Real Estate Remains In Sell Mode
Vast swathes of hitherto agricultural or even barren lands in North India, some call them tier 2 or tier 3 cities, have been seeing massive construction and land acquisition since 2005. The chickens are now refusing to roost or leave home.
There were two false premises on which the Real Estate bubble was created in India. One, Real Estate price never falls and two, industrial and IT demand will move from metros to smaller cities as capital costs bite.
Neither view has proven right. Commercial properties all over India are finding unoccupied inventories pile up and alongside rentals have crashed to a third of what they were 3 years ago. Worse, developers are unable to find buyers in droves that can help them clear inventories. All across North India from developers like DLF and Unitech to corporates like Raheja, Nirlon, Bombay Dyeing, HDIL and deep south Sobha inventories have become bloated.
Realtors have massive funds either borrowed from commercial sources or from banks tied up in Inventories to begin or appear as Loans and Advances which are nothing but credit given Realty SPVs.
The fact obviously is that cash flows are non existent. The demand is fabricated by the Dealer-Builder mafia and Banks are fudging NPAs by the so called system based NPA recognition. A system that recognises NPA only when a corporate reneges on a quarterly default of interest or principal, but overlooks actual health of the corporate.
The land bank theory has been debunked by the collapse of concerns like Ajmera, Lok Housing, Agre Developers and so on. This brings us to basics. If Coal under the surface alone was valuable Coal India would perhaps be one of the richest entities on Earth. So why is it that the stock has been sliding? Because investors seek income and cash flows. Similarly so, having land for development or inventories for rent-out in a Real Estate firm have zero value.
Why not buy land or commercial property if the investor wants just the lease rental? I am pretty sure all Real Estate companies will go down the hole in the next twelve months. And a real collapse of Real Estate would have commenced. Could we then ignore the Banks?
A False Rally in Commercial property since the crash
The UK's commercial property market – offices, warehouses and shops – has been a disaster zone for most investors in the last four years.
The recession has knocked the stuffing out of building values, which have plunged by more than a third from their mid-2007 highs. And the share prices of stock market-quoted real estate investment trusts (Reits) have done a great deal worse.
In January 2007, most of Britain's major commercial property firms converted into Reits for tax reasons. Since then, shareholders have lost almost two-thirds of their money. Indeed, on balance, investors in the sector have made no capital gains since 1993.
However, over the last two years, the price of commercial bricks and mortar has picked up a bit. Average values in the sector have climbed almost 18% since their summer-2009 lows. Some areas, like central London office space, have enjoyed a purple patch. That's why those property companies were able to report their good news.
But before you pile into Reits, a word of warning. This is about as good as it's going to get for the sector.
The slowing economy will hit the prices of offices and shops
The pick-up in prices is losing steam fast. The last quarter saw the smallest climb in overall values since the recovery began. Over the last year, capital growth has slowed to an annual rate of just 1.7%.
And the outlook is deteriorating. Even the landlords whose estates have just increased in value sound pretty cagey.
Land Securities (LSE: LAND) is Britain's largest listed Reit. It saw a 4% rise in its net asset value (NAV) over the six months to the end of September. But the company is worried about consumer spending – or to be more precise, the lack of it.
Why? Most UK store operators don't own their shops: they lease them. So their landlords' incomes depend on the ability of these tenants to pay the rent on time. If the country's retailers are struggling to make enough sales to do this, property owners will also suffer.
The problem now is that Britons' pay packets aren't keeping pace with inflation. Cash-strapped consumers are spending more on the likes of food and fuel. That means they have less money to spend on everything else.
As a result, it's likely that more retailers will go bust. That would hit rent receipts. With 45% of Land Securities' portfolio in retail property, no wonder it's worried.
On top of that, shops – along with other commercial buildings – are valued on what they earn in rent. If the latter shrinks, their valuations drop.
But what about the sector's recent bright spot, central London?
One of the largest landlords here is Great Portland Estates (LSE: GPOR). Last week it also reported a slight rise in its NAV. But once again there was a sting in the tail.
Economic conditions and business sentiment have got worse since the summer, says the company. That means some firms are reining in expansion plans and are no longer looking for new office space. The fall in demand is putting downward pressure on rents.
The company pins part of the blame for this on the European sovereign debt crisis, which is undermining business confidence. But the net result will be the same as a retailer shakeout.
As Great Portland puts it, "secondary and overpriced assets [would] see a price correction as buyers become more discerning". In simple terms, it's another reason for property values to drop.
'The cuts' will take their toll on commercial property prices
This is all bad enough news. But there's more. Banks are shedding staff, which will mean they'll need less space. In addition, the full effect of government cutbacks hasn't hit home yet. A drop in the number of civil servants will mean the state also needs fewer workplaces.
Sure, the public sector probably accounts for less than 10% of central London occupied office space. But as Kelvin Davidson of Capital Economics points out, "the cuts still to come could boost the central London vacancy rate by up to 2%".
It doesn't sound like much, but we're talking about a finely balanced market here. So even a 2% rise in available space could be enough to tip the balance and send rents down much further. "We expect renewed falls of about 5% in City and West End office rents, perhaps by 2012", says Davidson.
And if even London is hit this hard, other parts of the country could suffer even more. As Davidson also notes, "regions such as the north east and south west appear much more exposed to the rationalisation of public sector office leases than London".
Add it all up, and the impact on UK rents and property valuations could be quite nasty. Reit share prices have been falling somewhat faster than the overall market recently. This underperformance looks set to continue – we'd steer well clear of the sector.
But I'd like to end with a share that is worth holding. Last week life assurer Resolution (LSE: RSL) also reported on progress. It's a company we've written about before, and all seems to be going according to plan.
The really good bit of news for shareholders was this: Resolution confirmed that the final dividend should be raised by 6.7%. That lifts the prospective yield for 2011 to an inflation-busting 7.2%. For income seekers, that has to be a good deal.
The UK's commercial property market – offices, warehouses and shops – has been a disaster zone for most investors in the last four years.
The recession has knocked the stuffing out of building values, which have plunged by more than a third from their mid-2007 highs. And the share prices of stock market-quoted real estate investment trusts (Reits) have done a great deal worse.
In January 2007, most of Britain's major commercial property firms converted into Reits for tax reasons. Since then, shareholders have lost almost two-thirds of their money. Indeed, on balance, investors in the sector have made no capital gains since 1993.
However, over the last two years, the price of commercial bricks and mortar has picked up a bit. Average values in the sector have climbed almost 18% since their summer-2009 lows. Some areas, like central London office space, have enjoyed a purple patch. That's why those property companies were able to report their good news.
But before you pile into Reits, a word of warning. This is about as good as it's going to get for the sector.
The slowing economy will hit the prices of offices and shops
The pick-up in prices is losing steam fast. The last quarter saw the smallest climb in overall values since the recovery began. Over the last year, capital growth has slowed to an annual rate of just 1.7%.
And the outlook is deteriorating. Even the landlords whose estates have just increased in value sound pretty cagey.
Land Securities (LSE: LAND) is Britain's largest listed Reit. It saw a 4% rise in its net asset value (NAV) over the six months to the end of September. But the company is worried about consumer spending – or to be more precise, the lack of it.
Why? Most UK store operators don't own their shops: they lease them. So their landlords' incomes depend on the ability of these tenants to pay the rent on time. If the country's retailers are struggling to make enough sales to do this, property owners will also suffer.
The problem now is that Britons' pay packets aren't keeping pace with inflation. Cash-strapped consumers are spending more on the likes of food and fuel. That means they have less money to spend on everything else.
As a result, it's likely that more retailers will go bust. That would hit rent receipts. With 45% of Land Securities' portfolio in retail property, no wonder it's worried.
On top of that, shops – along with other commercial buildings – are valued on what they earn in rent. If the latter shrinks, their valuations drop.
But what about the sector's recent bright spot, central London?
One of the largest landlords here is Great Portland Estates (LSE: GPOR). Last week it also reported a slight rise in its NAV. But once again there was a sting in the tail.
Economic conditions and business sentiment have got worse since the summer, says the company. That means some firms are reining in expansion plans and are no longer looking for new office space. The fall in demand is putting downward pressure on rents.
The company pins part of the blame for this on the European sovereign debt crisis, which is undermining business confidence. But the net result will be the same as a retailer shakeout.
As Great Portland puts it, "secondary and overpriced assets [would] see a price correction as buyers become more discerning". In simple terms, it's another reason for property values to drop.
'The cuts' will take their toll on commercial property prices
This is all bad enough news. But there's more. Banks are shedding staff, which will mean they'll need less space. In addition, the full effect of government cutbacks hasn't hit home yet. A drop in the number of civil servants will mean the state also needs fewer workplaces.
Sure, the public sector probably accounts for less than 10% of central London occupied office space. But as Kelvin Davidson of Capital Economics points out, "the cuts still to come could boost the central London vacancy rate by up to 2%".
It doesn't sound like much, but we're talking about a finely balanced market here. So even a 2% rise in available space could be enough to tip the balance and send rents down much further. "We expect renewed falls of about 5% in City and West End office rents, perhaps by 2012", says Davidson.
And if even London is hit this hard, other parts of the country could suffer even more. As Davidson also notes, "regions such as the north east and south west appear much more exposed to the rationalisation of public sector office leases than London".
Add it all up, and the impact on UK rents and property valuations could be quite nasty. Reit share prices have been falling somewhat faster than the overall market recently. This underperformance looks set to continue – we'd steer well clear of the sector.
But I'd like to end with a share that is worth holding. Last week life assurer Resolution (LSE: RSL) also reported on progress. It's a company we've written about before, and all seems to be going according to plan.
The really good bit of news for shareholders was this: Resolution confirmed that the final dividend should be raised by 6.7%. That lifts the prospective yield for 2011 to an inflation-busting 7.2%. For income seekers, that has to be a good deal.
Safe Harbor Statement:
Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.
Nothing in this article is, or should be construed as, investment advice.
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