Indian realty stocks that looked all set to fly on the wings of rising demand amid easier access to bank loans and higher purchasing power have been beaten down once again in the recent market correction. In the past one year, Bombay Stock Exchange's Realty Index has been a stark underperformer, losing half of its value when benchmark Sensex managed to churn out a 2% return.
The price-to-earnings ratio of the realty index corrected from its peak of 59 in January, 2010, to a modest 19 in March 2011. But factors such as a rise in borrowing costs and peaking asset prices - that are weighing down the residential home segment - have stopped investors from bottom fishing in the stocks.
Already considered a wild child in corporate governance norms, the sector was also hit by revelations of some firms being allegedly tainted by scams that fed into the negative sentiment. On the valuations side, the sector is attractive as the price-to-book value currently is at the same level as it was when both realty and stock markets had crashed in 2008, despite better fundamentals.
On the flip side, increasing interest rates will hit realty firms that have high debt on books and those whose demand is typically affected by higher borrowing costs for end consumers. But the impact will not be uniform on all builders with varied exposure to residential, commercial, and retail sectors. So, is it a good time to buy into the sector? ET Intelligence Group looks at the sector dynamics and its impact on the players.
FUNDAMENTALS OF THE SECTOR
The real estate market can be broadly divided into three sectors - residential, commercial, and retail. Residential housing is the biggest driver of demand in the sector. In commercial realty business, nearly two-thirds demand come from office space and the rest from leased retail space. The demand for office space in the country has improved on the back of growth in information technology and banking sectors, which account for a big chunk of demand in the category. The Indian realty market went through a downturn following the global economic meltdown in 2008.
A squeeze on credit flow and slowdown in demand as job growth in the country came to a standstill led to a sharp fall in asset prices and many new projects were held back. This also pushed up inventory or vacant and unsold space across cities, resulting in high working capital pressure for the real estate companies. But in mid-2009, signs of revival in domestic economy, correction in asset prices, and lower interest rates led to a pick-up in realty demand.