India: An Unsettling ReWind

Real Estate: The unwind and its side effects 

We are seeing a broad-based real estate pullback, with prices correcting in most tier-1 and tier-2 cities alongside sharp drops in transaction and new launch volumes. The drivers for this slowdown are a mix of supply-side factors (banks have pulled back lending to developers) and demand-side factors (the Black Money Bill has created fear amongst speculators). The result is not just a drop in demand for building materials and challenges for lenders with big mortgage, LAP and housing finance books, but also a generalised slowdown in GDP growth, as the sector which drives 50% of India’s capex and 30% of its jobs conks off. Our four large-cap SELLs on this real estate correction are Ultratech, Asian Paints, ICICI and HUL. 

A broad-based real estate slowdown Whilst the RBI’s Housing Price Index suggests that prices have moderated on a pan-India basis, data from property websites suggests a deeper slowdown in India’s large cities, with prices falling by 7-18% YoY. Alongside this, we are also seeing a significant drop in transaction volumes: our visits to five property registration offices in Mumbai suggest a sharp drop in the registration of new residential properties and data from property valuers in Maharashtra and Tamilnadu suggest that transaction volumes have fallen by 10-15% per annum for three consecutive years now.

Also, new launch volumes are down 40-80% on a pan-India level (see Exhibit A).  Combination of supply-side and demand-side factors trigger the slide Supply side: (a) RBI data suggests that the banking system seems to have turned the tap off for property developers over the past year. This has in turn made developers either stop construction or cut prices. (b) The NDA has cut subsidies sharply (down 9% in FY16) and is shifting subsidies to Direct Benefit Transfer. As a result, the ability of the politician-and-builder to pilfer subsidies to fund real estate construction has been checked. (c) 

The knowledge that there is many years’ worth of unsold real estate inventory in most of India’s tier-1 and tier-2 cities is causing investors to hold back further purchases.  Demand side: (a) The draconian Black Money Bill went live on 1st July and has made HNW families reluctant to invest in Real Estate. (b) The 8% point gap between the gross rental yield and bank base rate highlights the unattractiveness of real estate for investors. (c) Key state governments (Maharashtra, West Bengal, Delhi) have hiked “ready reckoner” rates sharply this year and thus prevented prices from dropping to a market clearing level. 

Investment implications Real estate accounts for half of India’s capital formation and 30% of its job creation. With the sector on the slide, GDP growth is under pressure, directly, because of the drop in investment, and, indirectly, through pressure on wages. We reiterate our  FY16 GDP growth forecast of 7% (vs consensus’ 7.8%). Beyond real estate itself, the sectors most impacted are: (a) Cement – we expect YoY volumes to remain flat in 1Q; (b) Paints – we expect weak volume growth of 34% again in 1Q; and (c) Lenders – 15% of the banking systems’ assets are directly exposed to real estate and the experience of other Asian economies suggests that once property prices start falling, NPAs have a tendency to more than double from their pre-stress levels. Our key large cap SELLs on this theme are: Ultratech, Asian Paints, HUL and ICICI Bank.