Demonetisation move will bring in much-needed transparency and also credibility to the real estate sector, says Sunil Rohokale, MD & CEO, ASK Group. Strong risk management framework like controlling cash flows and working closely with developers would ensure that returns for real estate funds are predictable and sustainable.
ASK Group, through its real estate investment funds, has significant exposure to residential real estate in metro cities. To what extent, has demonetisation impacted or would impact the Real Estate sector as also Real Estate Funds?
Demonetisation is certainly revolutionary in nature and will bring in the much-needed credibility and transparency to the sector which is wrongly perceived to be largely dependent on black money.
Real estate is a huge asset class which comprises of residential, commercial, retail, agricultural land and industrial segments and the impact will vary depending on the segment. Cash component has been traditionally high in some of the segments like agricultural land especially in the far-flung peripheries. To understand the actual impact, developers operating in the industry should also be categorised as (1) majorly governed/bankable (2) less governed (3) Ungoverned and non-bankable which typically relies on the cash component. The perception of the entire real estate industry being a black money dependent one is created because of some of these segments and categories of developers. So to conclude that the entire real estate industry depends on black and hence with demonetisation, prices will crash would be incorrect.
I strongly believe that demonetisation will bring in a sea change in the behavioural pattern of players, buyers in the industry who were involved in cash transactions and were huge beneficiaries of wealth creation in the past.
Coming to the residential segment, buying a home is a need and is not perishable in nature and in a country like India there is a huge demand for homes at the right price. So within residential, I think the impact will be pronounced on certain segments only such as luxury segment and non-bankable developers where cash intensity is high. Prices in the secondary sale will only be impacted if it’s a distressed one. On the other hand, the majorly governed developers with good track record/strong balance sheets and lower reliance on cash are unlikely to be impacted much as the negative effects will likely be offset by higher demand due to increased affordability and lower interest rates. With this, we expect the heterogeneous markets to become homogenous.
In terms of expected returns from real estate funds, these are mostly long tenor investments of 5-7 years and I do not expect demonetisation to have negative effects as in the long run. Increased affordability and lower interest rates will provide a much-needed push to the weak environment currently.
Is it Achche Din for real estate sector? How are your real estate funds faring?
Real estate, as we know, is a cyclical sector and while there is always a large demand for housing in India, the buyers have largely stayed away in the last 3-4 years due to weak macros and concerns about affordability in cities like Mumbai. We have already seen some time-value correction in recent past and possibly there could be some more pain left that will play out in the coming 2-3quarters. With an increase in liquidity and decline in yields, interest rates will come down and in turn boost demand.
In the long run, with demonetisation and enforcement of Real Estate Act, governance standards of this sector will definitely improve which in turn will bring down the cost of capital for the developers.
As far as our funds are concerned, we entered the real estate PE business to finance equity projects in the sector at a time when no fund was interested in equity financing; most preferred debt financing. We all know that high-cost leverage is responsible for the current status of the real estate business. Over the last seven years, we have raised Rs.3,800 crore through four funds, all dedicated to equity financing. Our core investment philosophy of prudent partner selection, mid-income housing focus, selection of growth corridors backed by job creation has enabled us to do full/partial exits over the past four years with 25-30 per cent returns despite the slowdown.
There are a lot of residential projects in Metro cities belonging to reputed real estate players, which are nowhere near completion. Would the current situation not prove death knell for these projects?
I am not so much concerned about the unfinished projects belonging to reputed developers. The reliance on cash is already quite low for these developers who are majorly governed and therefore the demonetisation is unlikely to affect their ability to complete the projects. Like I have said before, the impact of price erosion in the shorter run, if any, is unlikely to be material and this will be reverse at a faster pace in the medium term with a positive impact of affordability and lower interest rates playing out.
To what extent you think home prices would come down? Would this differ with metros?
The ones in north India will see the most impact as buyers largely comprise self employed people and investors. I would expect these markets to face some price pressure. While cities in western India will have a marginal impact, the ones in southern India will be the least impacted because of the nature of buyer profile. Also, stronger brand developers with better balance sheets and less reliance on cash are unlikely to be impacted much as the end buyers / investors will be willing to pay them a higher premium for better execution capabilities.
Recently the government announced Voluntary Income Declaration scheme, demonetization and plans to introduce Real Estate Bill. Are these reforms expected to help Real Estate and Real Estate Investment Funds? How?
A declining interest rate regime in the long-term will result in a reduction in the cost of capital to developers and buyers which in turn will strengthen demand. Moreover, enforcement of Real Estate Regulation Act will ensure project completion and project delivery will certainly improve. This, in turn, will further boost buyer confidence/sentiment and hence demand.
I think these reforms will also lead to a consolidation in the industry with governed / bankable developers being beneficiaries of consolidation. Overall, I see this as an excellent counter cyclical opportunity to make investments at a distressed valuation with these developers. So real estate funds offer an attractive opportunity to investors over the coming 5-7 years to participate in the next cyclical upswing with benefits of governance, lower cost of capital and better predictability and earn superior risk adjusted returns.
In India, 95 per cent of homes are bought by mortgages. After fulfilling the basic need of owning a home, do you think it makes sense for second or third time home buyer to invest in Real Estate funds, even in the prevailing scenario?
By investing in real estate funds, one can look forward to participation in profits. Plus, one can get exposure to multiple projects under development in different geographies thereby reducing concentration risk as well as professional expertise to manage funds on their behalf. However, gone are the days when everybody would make money in real estate. One has to partner with the right developers and also be careful about the entry price in real estate projects. The returns on real estate funds not only depend on the real estate prices going up, but on the execution of projects the fund has invested in. Controlling investments through a strong risk management framework like controlling cash flows, having a board membership; working closely with developers (active asset management) ensures real estate returns are predictable and sustainable. Hence, the new normal is investing in a fund which has a successful track record.
What is your take on the interest rates?
I expect mortgage rate of 8 per cent in the near future.
How is Housing for All by 2022 progressing? Do you think present government would be able to fulfill aspirations for 1.3 billion Indians?
Undoubtedly, the government intentions are noble but the biggest challenges today are the acquisition of land at reasonable prices and obtaining approvals within less than 90 days. There is definitely a shift towards Housing for All but we need to monitor the progress carefully as we still grapple with issues like high cost of raw material, long approval process and lack of economical construction technology.