India’s Real Estate Valuations: How will the new reality be reflected?

Valuation has become an enigma for the real estate industry in the last months, with no clear sign of when we will go back to business as usual. The pandemic has also ignited  a debate as to how and when assets are to be valued. GRI Club India members gathered to look for answers for many questions and challenges that have risen  in valuations of existing and new projects with the impact of the COVID-19 pandemic.
 

• COVID-19 has posed various challenges such as job loss and decreased salaries. Is it likely to impact the residential sales proportionately and call for a price cut? 
• With a large workforce adjusting to working from home, once the situation at hand normalizes, would it lead to reduced office space – leading to reduced rentals?
• Social distancing is being practiced actively now – What impact would it have on retail malls.
• There has been positive buzz surrounding data centers and warehousing – is this noise going to continue to resound in the next months? 
• How will this pandemic impact valuations going forward? – specifically in relation to demand /supply for residential and the rental cap rate for offices. 

Residential Sector: The Opportunities and Complexities

Equity valuation remains unclear and developers are finding it more difficult to price new equity capital resulting in placing equity in a black box for the last 150 days. The private market has not been able to catch up with the repricing in the public markets. The possibility of portfolios being revalued on the basis of the 30 June portfolio is bleak relying on the past patterns. At the beginning of the lockdown, developers implemented the 10:90 scheme to support sales and continue encouraging buyers to close the deal, and with it boosting job security. Prices have also decreased 7-8 percent, which were integrated into the payment plan and the volumes are floating at 1/3rd or 1/4th in volumes baring the volumes in the affordable sector which are doing much better. The volumes of constructed properties are at a 30 percent level for properties which are close to completion. There are hardly any sales; surprisingly there is volume at the beginning of property on the condition of schemes and NRI sales have also spiked up during the lockdown. 

Members believe that there may be a 15-20 percent drop in the asset pricing, with luxury properties offering a 10 to 12 percent price reduction at the culmination of sale. Affordable sectors have not shown any loss in value and premium units have shown a medium loss. In summary, the key takeaways for the residential segment are dearth of capital, fight towards quality, consolidations, limited sales, virtual freeze on lender liabilities. Residential sector is likely to turn into a private equities market achieving financial closure with little to no losses. Nevertheless, as the overall business is down to 30-40% at best, times will get tough with everything revolving in function of location, brand, product and pricing. 

Outlook for New and Existing Residential Investments

For existing investments in the residential space, sales have continued through different channels, especially in the affordable housing segment. When it comes to cancelations, in the past five years the average of cancelations has been 10 percent and in the last 100 days of lockdown, this figure has not moved. This is a reassuring sign for industry players. Delays in accounts receivable have also proven to be marginal in comparison to what was expected. 

As for new investments, pricing has shifted from 200 to 300 bps for debt. The opportunity to obtain higher returns has also increased in the market in comparison to the last three to four months. Capital scarcity in cheaper markets has halted developers access to cheaper capital which has resulted in a broader base for players with higher capital to create partnerships with higher quality developers. This will create an avenue for lower risks against the same returns that were available one year ago. There has also been an increase in the scale of transactions in comparison to the transactions undertaken last year as larger developers would want larger check sizes either at the time of refinancing or when looking for new money.

If prices were to drop, would this lead to an increase in purchases of residential products? The response to this question has divided players in two stances: 

• A price cut will provide the much-needed traction in terms of velocity 
• Price cuts would not impact the velocity in the current atmosphere 

In India, the cost of buying a house is much more than the cost of leasing, if the mortgage rates are where they are today and developers decide to cut prices due to the denominator effect, the cost of buying a house ought to come down drastically bringing in some sought of parity between leasing and purchasing the property. Some market players believe that the only hope that could relieve some of the impact of the RBI moratorium is by way of a one-time restructuring. In absence of which would push for a flurry of activity come October or November in terms of willingness to drop prices. 

The Commercial Sectors Wait-and-See Stance 

The commercial sector has been greatly hit by the lockdown. Companies are being more cautious and are not ploughing in CAPEX in this segment until they can assess the damage. For a company doing 40 million square feet in the past year would be fortunate to record 20-25 million square feet for the next two years. 

Although there have not been many rent corrections with IT tenants, newly developed properties there may be a need to discount rents significantly. For leases that are close to expiring there is a low probability that they will suffer drops but instead lease extensions. The numbers in the retail segment have been hit gravely, however purely commercial spaces have recorded sales in both larger floor plates and smaller floor plates. 
Members believe that it is still early to tell, and that one or two transactions cannot define the market. The consensus is that players are continuing to take a wait and see stance. Investors are likely to wait into the 3Q20 to have a better understanding of what the earnings could be. 

The Financiers Perspective

The cost of capital or the expectation of cost of capital has increased by 100 to 200bps. The 15-20 percent drop in the value outlook has resulted in a higher cover, underwriting larger tenures, and liquidity to be created even at the expense of an immediate hit on cash flows. The first strategy  players are implementing is to try and get good credit quality and increase the receivables, all the while ensuring that the cash flows are lower. The second strategy is to de-risk the check size. Underwriting has grown more difficult due to the unknown variables and it has also become extremely difficult to underwrite the velocities. There is no expectation of purchases or leases in the commercial segment for the next 12 months. Before, money was committed to the commercial properties at a premium during the development stage itself. Now, this has shifted toward the closing stage or when the OC has been obtained without the premium.

Members discussed that the focus should be shifted to the top 20 percent of the development population and look towards resolving the problems as well as expecting more challenges The top 20-25 percent is where the LPs are willing to partner as they believe that this is an opportunity that was not available to them earlier at the premium which was demanded. There is double whammy due to the moratorium as the lenders would be paying to the customers the interest that they would have lost, which  must be budgeted to be recovered in some manner. The financiers are more optimist toward residential than commercial, as while the next 12-18 months will be challenging for residential, the long-term outlook on a 5-7 years’ timeline is fairly positive. Another opportunity that has arisen is last mile funding, but there are various complications to extract the value from these projects. COVID-19 has forged uncertainties in estimating the risk involved in creating pricing pressure coupled with the RBI moratorium. Resulting in the Indian real estate industry being in a state of virtual freeze, with the next 6 to 12 months truly challenging. With the business functioning at one-third levels and bringing in liquidity becoming the new mantra, the GRI meeting held last week initiated noise at both ends of the table on whether a price reduction would lead to the much needed velocity?

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 This is minutes of the discussion: Post COVID19 Pricing - When will valuations reflect new reality? Carried out on July 2 by GRI Club India.