years. They believe that under the RERA regime and the current state of the market, residential will be a challenge.
5. Deal-making on the pre-leased commercial asset space continued unabated. There are limited Grade A buildings in the country and those coming up for disposition are seeing increased interest not only from the likes of traditional aggressive players like Blackstone, etc., but also folks like Xander Funds. They have been joined by Indian incorporated funds and domestic insurance companies who have started looking aggressively at pre-yielding office assets. The new trend (as the war on cap rates gets aggressive) is to look at structured transactions like forward sales, partly leased assets as buyers believe that there is a better opportunity at pushing up their IRR’s.
6. The warehousing business sees unsatiable appetite from a wide range of players like Indospace, Embassy, Logos, ESR and a lot of smaller niche funds are also actively looking at a play here. The growth of e-commerce companies, 3rd party logistic players has led to a demand for warehousing space and a lot of newer entrants have come into this segment. There is adequate equity available for infusion into well located, clean parcels with good promoters.
7. The residential game has undergone a sea change – Developers are realigning their existing business plans to focus on reworking unit sizes, concentrating on the project aesthetics, looking at infrastructure availability while zeroing in on potential sites – all to deal with the new reality where the product and price need to make sense in a current location (as with current available infrastructure) rather than a futuristic location. The affordable segment continues to garner good interest with a lot of funding (debt and equity) chasing good projects in this space.
So what does 2019 promise to bring? Besides the general elections which will be a big event in itself, 2019 should see a deepening of the following trends. I am also adding my thoughts on what developers ought to be looking at.
1. There will be opportunities galore to pick up land, stalled projects, and even assets as some the developers get deeper into the quagmire if the funding situation does not improve by the end of March 2019. They would look at liquidating land and other assets to keep meeting their financial obligations to lenders and their commitments to customers. Lenders would also nudge them to liquidate assets before problems arise. Strong developers/funds would have the opportunity to pick up land parcels, assets at reasonable values.
2. As the real estate industry starts behaving more and more like the Manufacturing Industry (where exponential gains from land appreciation don’t exist but rather you make money from the value-added manufacturing life cycle), margins will come from selling a well-made product which makes sense to the customer. The scale of margins would be decided by the ability to generate faster sales. This would also mean keeping a robust eye on the development lifecycle – planning, architecture, the phasing of projects, amenities, the project management, and upkeep. More and more developers would rely on specialist Project Management Companies to drive better productivity, compliance, and efficiency to deliver good quality products within cost budgets and timelines. Developers will also realize that holding on to large land banks is not necessarily a boon. It would make sense to hold on to only that much land as could be consumed in the next 5-6 years.
3. Residential to make a comeback: As new residential launches continue to be slow and as more and more developers concentrate more on commercial – gradually reducing inventory would also mean a big opportunity in residential by the second half of 2019. The better-placed developers would see much higher offtakes and the trend of corporate (with the presence in other sectors) developers making an entry would become more commonplace. The stronger developers will capitalize on their brand to strike even better joint development and venture deals.
4. Grade A commercial assets would continue to be in demand simply because of the finite supply in existence but the hardening interest rates and more volatile rupee would put pressure on the ability of cap rates to go too much finer for Grade B assets. There would be increasing interest from players on striking deals at the post land acquisition and approval stage which would involve putting in money for construction and prior agreements to buy the asset (entirely or part) on completion of leasing at pre-approved cap rates.
5. The demand for warehousing would remain strong with players ready to look at smaller deals as the larger ones become more difficult due to more players chasing a limited supply. The sweet spot of 25 plus acres may reduce to 15 acres or so as the pace of interest continues to increase. Transactions would go beyond the major metro outskirts to the next tier cities as well.
6. While we expect to see some of the travails of NBFCs being sorted out by March-April 2019, this would also lead to the emergence of some newer players who are looking at this as an opportunity. I believe that PSU banks would again start looking at RE funding with some vigor as their balance sheets start stabilizing and equity deals would see a lot many more conclusions than the ones that we only hear about currently.
7. While these will still be small in 2019, newer concepts like Student Housing, Co-living apartments will see more activity. The youth of today do not have the same mindset and inclinations as existed even 10 years ago. There is a premium for mobility and flexibility and concepts to cater to this flexibility would see more formats.
We will continue to live in interesting times in 2019, but the pace of change is expected to be frenetic and exciting – and focus, agility and keeping one’s finger on the sentiment pulse would ensure that you end at the front of the pack rather than at the back.
(By Gagan Randev, National Director, Capital Markets and Investment Services at Colliers International India)