DONT MISS THE BUS: INDIAN REAL ESTATE INVESTING IS CHANGING FOREVER

INDIAN RESIDENTIAL REAL ESTATE: A SNAPSHOT

Since 2005 Indian residential property prices, mirroring the economy went on overdrive. The economy all round was growing at double digit pace. Property and development was peaking and property investment became the norm for all small and large investors  ; after all property can never depreciate can it? The rich parked large amounts of wealth into real estate: ‘the safest asset class’.  Residential apartment buildings being cheaper, widespread and more accessible attracted the bulk of the investment. Ultimately, This created an artificial demand and hype which drove property prices upwards. It’s apt to state that the Indian property boom didn’t arise primarily out of consumer demand for housing, but from the perception that property is a lucrative investment.  Fast forward to 2015 and normalization was restored. The copious investments in under construction projects have today given way to hoards of unsold inventory ; reasserting the fact that there never was that scale of end user demand for housing.

The chart below shows the performance of residential property in tier 1 Indian cities. Between 2007-2013 real estate riding on the ‘India Growth Story’ saw a meteoric rise.

CITY PRICE CHANGE 2013-2017 ANNUAL GROWTH        2013-2017 PRICE CHANGE  2007-2013
BANGALORE 30%  ↑ 7.5% 8% 
HYDERABAD 16% ↑ 4% -16%
KOLKATA 26% ↑ 6.5% 89% 
MUMBAI 27% ↑ 6.75% 121% 
DELHI(with NCR) -9% -2.2% 99% 
CHENNAI 29% ↑ 7.25% 203% 
AVERAGE 4.95%

SOURCE – NHB RESIDEX

It is interesting to note that average increase in prices has been less than 5% per year since 2013. This means that every rupee you invest in residential property only offers a 4.95% return. Even Fixed deposits attract a higher return offering almost 7.9% with no risk.

GOING FORWARD

Residential real estate is currently on a downslope primarily due to oversupply and stagnant demand. RERA and Demonetization have created an uncertainty, and the market isn’t poised to recover anytime soon. The current inventory will be difficult to sell as prices are still very high. Even the secondary market is in doldrums. Transactions will be driven only by end users as investors are having a tough time liquidating their current positions. As Indian Real Estate matures and the middle class gets richer, residential property should appreciate at only a modest 2-5% per annum. This growth is on par with most mature markets around the world.

INVESTMENT IN RESIDENTIAL PROPERTY

Consider the scenario that you have invested in a flat and put it on rent. Nationwide rental yield on residential property is an average of 2.5% per annum. That means that a flat worth Rs. 1 crore will generate a rental income of Rs. 2.5 lakhs per year. Your net return on residential investment will be 4% (average annual appreciation) + 2.5% (rental yield) = 6.5 % annually with all the upside risk. Bonds and fixed deposits may offer higher returns with minimal risk.

WHY COMMERCIAL & INCOME PRODUCING REAL ESTATE IS THE WAY TO GO

Although commercial property values have mirrored residential properties as far as appreciation is concerned, the future of this asset class is much brighter.  With a further short term slowdown in the residential space imminent, commercial spaces are the way to go for a variety of reasons.

FDI is going to play a big role in Indian real estate in the near future. Instruments like REITs and specialty funds will prefer to invest in commercial space developments – specifically the highest quality or Grade-A properties – because of the higher rental yields in this asset class; this is because only 20% of an Indian REIT’s monies can be invested in development, which is the riskiest aspect. The remaining 80% of a REIT’s assets must be invested in income-producing property.

Foreign investment in real estate in India (2016) was approximately US$ 5.6bn, out of which approximately 40% of the investment was in the commercial space. This denotes a major shift in the asset allocation for funds towards commercial real estate, which stood at approximately 21% for 2015.. There is a reason why fund houses like blackstone, Ascendas- Singbridge are only attracted to commercial/retail projects. Grade A commercial spaces offer a rental yield of upto 12%. This is even higher for prime retail spaces. The market has matured enough to suggest that real estate investment decisions cannot ride on the appreciation factor alone. Income bearing property is the future.

At 12 per cent, vacancy levels for office spaces were at the lowest since 2012 when it was 21 per cent. Except Mumbai and NCR, vacancy levels remained low in other cities. Vacancy levels at prime CBDs in Mumbai and NCR were in single digits. Millennials  today want better working spaces. With the bustling start up scene and co working space boom, demand for office spaces is inevitable.

Average rental values across six cities grew at 7 per cent YOY during H1 2017. While Mumbai saw flat YOY rental growth, Hyderabad and Bengaluru experienced the strongest rental growth at 14 per cent and 8 per cent YOY, respectively. This is in direct contrast to the residential market where rentals have remained stagnant across the nation.

Lack of suitable commercial spaces in tier 2 cities is possibly the largest opportunity for appreciation. With a consolidation of real estate developers following RERA implementation, expect better and more quality projects in these cities.

 

EQUITY MARKET PERFORMANCE OF REAL ESTATE DEVELOPERS

graph1

PHOENIX MILLS | OBEROI | SOBHA | DLF | UNITECH

Let’s take a look at 5 year to date stock performance of India’s top Real Estate Developers as of August 22nd 2017.

COMPANY 5 YEAR TO DATE RETURN
PHOENIX MILLS +200%
OBEROI REALTY +57%
SOBHA LTD. +17%
DLF -14%
UNITECH – 64%

 

It’s interesting to observe that major players like DLF,HDIL and UNITECH for various reasons have suffered a loss is absolute value of their stock. Oberoi and Sobha Ltd. Have performed moderately well, but still haven’t managed to beat the overall BSE return which is at +94%. The only standout performer at +200% return is Phoenix Mills. Now what is different about Phoenix? They are the only developers who have so far dealt exclusively in commercial and retail developments.

CONCLUSION

Residential housing all over the world attracts a fair amount of investment. In mature economies like North America and UK, rental yields are in sync with property values. In USA for example, it is common practice to buy an apartment through a mortgage (home loan) and put it up on rent. The monthly rental payments received covers upto 80% of the mortgage EMI. In the Indian environment, an EMI is almost 4 times more than the monthy rental received. So your rental income received on your investment  is only about 25% of your EMI payout.

Amazingly for commercial property, the rental yields are 4 times that of residential (and rising). That means a commercial property worth Rs 1 crore fetches a fair rent of Rs. 8 lakhs a year (as opposed to Rs. 2 lakhs for a residential flat of the same value). Rental yields for retail and exotic property are even higher.

ASSET CLASS
PROPERTY  VALUE
MONTHLY RENTAL RECEIVED
ANNUAL YIELD ON INV.
PROPERTY APPRECIATION (annual)
GROSS RETURN ON INVESTMENT % P.A
COMMERCIAL OFFICE
1 CRORE Rs. 67,000 8 % 4-8% 12-16%
RESIDENTIAL APARTMENT
1 CRORE Rs, 21,000 2.5% 2-5% 4.5-7.5%

An apartment is a home first, and an investment later. The primary purpose of a home is to be a place of origin, it is one’s residence. The fact that it is backed by a monetary currency makes it valuable and transactional. What it shouldn’t be is an instrument of income, speculation and trade.

It’s essential to understand that residential real estate must transform itself from an investment game to a product. The value of any product depends primarily upon its quality. Flats and apartments must be looked at from the end users point of view. The very principal purpose of RERA was to establish this fact and put an end to speculative investment in real estate. That being said, real estate will always be one of the most exciting and less volatile avenues of investing. How, which and what kind of Real Estate you invest in will become sacrosanct.

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