Gain from realty stocks

Investing in real estate stocks, as opposed to a direct exposure to realty, is not only a sound strategy but will yield rich rewards in the coming years.

Lovelesh Manocha        Print Edition: October 2010

The 2008 global financial crisis led a few doomsayers to predict that the markets might collapse again over the next couple of years. Wary of losing more money, Indian investors steered clear of the markets, only to be left gaping when, instead of going down, the markets made a steep recovery.

Most investors have now begun to scramble back to the markets to invest in equities and mutual funds and reap whatever gains they can. Surprisingly, they have ignored the real estate stocks.

This omission is perplexing because real estate has been among the best performing sectors during the last two bull cycles and, given that India has a long way to go, the sector should maintain the bull trend at least for a few more decades.

Anyone even mildly interested in the sector can clearly see that there's a disconnect between the strong and improving fundamentals of the sector and the stock prices of real estate companies.

While we expect property prices to continue to rise, we also envisage a strong appreciation in real estate stock prices as they completely missed out last year's rally.

India's sound macroeconomic environment, huge domestic savings, demographic shift, limited alternate investment opportunities and scarcity of clear title land are some of the factors that make us confident about the sector. Boosted by an improving demographic mix,

India's savings rate increased from 24% in 2001-2 to over 36% in 2007-8 and is expected to rise further in the next few decades. This is the time when we will witness a huge addition to the working age population, especially the prime-age savers (35-60 years), which should further enhance the domestic savings rate.

This, along with a growing per capita income, an exploding middle class, rapid urbanisation and lack of other investment opportunities, particularly for the huge parallel economy, will translate into a higher demand for housing.

Stocks are a much better investment vehicle than a direct exposure to real estate. Over the past two years, most real estate companies have sold their non-core assets and land, thereby reducing the debt-equity ratio and appreciably improving their balance sheets.

A few companies, such as Anant Raj Industries, were able to time the market to some extent. The company managed to sell land at a high price, raise funds at attractive valuations and invest them when the land was available at throwaway prices.

Currently, when property prices are at an all-time high, the company is available at just a little premium to its book value. Ahmedabad-based Ganesh Housing Corporation too stands to benefit from its large and well-located land bank. The company had bought land at a fraction of the current value and its strong brand equity is helping it sell land at a premium compared with the competition.

A disconnect between fundamentals and stock prices is understandable when the future of the sector appears bleak. However, when global experts are confident about India's domestic story, investors have missed one of the key domestic demand-driven sector.

Unlike most other sectors, real estate is a pure domestic theme, which is produced, consumed and sold locally. Global developments have only an indirect impact on the demand through confidence and capital channel.

Other than the attractive valuations, stocks make for better investments because of the net asset value (NAV) growth multiplier. Any increase in the price of a built-up property will lead to a more-than-proportionate increase in the NAV of the project and, consequently, of the company's stock price.

Illiquidity, difficulty in getting clear title properties and the associated legal hassles further emphasise the advantage of buying stocks. This also offers the benefit of investing small amounts and lowering risk through diversification.

Investors are shying away from this sector as they are concerned that the interest rate hike by the RBI will lead to a decline in the demand for real estate. However, we believe that the rise in the interest rate will have minimal impact, if any, on the demand.

The real estate industry in India is also more stable as, unlike in other countries, it is not driven by bank/non-bank finance. Only about 30% of the total realty deals are funded by financial institutions.

The bulk of the purchases are paid through savings, and mostly in cash. This partially explains India's relatively low mortgage to GDP ratio. Investing in real estate stocks is not only a sound strategy but will offer rich rewards in the coming years.

The writer is Vice-President, Ideas1st Research, an equity research company.

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