Real Estate sector which has been struggling for last five years due to increased supply, increasing land cost and some regulatory interventions, was seeming to be crawling back to normalcy and was on path of slow and steady growth. However, recent eruption of problems in Indian non-banking financial institutions (NBFC) is a cause of fresh worry for our realtors. NBFCs have been major source of funding for Indian realtors and trouble in NBFC segment has all the chances of spilling over to realty sector too.
The cash crunch in the system was triggered by a series of repayment defaults by IL&FS, resulting in mutual funds and other financial players virtually freezing investments in the Commercial Paper (CP) market, a key source of funding for NBFCs. According to one estimate, funding for nearly 15% of NBFC business is met through the CP market.
During the period from FY 2014 to FY 2018, Indian real estate sector has received more than Rs 4,000 billion of funds from banks and NBFCs. However, of late, real estate developers have been leaning more on NBFCs than on banks for their funding requirements. This is visible from the fact that while bank funding to developers was reported to post a 4.7% compounded annual growth rate (CAGR) over FY14-18, NBFCs reported a 45.3% CAGR. Further, NBFC share in real estate financing has increased from 24% at end-FY14 to 53% as at the end of March 2018.
Therefore, health of NBFC is very much a matter of concern for realtors too as it has been to RBI. Disruption in NBFC sector may ultimately make it difficult and expensive for the realtors to get funding for their ongoing and future projects. If funding availability remains benign, developers have limited incentives to cut prices.
For realtors, other channels to raise capital are private equity deals and public listing. While private funding has been available, a lot of capital has been attracted by the commercial segment. Also the downgrades by the credit rating agencies primarily arising in residential segment as against the commercial segment. However, it is also true that the number of companies in the commercial segment is significantly less than that in the residential segment.
A section of realtors we have spoken to indicated that developer funding is unlikely to continue at the pace we have seen over the last 4 years. Further, according to our sources, liquidity tightening has resulted in increased funding costs. However, developers having strong pre-sales and robust collection mechanism are largely unaffected by the current situation.
Liquidity tightening may result in developer or financial institutions selling properties that are marketable in the current environment either to meet the financial obligations or to recover the lent money. We may also see builders offering more schemes and discounts on ready projects or near-completion projects to improve cash flows. The current liquidity crisis will strengthen the position of large developers having minimal dependency on external funding for project completion.
Developers with strong Balance Sheet can also look at REITs (Real Estate Investment Trusts) as an option to raise money. REIT is an investment tool that owns and operates real estate related assets and allows individual investors to earn income through ownership of commercial real estate without actually having to buy it. The concept is similar to mutual funds and provides its investors with various income streams and long-term capital appreciation akin to mutual funds. In this tight liquidity scenario we may soon see first REIT getting listed on stock exchanges.
Present liquidity crunch faced by the real estate sector is likely to delay the cyclical recovery in the sector. However, there are certain positive developments which will have implications on the Indian real estate sector.
The government’s greater push on urbanisation and affordable housing will have long term positive bearing on the sector. The government has decided to set up a dedicated affordable housing priority sector fund under the National Housing Bank (NHB). This will open new avenues for developers who are planning to offer budgeted homes to the customers. In the meantime, RBI has raised housing loan limits for priority sector leading eligibility from Rs 28 Lakh to Rs 35 Lakh in the metropolitan center and from Rs 20 Lakh to Rs 25 Lakh in other centers.
However, in the short term, recent events could cause some more disruptions in the industry and also speed up the process of consolidation in the industry. Some real estate analysts believe that prices of properties could further moderate in the short term. Some builder may offer more schemes and discounts on ready projects or near-completion projects to improve cash flows. However, commercial segment is expected to fare much better than residential segment and most of the available funds may be diverted there thus further aggravating the funds scenario in the residential segment. Next 6-12 months will be very crucial for the sector.