India's Real Estate Sector: An Overview

Mohit Saraf

Amaresh Singh - Luthra & Luthra Law Offices

The real estate boom in India was inextricably linked to the country’s economic stability, which had made India a preferred investment destination.

India is on the verge of becoming one of the fast-growing economies, driven by many factors including multinational entrepreneurialism, buoyant local stock markets, robust economy-changing demographics and the overall emergence of India on the global stage. With great demand for housing for India's huge population and for commercial and industrial premises for its booming economy, large-scale real estate projects were launched across the whole country. This transformed the real estate business into one of the most lucrative sectors in the country. A sector which attracted venture capital, and diversified sources of funding including overseas, and private domestic funds and private equity funds. To create an environment friendly to foreign investors, foreign direct investment to up to 100 per cent was allowed in 2005 in townships, built-up housing and construction development projects with the liberalisation of FDI regulations. The inflow of funding catalysed the organised development. However, in 2008, the global meltdown in real estate produced a corresponding downturn in the Indian real estate sector.

Needless to say, the real estate sector plays a significant role in the Indian economy: it is second only to agriculture in terms of employment generation and substantially contributes to the gross domestic product of the country. Almost 5 per cent of GDP is contributed by the housing sector, and in the next few years it is expected to rise to 6 per cent. Moreover, the construction sector has also been responsible for the development of over 250 ancillary industries such as cement, steel, paints, brick, timber, building materials, etc. A study by a credit rating agency ICRA shows that the construction industry ranks third among the 14 major sectors in terms of direct, indirect and induced effects in all sectors of the Indian economy. A unit increase in expenditure in the real estate sector can generate a fivefold increase in income.
With the downturn in the economy, and being a capital-intensive industry, the real estate sector started to face a liquidity crunch emanating largely from banks' cautious approach to financing the real estate companies. This approach was reflected in lower loan-to-property value, construction-linked payment and financing only for projects nearing completion. Further, real estate developers also had to cope with other sources of funding, such as private equity and stock markets, drying up considerably; receivables from residential projects under construction getting blocked; falling demand and buyers deferring payments until they took possession of properties. The resultant fall in valuation in the past few months coupled with high interest rates and low availability of money had put real estate developers on the defensive and kept homebuyers away.

The true test of the professionalism in the real estate sector has to be seen now. In the past a seller's market existed, in which it was only necessary to market products or think about what kind of products to make. But now the market has perceptibly shifted towards the buyer and products must be designed to respond to market requirements. Because the demand in the affordable housing segment is encouraging, real estate developers now need to concentrate on profits through high-volume, low margin deals instead of high-margin and high-quality transactions. This will mean designing affordable housing options suited to average Indian families whose disposable income is steadily on the rise.

In the residential segment, the first quarter of 2009 witnessed the launch of residential projects with some price rationalisation. However, the price corrections are more pronounced in new launches than existing projects, which are mostly sold to end-users or investors, and whose costs are covered. Further, the correction in prices, cuts in bank interest rates and smaller unit sizes per apartment - owing to a shift from luxury to low-cost housing - has led to increased affordability for homebuyers. The current scenario has also opened up new locations for residential development, which were otherwise not very attractive to homebuyers. Far-flung suburban locations, where land is relatively inexpensive, have witnessed the launch of aggressively priced projects in the recent past. With a huge latent demand for housing units in India, the residential sector is a strong driver to lead the recovery in the real estate market in terms of sales volume and asset pricing.

As far as the commercial segment is concerned, with a substantial surplus of office space, demand for rentals has declined overall. This has been compounded by subdued absorption levels and a decline in pre-lease activities across the country. Rents are expected to correct in varying degrees, creating considerable opportunities for occupiers and investors. The market is expected to improve some time in late 2010 based on a better global capital spending environment and stabilisation in other sectors of the economy. Certain reports estimate that the IT and ITES sector alone will require 150 million ft2 of office space across urban India by 2010.

In the retail segment, while rentals are being negotiated downwards, revenue-sharing models for new lease agreements are also being explored. Furthermore, with the liberalisation of the foreign direct investment policy to allow single brand retailing in India (though to a limited extent) coupled with price correction in rentals and growth of organised retail industry, India is enjoying a flurry of tie-ups between the foreign brands and Indian real estate developers and the scope and depth of investment in the retail segment seems to be expanding. The growth of the organised retail industry across India is likely to generate an additional 220 million ft2 of retail space by 2010.

While the government has taken various steps to develop the whole industry, there is a further need to streamline government policies and introduce reforms to boost the real estate sector. Industry experts are advocating a further substantial cut in interest rates and greater ease in credit financing. The government has already announced two stimulus packages, in December 2008 and January 2009, which included cuts in key lending rates and classification of loans up to US$41,670 (approximately) per house, per family, as priority-sector lending. These stimulus packages were crucial steps in the right direction and the momentum needs to be maintained by the recently elected new government.

The government's recently announced stimulus package, coupled with the Reserve Bank of India's move allowing banks to provide special treatment to the real estate sector, is likely to have a positive effect. Banks have announced a package for home loan borrowers in various categories. Subsequent to RBI permission to restructure loans to real estate developers, these developers have rolled over nearly US$1.8 billion debt. The government has allowed external commercial borrowings (ECB) for integrated townships development and has dispensed with the requirement of all-in-cost ceilings limits for ECB until June 2009, which is expected to increase borrowings and in turn boost the sector. Moreover, recent excise duty cuts on cement and steel will bring down construction costs and the most recent exemption for real estate developers from service tax in relation to construction of a residential complex will reduce prices further for homebuyers.
The recent government initiatives have already increased liquidity in the market and brought down the interest rates to a more realistic level. Supporting the government's initiatives, many developers have also lowered property prices by up to 20 to 25 per cent and customers are once again interested in buying a house for themselves.
With the election of a stable central government, the real estate market is expected to get a boost, as improved economic sentiment and rallying stock markets are bringing back confidence into the real estate sector. Some of the recent reports have stated that with a strong and stable government at the centre, the probability of recovery in the economy in the second half of 2009 to 2010 has increased. The new government is expected to stimulate the economy by introducing favourable policies for all industries and sectors, which would help the country forge ahead. This obviously will have a direct impact on the real estate sector.

The long awaited Real Estate Management (Regulation and Control) Bill, which is expected to establish a regulatory agency and streamline the real estate sector by introducing various reforms, is due for introduction in the forthcoming sessions of the Indian parliament. The new government is also expected to address the longstanding issues of grant of industry status, tax-breaks and exemptions, streamlining and increased harmonisation of registration and stamp duty rates across the country, liberalisation of the economy to allow foreign investment, allowing REIT and REMF structures to channel investment into real estate and permitting even small investors to participate in property development. The Securities Exchange Board of India, the stock market regulator, is reported to have initiated discussions with experts to set up a framework for REITs. These measures will go a long way to building up overall confidence and creating an environment conducive for a substantial increase in foreign investment into the real estate sector.
Things have already started to look up for developers in the past few months. Three major developers DLF, Unitech and Indiabulls Real Estate have raised around US$1.6 billion through the financial markets, indicating the beginning of a revival of investor confidence. These funds are largely being used to complete ongoing projects and lowering of debt obligations, which would improve the companies' balance sheets and their stock performance and ultimately strengthen the whole sector.

Recent stock market activity in India and aggressive capital raising mechanisms - including qualified institutional placement - adopted by developers reflect the growing positive sentiment and the efforts of recent months and an increasingly stable global environment. The downturn has motivated developers to adapt by restructuring debt, disposing of non-core assets and refining their product mix. Significant loan restructuring by the financial institutions and a reduction of interest rates have resulted in more robust financial statements among real estate companies. The companies are also successfully managing to cut debt and attain liquidity either through non-core asset sales or share sales to investors.
At present, the ideal course should include the restructuring of loans and increasing demand by reducing prices, offering customer-friendly financial structures, rebuilding foreign investors' confidence, introduction of innovative real estate products and widespread policy measures by the new government to strengthen the real estate sector in India. The revamped sector would definitely experience a boom again and it is envisaged that the value of the real estate sector in India would grow to over US$100 billion in the next 10 years with improved stock of housing loans and mortgage penetration, reduction of risks for venture capitalists and private equity firms and rationalisation of the real estate regime.

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