Demand across six key cities to increase at a CAGR of 7% during 2012-14 : CRISIL

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CRISIL Research expects real estate developers’ earnings and return on equity (RoEs) to improve next year. Sustained growth in demand, expected to improve on interest rate cuts likely next year, will be a key determinant for the improvement in industry’s profitability and RoEs. Over the past two years, subdued demand, high construction costs and high interest rates have dented the earnings and return ratios of real estate companies in India.
Overleveraged, many large real estate companies could not substantially reduce debt. Most real estate stocks, therefore, have significantly underperformed the benchmark S&P CNX NIFTY and trade at historically low valuations. CRISIL Research believes select real estate stocks offer upside potential from their current valuations and expects valuations to improve and return to historical levels of FY09-10.

Earnings and RoEs under pressure over the past two years
Earnings and RoEs of majority of real estate players have been under pressure over the past two years. Our analysis of 23 listed real estate companies highlights that earnings declined 21% and 9% y-o-y in FY12 and H1FY13, respectively, RoEs declined from 7.7% in FY10 to 4.7% in H1FY13. Subdued demand and high construction costs impacted revenues and margins. This coupled with high debt and rise in interest rates dented earnings and return ratios. We expect earnings to remain muted for the rest of FY13 but should pick up in FY14.

Real estate players to tread on smoother ground next year
Despite deteriorating financial performance over the past two years, CRISIL Research foresees light at the end of the tunnel. We believe GDP growth has bottomed out and expect gradual recovery in FY14. Further, inflation is showing signs of cooling down. In this backdrop, CRISIL Research expects the Reserve Bank of India (RBI) to cut the repo rate by at least 50 bps in the next one year. This is expected to improve affordability and provide the much-needed stimulus to demand. Consequently, earnings and return ratios are expected to improve in FY14. An analysis of the historical absorption trend post softening of interest rates
supports our argument. Our analysis also suggests 8% improvement in PBT and 100 bps increase in RoEs at an aggregate level purely on 50 bps decline in interest rates.

Demand across six key cities to increase at a CAGR of 7% during 2012-14
CRISIL Research expects absorption of new residential units across six key cities – Mumbai, National Capital Region (NCR), Pune, Bengaluru, Chennai and Hyderabad – to increase at a CAGR of 7% to 251 mn sq ft in the next two years. Mumbai is expected to record the highest CAGR of 14% over the next two years due to pent-up demand. Capital values across regions are expected to remain at H1CY13 levels and are anticipated to rise marginally in H2CY13.

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