Is Indian Real Estate Over-Valued?
Unitech, Parsvnath and Sobha carry a 200 per cent gearing on their construction projects, offer higher costs of entry to first time buyers, fudge up valuations by incorrectly computing the percentage of completion method, are poor on delivery schedules and quality and have wasted more funds in aggregating agricultural land, 30-40 minutes away from normal work areas.
Except for being cloistered with politicians and sharing a cosy relationship, they offer little value to property buyers. A season of discount on unsold inventories is soon going to be in the offing. Real Estate stocks in India are still exceptionally over-valued compared to their Regional counterparts, have a lot of weight to shed and so would the Banks backing these developers. Investors may rather buy the property than the Real Estate stocks and stay away from Housing Development and Housing Development Finance Companies and Banks.
We spent a week in China, comparing property markets in the two countries and came back incrementally bearish on India. We met eight property development companies, visited six cities and more than twenty project sites. The key takeaways have been conservative accounting policies, lower landbanking, lower gearing levels and lower
office rentals in China.
Indian companies score better on project level cash flows, lesser government
interference and paucity of supply. Property markets have weakened in both, India
and China: Sentiments in the property markets have been adversely impacted and the consumers are postponing purchases in the anticipation of softer pricing trend going
forward.
The key difference however, is that the property prices in China are still considered affordable, whereas, one of the key reasons for lower volumes in India is adverse affordability, aside from sentimental issues. Government policies impact the sector much more in China: Chinese real estate development sector is more susceptible to regulatory changes than Indian property sector.
Over the last two years, Chinese government has introduced several measures adversely
impacting the real estate sector viz., 70/90 rule, Land Appreciation Tax etc over and above the monetary tightening measures.
Regulatory environment in India remains relatively benign towards the real estate sector.
Property developers are 'friends' of policy makers in India, NOT in China: While the current regulatory environment remains relatively easy in India, we believe that it will remain so due to good relationship enjoyed by the real estate developers in India with the state / central government.
In China, the real estate developers enjoy a similar good relationship with the provincial government, however, the policy maker i.e. the central government has been seen to be taking aggressive steps against the sector.
Tight credit conditions for both, stricter regulations in China: Credit conditions for Chinese developers have also tightened with average cost of borrowing going up by 200 bps over the last six months, almost similar as that in India.
But we observe that the Chinese developers are subject to tighter regulations such as mortgage payments by buyers have to be utilised for the particular project itself, etc.
Indian developers have better project cashflow cycle: Due to regulations, Chinese developers can pre-sell a residential property only when the construction is 1/3rd or 2/3rd complete, depending on provincial norms.
Indian developers can pre-sell even before starting to dig. Chinese developers are much less geared: The average gearing for the listed Chinese developers is about 50-60% (only one or two are 100%+), while that for Indian ones is 100% on an average and some viz. Unitech, Parsvnath and Sobha are close to 200%.
Chinese developers carry relatively lower landbank: Usually 4-10 years of landbank (taking into account growth targets) is carried by Chinese developers as compared to 8-15 years of landbank. One of the key reasons for lower landbank for Chinese developers is that bulk of landbank is ready to develop with most of the approvals in place, whereas, a large chunk of landbank of Indian companies is agricultural / yet to be possessed.
This puts the Chinese developers in a situation where they could buy incremental land in case of distress sale possibly, 6 months down the line. A similar landbank addition at distress valuations will be difficult Indian developers due to existing large landbanks and
larger leverage.
Accounting policies of Chinese developers more conservative: In China and Hong Kong, the developers follow project completion method of revenue accounting i.e. revenue is recognized only once the project has been handed over to the customers. While the PoCM (Percentage of Completion Method) adopted in India implies that the revenue (and therefore profits) recognition of Indian companies is about 1-2 years ahead of Chinese counterparts - a point to remember while comparing PEs.
Indian developers have better margin profile: Indian developers have significantly lower land cost as usually, large scale land aggregation by Indian developers - especially at city outskirts - is through direct purchase of agricultural land from farmers at a
much cheaper price.
Chinese developers have to buy land from the government through auction / tender at a market determined price. E.g. During 2007, China Overseas Land bought 94m sf of land at Rs1,604/sf, whereas average cost of land for larger Indian companies is typically about Rs300/sf.
Chinese developers are largely residential only: Large developers such as Vanke, China Overseas, Agile properties and Country Garden etc are pure residential developers, whereas most of the Indian developments are mixed use. One of the key reasons, we believe, is better infrastructure in China reduces time to commute between office and work,
thus, lowering the need to provide onsite job opportunities /entertainment, which requires a different skill set.
Larger Indian companies viz. DLF and Unitech has acquired these skills which is a value add for these companies and also helps generate better margins for the Indian companies.
Extent of full down payment higher in China: Of the 20+ projects we visited, we observed that about 20-40% of the buyers pay the entire house price through full cash down payment at the time of presale.
We estimate the proportion of buyers paying full cash upfront would be significantly lower in India. We believe that this highlights riches in China, partially attributable to 4 earning parents helping out financially, a young couple (due to single child policy) as against usually 1 earning parent helping out a young couple in India (assuming only father earning and each family having two children).
Scale of supply in China is much higher: Level of construction activities, even in smaller towns such as Shenyang, appears to be superlative by Indian standards. This town with a population of approx 7m had a new supply of 100m sf of residential properties in 2007 and
probably a similar number in 2008.
Knight Frank estimates that the total supply of residential properties in Mumbai including its suburbs, Navi Mumbai and Thane etc will be 85m sf over the next 3 years.
Markets as fragmented in China with several local differences in regulations: China has some 50,000+ developers and the largest companies viz COLI and Vanke will have an estimated 1-2% market share each.
This is quite similar to India. While the central government sets the tone for policy initiatives, the provincial governments enjoy flexibility to set rules at operating levels. Viz., for certain projects, the provincial government can give some special permission
to sell a project to foreigners, notwithstanding the strict foreign capital control norms by the central government.
Transparency of Chinese developers much better: While Indian corporates are generally considered better in terms of corporate governance and transparency level across Asia, property sector in India scores quite poorly vis-à-vis Chinese counterparts. The Chinese developers usually offer much better granularity in terms of land bank details and sales data.
Office rentals in China lower: City centre office properties in Shanghai and Beijing are being offered at US$4-6/sf/month while the prime locations in Mumbai are going at US$6-8/sf/month.
Residential property prices comparison - a mixed bag: Of the 20+ project
sites / sales offices that we visited across the 6 cities, the cheapest residential project was RMB5,000/sm (i.e. Rs3,000/sf) and the most expensive was in Shanghai Xiantindi area (city centre) by Shui On at RMB100,000+/sm (Rs60,000+/sf).
We believe that the comparable prices in Tier II cities in China are higher than the
comparable towns in India (viz. Gurgaon) but the prices of properties located
about 30-45 mins from the city centres in the bigger cities viz. Shanghai / Beijing appear comparable/ possibly lower than a similar properties in India.
However, China's per capita income is nearly 3x that of India and the superior buying power of Chinese consumers is evident in the fact that the Tier II city viz., Shenyang and has two Louis Vuitton stores. Property developers in China have already taken the bold step of price cuts : Developers in certain areas (dominantly southern China viz. Guangzhou and Shenzhen) have already lowered prices by 15-20% at the cost of irking the older buyers.
In India, we have seen DLF offering products at lower than market prices but that's only in the new geographies and not in existing projects. Soon, Indian developers may have to
start lowering the existing project prices if volumes do not pick up.
Retail rentals higher in China but much higher foreign brands activity: Prime retail rentals in Shanghai are nearly double those of price retail rentals in Mumbai and Delhi, then again, Shanghai boasts of outlets of some super premium global brands viz, Louis Vuitton,
Hermes, Fendi etc.
Safe Harbor Statement:
Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.
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