ICRA maintains negative outlook for residential real estate, stable outlook for commercial realty

Rating agency ICRA has maintained a negative outlook for the residential real estate (RRE) segment due to high inventory, weak affordability and muted demand and a stable outlook for commercial real estate (CRE) segment.

The RRE has witnessed a prolonged down cycle owing to high inventory, muted demand, weak affordability and declining investor interest. However structural changes over the last two years in the form of implementation of Real Estate Development and Regulation Act (RERAD Act) and Goods and Services Tax (GST), along with increased government focus on affordable housing, have raised expectations of demand revival in the industry, ICRA says in its year-end assessment of the real estate sector.

It also notes that a broad-based recovery in demand across the country appears to be some time away. States such as Maharashtra and Karnataka which have seen relatively better implementation of the RERAD Act are benefiting from increasing confidence of end-users, it says.

Demand in the premium and luxury category of residential segment are likely to remain suppressed for under-development projects due to the increasing preference for completed properties under the GST regime.

New launches hit

New project launches had been severely curtailed in the calendar year 2017 due to the impact of demonetisation and transition issues in RERAD Act implementation.

While certain cities like Bengaluru, Mumbai and Pune have witnessed a notable pick-up in new project launches in 2018, other markets like the National Capital Region (NCR) may take longer for major uptick in project announcement due to existing inventory overhang.

Due to the high compliance obligations imposed by RERAD Act, new launches from small developers have reduced, thus market share is being garnered by the larger developers who are better placed to operate under the new regulatory framework. This process of market share consolidation is only likely to strengthen over the coming years, it notes.

The residential realty segment has been increasingly relying on non-banking financial companies (NBFCs) and housing finance companies (HFCs) to raise debt financing, owing to the risk perception attached with the segment by banks. The liquidity crunch faced by the NBFC and HFC segment towards the end of the calendar year 2018 has impacted the funding availability and cost for many real estate developers, it says.

In the coming year, ICRA expects residential real estate developers to maintain a cautious stance towards new project launches and land acquisition deals, especially due to the constrained debt funding scenario, it says.

The upcoming elections in CY2019 may also keep the fresh project launches in check, considering the uncertainties developers may face relating to timeliness of regulatory approvals for projects.

DMs and JMs are the flavour of the season

With RERAD Act limiting the ability of small-scale developers to launch projects, the industry is likely to see more of development management or joint development model of project implementation. The existing gaps in the implementation of RERAD Act in many states need to be corrected for customer confidence to be fully reinstated and the full benefits to be realised.

Demand growth is likely to be sustained in the affordable and mid-income category of projects in Tier 1 markets, especially those where the fresh leasing activity of commercial office space continues to be robust thus creating fresh job opportunities, the report says.

Stable outlook for commercial segment

As far as the commercial segment is concerned, ICRA has given a stable outlook. In contrast to the residential segment, the commercial realty sector has been growing at a steady pace and has garnered the major share of the institutional investors’ interest in the real estate space over the last 4-5 years.

Some factors that have supported the growth prospects for the sector include stable demand for office space from various multi-national and domestic corporations, calibrated supply of stock, a more organised industry structure and availability of adequate capital for projects, backed by healthy investor appetite for rental yielding assets.

Most of the tier 1 markets have seen stable levels of fresh leasing and supply additions, resulting in either a declining vacancy (in cities like Bengaluru and Pune) or a status quo in vacancy levels (in cities like Delhi NCR and Mumbai), ICRA notes.

The Hyderabad market is in the midst of a boom in office space absorption with resolution of earlier political uncertainties and relatively lower costs along with high quality of living indices. Nonetheless, with significant supply of stock lined up over the medium term, occupancy levels and rentals in this market may come under pressure if the current demand trends are not sustained.

Bunching up of SEZ stock

The upcoming sunset clause for SEZ units will result in some bunching up of SEZ stock completions during the calendar year 2019, which may temporarily create pressure on the vacancy in certain markets like Bengaluru and Chennai.

Consolidation by large tenants

Some of the other key trends that have been witnessed in the commercial segment include strong interest from institutional investors in building commercial real estate portfolios, consolidation of office spaces by large tenants resulting in increased demand for large-format office parks, healthy rental appreciation in certain micro-markets in cities like Bengaluru and Hyderabad, which has encouraged some amount of speculative construction, rapid growth of co-working format of leasing, and the expected launch of the first Real Estate Investment Trust (REIT) in the country by Embassy and Blackstone.

Going forward, ICRA expects similar demand and supply levels to continue in the major cities, which will support a further expansion of the asset portfolios of the established incumbents.

Developers and micro-markets which have more diversified sectoral exposure would be more resilient in weathering any near-term challenges due to the decline in demand from any particular sector, such as IT services, it adds.