Real Estate Investment Challenges and Opportunities, Pre Sale Deals Analysis

and Risk Mitigation Techniques

By Pankaj KapoorLiases Foras

WHERE DO WE STANDThe Present Market

Ressex Index Figures- MMR

Sept 20103

The business turnover continuously declined in the present and the prior quarters of this fiscal, indicating weakened market.

Builders are trying to withhold the market at the prevailing prices. However, it is difficult to find takers at the prevailing rates, as evident by the efficiency and sales index figures.

The prices have crossed the peak level that were seen in the Mumbai market before recession.

Movement of Inventory, Sales and corresponding Prices, and Business Turnover and Efficiency movement since Jan 05 (index figures)

Price Movement - MMR

The real estate prices in MMR kept emulating the stock market performance per se – scaling new heights every few months, irrespective of composure of the market.

Compared to last quarter the weighted average price increased by 15% and touched an all time of Rs 8,870/- psf by the end of third quarter of this fiscal.

Cost of Flat

Movement in Avg Cost of Flats in Greater Mumbai

Avg cost of the flat in Greater Mumbai has gone up – with whopping 35% CAGR growth.

The avg cost of flat in 2004 was 27 lac. However by Sept 10 the avg cost has gone up seven times and now stands close to Rs 2.13 cr.

MARKET RISK

Price Correction Risk

• The correction in Prices is imminent

• The declining sales are clear indications that the market should undergo corrections, and we are estimating 25%- 30% correction in the prices.

The Inventory to Sales Ratio went up alarmingly, from 4.5 in June 09 to 7.6 in June 10. 68% increase in the inventory pile up was a result of a whopping 45% increase in the weighted average price of Mumbai Metropolitan Region.

Super Builtup Area – a regulatory risk

• The ornamental projections have increased the super builtup area loading to 70% to 100%.

• Almost all the new launches have their saleable area approximately 65%-70% more than the actual carpet, whereas, old projects are offering 40-45% loading.

• This new trend has created two differential carpet prices in the market.

• In all fairness this looks to create a confusion in consumers’ mind, when the saleable area rate in both the categories are same.

Glut in Luxury Segment

• The expensive flats sell slower. The ever-increasing inventory in this segment is a cause of concern.

The Challenges

• Entry level challenges

• During the course of journey

• Exit level

Entry level

– Due diligence – Valuation and other associated risk

• The two dimensional increase (price rise & super built-up area) increased the risk manifold

• Current Valuation techniques does not account for sales velocities and gestation period

Price Vs Sales Gestation

• Increase in prices also increases the gestation period in sales which in turn, has a bearing on the valuation.

Velocity is mapped on actual project sales during the period

Date of Survey Sale Velcotiy Per Month Rate Per Sqft Gestation Months

Jan-05 3.6% 2,875 28

Oct-05 1.9% 4,168 53

Oct-06 0.7% 4,330 140

Nov-07 0.0% 6,176 2249

Jun-08 -0.1% 7,110 -691

Nov-08 0.1% 7,500 1000

Mar-09 3.9% 4,904 26

Jun-09 2.3% 5,700 43

Sep-09 1.1% 6,157 89

Dec-09 0.5% 6,212 184

Property can be sold at any rate!

Rate Gestation period (Months) NPV

4400 22 3,724.16

4800 26 3,950.52

5500 33 4,313.16

6200 53 4,256.12

But, not all the higher prices bring higher valuation.

Discounting Rate @18%

Another assessment error in Valuation

• The Land Banks and their valuation defy the laws of spatial mobility

- Most of the developers have their land banks in the outskirts. While valuing these land banks, affordable housing is planned and any capacity of the consumption is assumed. Millions of sqft of the saleable area is consumed in 4-5 year in the spread sheet, which is not true.

- Secluded piece of these lands do not offer life and it takes longer gestation to create critical mass on such land. Despite the cheapest housing alternative of the city, these assumptions defy the laws of spatial mobility.

Not all the locations are inhabitable.

• Peripherals areas have remained low density area. Any capacity consumption on these locations is not always possible despite lower price or affordable housing schemes.

• This can be explained through Theory of time and space, “Together space and time form the framework of a cage within which human life unfolds.”

• What this explains is that we have a body clock which requires 8 hrs of sleep, then 8-10 is required at work then if 4-5 hrs are required in travelling to the place of work and back, such locations would not have the preference of the consumers.

Market Composition in a Travel Time To & Fro from Lower Parel

35% of the market fall at 3.5 Hrs travel time, the rate corresponding to this is Rs 3700/- per Sqft. We can attribute these rates and these coordinates as convenience coordinates

Farther, locations despite being cheaper see the diminishing composition of the market.

Rate Per Sqft

During the journey

Delays

• Trivial Title issues causing delays longer than expected.

• Approvals

• If construction takes off - Attaining sales velocity

Exit Level

– Can I get out?

PRE DEAL ANALYSIS

Is it a Trading Market

• We fear that the most of the sales in new launches are made to investors, implying a trading market rather than a consumption market.

• Should these bookings be considered as true sales?

• Would end-users find these prices affordable or be able to pay a price higher than what the investors have paid?

• Let us analyse risk associated with trading market

Pre sales deal analysis

• General Practice:

– Call for a brokers meet

– Go for bulk deal, mostly to the investors

• The risk due to the investors defaults

Case Study – 1 Gurgaon Market

The table above shows the higher sales for the projects, which are expected to be delivered by 2012 and 2013. The sales of the ready or nearly completion is virtually Nil.

Gurgaon real estate is more of a trader’s market. The flats are being traded in Gurgaon as the stocks are traded in any stock market. Before being rented out to end consumers, the flat changes hands among a chain of investors and brokers.

It is a practice to offload 70% of the inventory in a project to investors at a booking amount of 10%. The whole process artificially jacks up the property prices in the city.

Trading Equations

Developers – Investor 1 - Investor 2 – Investor X - Rental ConsumerORDevelopers – Funds - Investor 1 - Investor 2 – Investor X - Rental Consumer

Process Time Line (Months)

Project marketing 0

Time taken to begin construction 12

Project completion 48

20% occupancy 72

80% occupancy 120

More than 80% occupancy After 121 months

DEFAULT RISKWe have computed the Default risk in Gurgaon to be as high as 33%.

Case 2 – Default Impact on Individualproject

Rs CroreProject value 149Total Sales 100% Sold till now 66% Amount Received till Date 24Amount Default 22Default % 50% Estimated Land Cost 25% of Land Cost Recovered 95%Construction stage 1 Building nearing Completion

3 Building Construction at 3 Floor (7 Floor building)4 Building at Plinth

In this case study, even after the sales of 66% of the project, the developer is unable to recover the land cost leave aside the construction Cost .

Scenarios for P&L – with & without Default

Figures in Rs Crore Scenario 1 Scenario 2

Existing Sales velocity with Defaults

Existing Sales Velocity with no default

Total Revenue 149 149 Cost Land Cost 25 25Approval Cost 7 7 Consultants 3 3 Construction Cost 64 64 Infrastructure Cost 7 7 Interest 21 8 Sales & Marketing 4 4 Planning & Admin 6 6 Total Cost 138 124

Profit 11 25 IRR 10% 33%

Even though the defaults may not have much impact on the revenue, however it creates the imbalance in the cash flow, forcing developers to employ various other means to finance the project, thus increasing the cost of funds, which severely affects the Net Present Value (NPV) of the project.

Impact of trading is visible in MMR

BT decreased by 6% QoQ from Rs 8,527 Cr to Rs 7,985 cr. Approximately 30% is accounted due to sales in new supply mainly presales.

Risk Mitigation

• Read future from the past!

• Don’t pay a high price today, for future earning

• Learn Probability –

– The future of the location is bright. Airport is coming up, it is closed to SEZ. Trans Harbour link would reduce the travel time from 2 hrs to 20 Min. On going rate of the location is Rs 2 Cr per acres.

– Put the probability to the scenario of happening of these events and then put the premium on the prices

Premium based on probability of happening

row/column I II III IV V

A Mode of TransportVia Existing Jetty

Existing Possibility by Trans Harbour Link

Via Existing Road

Sum of Total Probability

B Travel Time From Lower Parel to Subject Site 80 120 160 C The Probability of its Existence 0.75 0.5 1 D Probability of its Usage 0.75 0.06 1.00 1.81E Indexing for sum probability of 1 0.42 0.03 0.55 1.00

F

Attained Per Sqft *Price through regression equation(Real Estate Rate = 23902 * e-0.019 *Travel Time) for respective travel time 5,228 2,445 1,143

GAttainable Per Sqft *Price with the probability of its usage (C= E*F) 2,171 75 633

IThe Average Attainable *Price for a Average Building at the Subject Site (G-II+G-III+G-IV) 2,880

JThe *Fair Price Per Sqft of an exclusive villa project at subject site having 59% Grades 3,398

Price behaviour with travel time in MMR

REAL ESTATE IS NOT A RISKY VENTURE, PROVIDED YOU HAVE TIME TO STAY AT IT.

Thank You.