Receding Housing Demand May Hamper Real Estate Recovery

Published: January 5, 2011
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The demand for residential properties, a major revenue source for most real estate companies, is receding. An expected increase in borrowing rates and the near-peak realty prices may reduce the demand further. This will affect most realty firms that had started showing signs of recovery in the recent quarters. This explains why the 29-stock ET Realty Index has underperformed the broader benchmark Sensex in the past three months. During the period, the realty index fell by 16% while the Sensex gained 13%.

The negative impact of the tapering housing demand may be partially offset by the gradual recovery in the commercial segment. The pick-up in business activity last year has led to a revival of demand for commercial properties, especially in the past six months. The segment was previously struggling even as residential housing demand bounced back from the slowdown. As much as 70% of commercial realty demand is for office space, followed by retail leasing. Under office space, demand is dominated by the information technology (IT) sector followed by banking & financial sectors. Better growth in these sectors over the past few quarters has improved demand for office space across various pockets of the country.

This is reflected in the 2-4% sequential increase in office rentals in commercial business districts of Mumbai, Delhi and Bangalore during the September 2010 quarter. The improvement in commercial property business has propped up earnings of realty firms for the quarter ended September 2010. It is likely to provide some relief if demand for residential properties dwindle. Companies who derive a significant portion of their business from commercial segment include DLF , Unitech and Anant Raj Industries . These firms could be relatively less impacted by the expected slower growth in housing demand.

Managing borrowing costs and supply absorption would be key for realty companies, given the spiraling interest rates and higher supply by builders. Besides 161.1 million sq ft of office space that is under construction, developers launched commercial projects with cumulative space of 88.2 million sq ft in the top-seven Indian cities as of October 2010, according to a report by property consultancy Jones Lang La Salle India. The ET realty index trades at a P/E of 20 compared with 35 a year ago. Given the relatively benign valuations, the stocks of realty companies with diversified assets and better operating cash flows may regain momentum in the near term. In the long term, execution capabilities would be crucial to justify valuations.

Source: Indian Realty News


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