As a research analyst tracking the Indian real estate business, over the past decade I have witnessed the balance sheets of major developers swinging from one extreme to the other, from limited land banks and low debts to large land banks and huge debts. How did this happen?
Following the economic crisis of 1998, it was not until 2003 that the real estate business found stable ground. With employers trying to retain talent, more money became available in the hands of Indians who opted for investment in high beta assets and the introduction of new projects met with huge demand.
With FDI permitted in 2005, foreign investors willing to pay high prices entered the market. Furthermore, with the easy availability of capital through primary listings, developers started actively expanding by acquiring large land parcels at aggressive valuations and entering unfamiliar parts of the country.
Substantial increases in land banks between 2006 and 2008
Source: Company annual reports, DLF IPO prospectus, Jones Lang LaSalle
Due to high investor interest, developers increased the pace and scale of launches and committed execution which was considerably higher than they had achieved since incorporation, resulting in construction delays. In addition, since large portions of the projects were sold to channel partners for nominal payments, sales did not produce enough collection, and debt replaced internal accruals as a means to cover construction.
Further, rapidly increasing capital values affected affordability and end-users stayed on the side lines, forcing investors to withdraw from the market and leading to capital values plummeting. During the global financial crisis of 2008-09, the situation became worse and developers found themselves laden with huge debts.
To support the sector, the government allowed banks to ease repayment terms. Developers reduced prices, and buyers responded well. However, within 24 months, capital values returned to their previous peaks, absorption started to dry up and developers found themselves sitting on huge undeveloped acreage.
With the slow pace of government approvals and weak demand, project launches became difficult. Developers opted for high-cost funding instead of increasing sales and started falling deeper into the debt trap.
Considerable increase in cumulative debt of the top seven listed developers in India
Note: The top seven developers include DLF, Unitech, HDIL, Godrej Properties, Sobha Developers, Oberoi Realty and Prestige Estates
Source: Company annual reports, Jones Lang LaSalle
Post 2011, developers opted to reduce debt by monetising non-core assets and undeveloped land, which I believe can only be a short-term solution. For a stable turnaround, the focus must be on improving absorption, even at the cost of margins.
Going forward, keeping in mind the mutual interest, developers and buyers need to act in unison. While developers need to plan their offering focusing on affordability, buyers need to make purchases promptly rather than waiting to catch a possible market bottom, which will usually end up being just a mirage once the cycle ends.
