Monday, 13 April 2015

Real estate firms: short-term pain before long-term gain

Real estate developers may end fiscal 2015 on a dull note, given that the March quarter earnings forecast, too, is weak after three similarly weak ones. Yet, surprisingly, the BSE Realty index has been an outperformer, compared with the BSE Sensex, with returns being three times more since January. The optimism is perhaps driven by positive tidings such as lower interest rates and tighter regulations to improve transparency and credibility of the sector. The Real Estate Regulatory Bill—tabled last week—also had a favourable impact on large realty stocks.

However, in the near term, the stringent requirements could strain balance sheets and cash flow. For example, unless the developer has all the clearances in place and has acquired land for the project, he would not be allowed to sell the project. This would imply ready liquidity with the developer. Further, the need to keep 50% of the advances in an escrow account and the restriction on the percentage of advance that can be taken from customers, would, according to analysts, lead to a funding mismatch in the near term.

This would mean that real estate firms would need to fund new launches with equity or debt, both of which seem an uphill task given the beleaguered state of the sector. Highly leveraged balance sheets and low revenue accretion is mirrored in the rising interest cost as a percentage to sales. Data for 13 listed realty firms showed that in eight quarters to December 2014, interest cost as a percentage to sales had surged by 300 basis points. One basis point is one-hundredth of a percentage point.

Three successive quarters of weak sales, especially in the National Capital Region (NCR) and Mumbai, are likely to translate into poor performance for the March quarter. A preview note by Edelweiss Research says that operating margins, too, may be subdued owing to a fall in pre-sales and delays in high-value projects hitting the revenue recognition threshold. Thereafter, the high interest costs could weigh on net profit.

But, if the bill becomes law, realty firms would gain credibility in the eyes of both investors and customers. A quicker turnaround of capital, faster deliveries and, in the final run, easier access to money are expected if the companies fall in line with the regulation. In the interim, any improvement in sales volumes could come if interest rates fall further and realty firms get new launches off the ground, which have been delayed for several quarters.

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