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The real estate sector has seen a boom in the past few years. The sector has seen asset prices increase exorbitantly, which has sparked speculations that real estate is a bubble that is waiting to burst. The sector is in the maturity stage of its lifecycle today, where after a period of explosive growth, prices have stabilised and the growth rates have moderated, leading to a slowdown. The slowdown has affected the developers adversely. Several developers have stalled their expansion plans, put the projects on hold, and sold their land banks to tide over the crises or have even defaulted on their debt obligations. Further, on account of tighter credit norms and the reluctance of banks’ to fund fresh loans or new developers, it is expected that players in the sector will find it difficult to access funds. It is likely that many developers will end up refinancing their debts.

Effect of Slowdown on Demand

The current slowdown in the sector has affected developer’s ability to acquire land. It is expected that many players that were in a frenzy to acquire land to build up their land banks have already postponed their plans.

One of the most active buyers in India’s real estate market was the wealthy NRI community settled in various parts of the world. The NRIs made up a significant portion of the real estate sales in India as they invested their surplus money in the sector owing to its high returns. However, it is expected that the global slowdown will result in a decline in investments from the NRI community in the Indian real estate market.

As a result of current slowdown many of the IT players have scaled down their employee hiring plans. For instance, the top three IT companies have scaled down their recruitments in the first three quarters of FY09. As these companies freeze their expansion plans or resort to job cuts and salary cuts, their well-paid workforce who are the potential buyers are likely to stay away from purchasing new homes creating an adverse impact on the demand for residential units.

Consolidation Expected

The stricter credit norms in terms of higher collaterals & personal guarantees and the cautious approach adopted by the banks have affected the cash flows of real estate developers as they strongly depend on the credit flow from banks for completion of projects. Their expansion plans were primarily funded by short-term debts and these developers will face debt redemptions in the near future. However, now that the banks have become cautious in lending to the real estate sector, raising capital is a big challenge. In such a scenario, developers who are not equipped to handle these challenges will struggle to survive, in which case the sector will see consolidation as these developers will merge or sell their projects to other strong players in the market. The consolidation in the industry will also see weeding out of small time developers who jumped onto the bandwagon when the going was good leading to emergence of stronger and organised players.

For established and large developers who are not really affected by the slowdown there can be a lucrative opportunity. These developers can cherry pick projects or land banks from small time developers that are cash starved and are looking for an exit opportunity.

Investment Vehicles Could Act as Catalysts

The declining real estate sector is expected to get a boost from newer investment vehicles like REMF and REITs. The Securities Exchange Board of India (SEBI) has introduced REMF regulations in 2006 and has issued draft regulations on REITs in Dec 2007 for public comments. As a result mutual funds can invest in the real estate sector through REMF while the REIT guidelines will be finalised after receiving comments from the public.

Through REMF the investors can participate in the ownership of real estate, which will open up newer financing avenues for builders with lower cost of capital and increased margin. REMFs will also bring down the builder’s heavy dependence on short-term debt. REMFs are thus expected to enhance the liquidity of the sector by infusing capital, providing opportunities to retail investors to participate in real estate and making the sector more transparent and organised.

Way to Revival

Owing to the economic slowdown, the current scenario for the domestic real estate sector is weak. Nonetheless, the sector does present some opportunities in the medium to long term. With the estimated shortage of 24.71 mn housing units in urban areas, and with a burgeoning population, the country does need to develop housing units to provide accommodation to the increasing population. However, this demand-supply gap cannot be filled by the government alone and therefore an opportunity exists in the housing segment for the builders. Further, India is fast catching up as an attractive destination for the Meeting Incentive Conference Exhibition (MICE) industry. Currently India accounts for less than 2% of the global MICE industry which indicates a huge potential for India to tap this market, which in turn provides a growth opportunity for the real estate sector.

Developers are expected to counter the slowdown by taking a number of initiatives. It is expected that developers will aim to complete ongoing projects and meet their commitments to maintain their brand identity, and to help them tide over the crisis. Also, it is expected that turning their focus to the low-cost and middle-income housing segment may attract buyers, as so far the developments were primarily targeted at high-end segments. Developers are also expected to look at the option of joint ventures with international developers to come out of the crisis.

Despite the current slowdown, the real estate sector is expected to have reasonable growth prospects in the medium to long term - which will be supported by the large demand-supply gap due to increased urbanisation and schemes like Jawaharlal Nehru National Urban Renewal Mission (JNNURM). Further, the various preventive measures undertaken by the RBI and the Indian Government like rate cuts, the stimulus package, providing priority sector lending status to real estate, reduction in excise duty on input materials like steel and cement, and the public sector bank’s initiatives to lower interest rates on home loans are some of the positive steps that are expected to stimulate demand as well as ease credit crunch of developers. These measures are expected to take the sector towards revival in the long run.