Real Estate Sector Rallies, But Here Is Why Investors Should Be Cautious

The Nifty Realty index hit a decadal high this week, outperforming the broader indices by a significant margin. The Nifty Realty index went up by 135 per cent in the past year, while the Nifty50 index went up by 53 per cent in the same period. Until a year back, realty stocks had been underperformers in the markets especially after the Covid-19 pandemic. The realty index is the second-best performing sector in the markets after the metals index.

The rally in realty stock prices reflects the positive developments in India’s real estate sector recently. The Mumbai real estate market, a key indicator of the sector’s health, saw the highest property registrations in a decade. Despite Covid, Mumbai hit a 10-year high in property registrations in July and September 2021.

September is usually a period of festive buying, and has seen a further push with low interest rates and discounts by realtors. The total number of property registrations in September 2021 stands at 7,540, up by 87 per cent compared to pre-pandemic September 2019 when 4,032 units were registered. The Maharashtra government had also declared a cut on stamp duty until March 2021, which had helped to prop up property sales. The sector, which was infamous for shady dealings, has become safer for buyers with various reforms.

With significant amounts of unsold inventory, relators are offering discounts to boost sales. According to reports, unsold inventory had dropped until July 2021, but has now witnessed an uptick in recent months. Realtors are attempting to monetise the inventory and stabilise their cash flows by offering various discount schemes. Low interest rates have also boosted buyer confidence as most residential properties are bought with loans. For builders, lower interest rates imply lower interest outgo and cost savings.

Another major factor is the requirement for larger and better homes as employees continue working from home. A report by real-estate service company Anarock stated that in a survey, 65 per cent of the people working from home were looking for a larger house. Almost 46 per cent of the respondents to the survey preferred a two BHK flat.

The demand for properties priced above 90 lakhs has also witnessed an increase according to the report. Godrej Realty saw sales of flats worth Rs 575 crore at its luxury Godrej Wood project in Noida. Branded realty projects usually inspire more trust in customers, as these projects have a strong track record and financial backing.

In contrast to the residential market, the commercial real estate sector has seen slower progress as vacancies have continued rising. However, counter-intuitively, it is not the lack of demand, but the continuous supply in the space that has resulted in higher vacancies. The users of office spaces are majorly IT companies, which saw their revenues and profits rise through the pandemic.

Though these companies have continued working from home, they have also continued with the rentals and expect to open offices soon. The Indian office market saw vacancy rise from 12.6 per cent in second quarter of 2019 to 16.6 per cent in the second quarter of 2021, according to a report by Knight Frank.

The real estate stocks have surged on the basis of these positive developments, combined with the deleveraging of the balance sheets by several real estate players. The capital intensive business model means that companies must take up debt to finance projects.

Consequently, several real estate and infrastructure companies collapsed due to high debt in recent years. However, the sector’s debt to equity ratio has come down to below one, a marked improvement from the past.

But after the strong rally, investors should be cautious about investing in the sector. Several stocks have doubled and tripled with a few months, and therefore the markets might already be pricing in the positives from the future.

The unsold inventory in the markets means that many of these companies cannot immediately increase real estate rates, and the current rally is based on sales volumes. It is unlikely that prices will rise anytime soon. But if prices don’t rise, real estate companies might see a margin squeeze, as prices of commodities and fuels go higher.

Further, all bookings don’t translate into sales, as different companies have different definitions for the term “Booking”. Announcements of large booking number should therefore, be taken with a pinch of salt.

Investors can also invest in the real estate story through sectors that benefit indirectly from the boom like tiles, pipes, cement, and other construction material segments. Housing finance companies would also benefit from the boom in the residential real estate sector. Nevertheless, investors should remain conservative and conduct due-diligence before investing.