Indian Real Estate Firms Face a RealityCheck

             

               Future economic historians may remember the month that just ended as Black September. Lehman Brothers collapsed; the Bank of America acquired Merrill Lynch; AIG was nationalized; banks such as Washington Mutual and Wachovia were wiped out. As credit and finance markets around the world tumbled like ninepins, so did stock markets in India, with the Bombay Stock Exchange Sensitive Index (Sensex) falling 3.35% or 469 points on September 15. The worst affected was the realty index which dropped 7.6% on the same day. Since then, while stocks prices in India have seen massive swings, shares of real estate firms have remained depressed, falling a total of 20% as of October 1.

            In addition to housing stocks, home prices are taking a beating. By some estimates, prices have dropped by 25% in certain urban markets. While in the U.S. -- and also in Britain -- the subprime mortgage mess has seen home prices fall dramatically, in India, such slowdowns have been rare -- at least in the past. Prices may soften, sales activity may slow and occasionally a distress sale occurs, but there has not been an overall fall in home prices. "India has not seen a boom-bust cycle in real estate mainly because the industry is still nascent," says Anurag Mathur, joint managing director of Cushman & Wakefield, a global real estate solutions company. "India has not seen a boom and bust cycle in almost any sector," adds Rajesh Chakrabarti, a professor of finance at the Hyderabad-based Indian School of Business (ISB). "While there have been variations, we have not had cycles of the kind we see in the developed countries. It is only after liberalization that the Indian economy has been seeing more cyclical movements."

          According to Irfan Razack, chairman and managing director of the Prestige Group, a Bangalore-based real estate developer: "We have boom and bust cycles in India but because of our huge population, the demand keeps growing and that sustains the industry. You can build for the next 100 years and there will still be demand for housing in this country."

            India has inadequate data on the real estate sector. For instance, no one tracks housing starts, an indicator that is regarded in many countries as an important yardstick of economic health. However, several real estate companies have gone public during the past couple of years, which makes information more transparent. Secondly, equity analysts have begun tracking these companies and the real estate industry.

            Still, confusion continues. Consider the reaction of the markets to the Lehman collapse. Real estate was hit for two reasons. Lehman had invested $200 million in DLF Assets, a company belonging to DLF, India's largest real estate company. It had also acquired a 50% stake in Unitech's Mumbai project for $175 million. (Unitech is India's second largest real estate company.) Among other Lehman investments or proposed investments were those in the Mumbai-based Peninsula Land Ltd. and Housing Development & Infrastructure Ltd. (HDIL).

            The market was worried that if the money had not already been received, the projects would be in limbo. Most companies (Unitech, for one) claim that the cash is already sitting in their bank accounts so there is no cause for concern. Others, like HDIL, have said the deals were not with Lehman Brothers but with sister companies. These are unlikely to be affected.

            The crunch might hit in the future. "With banks reducing their exposure to real estate, coupled with rising interest rates and volatile stock markets diluting the confidence of retail investors over the past one year, private equity investments have emerged as one of the most important sources of capital for real estate developers," says a FICCI-Ernst & Young (E&Y) report on the Indian real estate market released in early September. "The overall private equity investments reported in the real estate sector in India from August 2007 to July 2008 are estimated to be more than $5 billion." This tap could be turned off as a result of the financial crisis in the U.S.

            Real estate investors in India were also worried that Lehman might resort to a fire sale of its assets. While India has a three-year lock-in period for foreign direct investment (FDI) in real estate, it is unclear whether this applies when a company declares bankruptcy. The government is holding a meeting to decide the norms in such cases. The other issue is that Lehman holds small stakes -- bought from the market or in bulk deals -- in real estate and infrastructure companies such as IVRCL Infrastructure, Consolidated Constructions, Orbit Corporation and Vijay Shanti Builders. Here, too, there was the possibility of a fire sale, encouraging other investors to bail out.

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