Real Estate in India - A complete Insight

Published: 04th June 2009
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India Real Estate

The size in terms of total economic value of real estate development activity of the Indian real estate market is currently US$40-45bn (5-6% of GDP) of which residential forms the major chunk with 90-95% of the market, commercial segment is distant second with 4-5% of the market and organized retail with 1% of the market. Over next five years, Indian real estate market is expected to grow at a CAGR of 20%, driven by 18-19% growth in residential real estate, 55-60% in retail real estate, and 20-22% in commercial real estate.

Long-term outlook

Long term industry outlook remains attractive: We believe that long term industry outlook remains attractive, on account of increasing urbanization, growing nuclear families and the increasing number of Indian middle class. Fundamentally, strong GDP growth, increasing tourism traffic and increase in per capita income coupled with lower interest rates shall improve the outlook of the sector in the medium to long term.

Key Drivers of Real Estate

Economic Growth

• GDP growth rate of ~8-8.5%

• Double-digit income growth rate for the next 3-4 years

• Income growth should improve affordability, driving demand for residential units

• Lower interest rates

Demographics and Urbanization

• Positive demographic trends - middle class or the aspirers to show a CAGR of 10.4% to reach 124m in 2013 compared to 46m in 2003

• Urbanization - UNDP forecasts urban population will constitute about 40% of total population by 2030 from the current about 28%

• Indian household families moving from joint families to nuclear families

Favorable Interest Rate and Fiscal Incentive

• Housing loan interest rate, despite the recent rise, continue to remain low compared to 15-16% in the 1990s

• Easy availability of finance

• Fiscal incentives offered on owing a residential house is also a significant demand driver

IT/ITES Growth

• Strong IT/ITES growth should drive demand for commercial space - FY07-10 CAGR of 23% as a result of 568 000 employee additions; Indirect contribution to residential demand as well

• They consume about 75% of the commercial space

Organized Retail and Hospitality Demand

• Organized retail penetration level at 4.1% is lowest compared to other emerging markets

• Economic growth and changing demographics should increase retail penetration levels

• Strong tourist arrivals should spur demand for hotels across India. Foreign Tourist inflow is forecasted to show a 20%+ CAGR to reach 10m by 2010 compared to 4.4m in 2006

• Room shortages have resulted in a sharp jump in average room rates - Rs7,559 at end-FY07 vs. Rs2,004 in FY03; Approx. 105,000 hotel rooms are available in India

The real-estate sector offers a US$80bn-100bn opportunity over the next three years.

Growth in the next decade should come from Tier II/III cities

• Higher real-estate prices in Tier I cities coupled with manpower and infrastructure issues may force companies to look at Tier II and Tier III cities for expanding their operations

o Tier I cities- Mumbai, Delhi and Bangalore

o Tier II cities- Kolkata, Hyderabad, Pune

o Tier III cities- Nagpur, Ahmedabad, Indore, Lucknow, Jaipur

• Within the next three to six years, towns and cities such as Chandigarh, Jaipur, Mysore, Indore, Coimbatore, Vishakhapatnam, etc are likely to see an increase in real-estate demand from the IT/ITES sector

• According to Nasscom's projections, Tier II and Tier III cities, which account for about 29% and 5% of the total commercial space in FY07, respectively, will increase to 44% and 20% at the end of FY17


The affordability index, although at a reasonable 40% (EMI/net monthly disposable income), has risen about 50% over the past two years, suggesting a price run-up faster than income growth. The affordability is also affected by mortgage rates, which has risen by 400bp during the same period. Lending institutions managed to limit the EMI increase to a certain extent by adjusting the loan tenure, thereby controlling the affordability as well. Currently, the domestic real estate market has an affordability levels (Property costs / Annual Income) of 4.5 to 5.0x compared to global level of 3.5x

Capitalization Rate

• It defines the percentage number used to determine the current value of a property based on estimated future operating income i.e.

Cap Rate = Annual Cash Flow / Value of property

• Capitalization rates are an indirect measure of how fast an investment will pay for itself in net cash flows; each year, the percentage amount of the cap rate will be repaid

• Payback period = 100% / Cap Rate

• In real estate appraisal in the U.S., a stylized measure of cash flow is often used, called net operating income. It is essentially the same as net cash flow, except that debt service and income taxes are not included while a reserve for replacements is included

• One advantage of capitalization rate valuation is that it is separate from a "market-comparables" approach to an appraisal (which only compares what other similar properties have sold for based on a comparison of physical characteristics). Given the inefficiency of real estate markets, multiple approaches are generally preferred when valuing a real estate asset

• Cap rate would be determined based on an appraisal and/or the cap rates of similar properties that have sold recently

• By taking another property that sold recently, determining its rental income, divide the income by the sold price to get the cap rate

• Property price (IRR of investment) decreases as Cap rate increases

Structuring projects - an important element in effective cash recycling

• Project structuring as an effective mechanism to recycle capital and in the process earn higher IRRs

• One effective means to recycle cash is to transfer a project or a group of projects onto a special purpose vehicle (SPV)

• The SPVs are either sold to a REIT or are listed on a stock exchange (for example, Ishaan, a group company of K Raheja, was listed on AIM in November 2006)

• Companies tend to adopt innovative ways to ensure the property developed can be bundled into an SPV. One way is to provide a differentiation value by branding, which can then be easily hived off into an SPV when the situation demands

• Developers tend to earn higher IRRs the faster they are able to sell properties to REITs

SPV (Special Purpose Vehicle)

• In an SPV, the developer ties up with a private equity fund who provides capital, or alternately, ties up with foreign developers who not only have capital but also bring in technical and execution capabilities

• It is much easier to establish the forecasted profits in an SPV as opposed to when it is pooled into the entity

• Many developers are diluting a minority stake in their entity organization or going in for specific FDI compliant SPVs for different projects

• SPVs are the only way out in FDI projects, where you have a clear shareholder agreement and control in the project and exits becomes easier

• The foreign investor or fund wants to join hands with the local developer and an SPV is formed, so that any unsettled claims, litigations with respect to the existing entity are not carried forward

Residential properties: returns are highest in terms of IRR

From an IRR perspective, the residential segment is the highest return earner. This is possible due to the unique way in which the payment for residential properties is structured, where the buyer pays some upfront money and the balance by way of installments, which allows the builder to block less capital in the project. IRRs for residential projects range between 30% and 35%.

Commercial projects - profitability analysis

The return from commercial property is always lower compared with the residential project due to the following reasons.

• There is no cash inflow until the property is completely developed and in a handover stage

• No outright sale of the property occurs; the developer must contend with only lease rentals

As a result, the developer must invest far greater capital of his own before he sees any cash inflow, and due to lease rentals, his payback period increases, in turn reducing his returns from the project compared with the residential project.


Real estate investment trusts (REITs) are companies that own and often actively manage income-generating commercial real estate, such as shopping centers, apartments, offices and warehouses.

• A REIT is a company that buys, develops, manages and sells real estate assets and allows participants to invest in a professionally managed portfolio of properties

• Some REITs make or invest in loans and other obligations, which are secured by real estate collateral

• A REIT operates like a mutual fund, where investments of individual investors are invested in real estate rather than in the equities market

• REITS also help raise funds for the real-estate business - i.e. to fund construction of new offices, factories, residential flats, shopping malls, etc. Many private real-estate companies used REITs to access capital through the public marketplace


DCF-based NAV methodology to value the company's current land bank: The process involves the following.

• Breakdown of the land bank into verticals - i.e., residential, commercial and retail

• Further breakdown of land holdings by city (micro market)

• Establish the development profile (number of years to develop and annual development rate) for each micro market and vertical

• Estimate average realization/sq ft and rentals/sq ft for all the verticals and micro markets based on company guidance, channel checks and market reports published by property consultants

• The growth trend is projected on the basis of the demand/supply dynamics pertaining to each vertical

All the above helps us forecast cash flows and lease rentals, which are then discounted or capitalized based on our discount rate and capitalization rate assumptions. This gives us the NAV for the land bank. Premium to NAV is a more subjective analysis in our view, directed by factors such as land bank quality and execution and financial strength.

Land Bank Quality

• Land bank quality is primarily dependent on location of the same. Metros and Tier I cities are the ones that are preferred in terms of location. Typically, high-growth potential areas centre around IT/ITES development

• IT/ITES will have a CAGR of 25%-plus over the next three years and driving 70% of commercial real-estate demand - presents direct as well as indirect drivers for real-estate sector growth, in our view

• Another aspect of the land bank quality is the cost of land acquisition, where we believe most of the developers in India score well. The land-acquisition costs are on average 10% of ASP, as the land aggregation was either done a long time back or is in suburban areas where developers see potential in the long term

• A residential-commercial-retail-hospitality mix of the land bank is also important. While most of the land banks are residential-focused, a 60/40 residential/non-residential mix may be optimal

Financial and execution strength

• A debt/equity ratio of 1:1 would be reasonable for real-estate developers.

• Do a comparable analysis of the developers on the basis of interest coverage for further comfort

• To determine execution strength check

o Asset-Turnover ratio

o Annual GFA delivered

o Backward integration

o Initiatives such as partnerships with construction companies, centralized sourcing of raw materials, investment in high-end equipments etc

On the basis of our evaluation of the companies on the above four factors, we assign a premium or discount to the NAV if needed.


Before I proceed I would like to know whether it is a vacant land or land with some improvements.

Sales Comparison Approach

• It utilizes prices paid in actual market transactions of similar properties to estimate the value of the site

• The market or sales data should have been recent enough to reflect true market conditions relative to the time period of appraisal

• Comparable sales should be similar in size, location and zoning

• This method could also be used to estimate the rental value

Cost Approach

• It is based on the principle that the informed purchaser would pay no more than the cost to produce a substitute property with the same utility as the subject property

Income Capitalization Approach

• It is widely applied in appraising income-producing properties either through rents or leases

• Anticipated present and future net operating income as well as any future revisions are discounted to a present worth figure though the capitalization process

• It relies on market data to establish current market values and expense levels to arrive at an expected net operating income

• The higher the cap rate the lower the asking price

Gross Rent Multiplier (GRM)

• GRM uses the gross rentals of a property rather than the net operating income used cap rate

• There are two ways to do this calculation using either Gross Potential Income (GPI) or Gross Operating Income (GOI)

• The value estimate is much better using GOI as losses for occupancy and non-payment are considered

How do you estimate land value when there have been no vacant land sales?

It is a typical problem in urban and built-up areas. The solution is to select comparable improved sales and subtract the value of the improvements- extract the depreciated replacement cost of the improvements.

Criteria for FDI in real estate

Project criteria

• Minimum area of 10 hectares in the case of servicing housing plots

• Minimum area of 50,000 sqm in the case of construction development projects

• For combination projects, any one of the above two conditions will suffice

Project development

• 50% of project must be developed within five years, from the date of obtaining all statutory clearances

• Not permitted to sell undeveloped plots Capital requirement

Capital requirement

• Minimum capitalization of US$10m for wholly-owned subsidiaries and US$5m for JVs with Indian partners

• Capital to be brought within six months of the incorporation of JV or subsidiary

• Original investment cannot be repatriated before a period of three years from completion of minimum capitalization

• Repatriation allowed only after prior approval from the government

Facts and Trends

Impact on NAV in a declining property price scenario: A 30% price correction in residential price can lead to 50% erosion in NAV. In a few cases where margins are not high enough, there could be little value creation. Hence, valuation assumption for big land banks would need to be re-looked at in the current scenario (high interest rates and declining price).

Each square feet of IT space generates demand for 5 to 6 square feet of other real estate segments, namely residential, retail, hospitality, etc.

Retail and Hospitality

The supply would still be more than demand and the rentals for all would get impacted since most retailers are not making money. India too would move more towards revenue sharing followed in many developed markets rather than the fixed rental concept. This forces the developer to maintain the mall and create value for the shoppers. This forces the developer to maintain the mall and create value for the shoppers. Same-stores sales in most markets have been facing pressure owing to increased mall density.

Execution Delays

Most of the companies are facing execution delays. Regulatory approvals and physical execution are the main challenges. Companies are trying to overcome this challenge by having in-house construction and forming joint ventures with international construction majors (DLF and Liang O'Rourke).

Pan-India ?

It doesn't matter. What matters is the economics of individual projects. Focus should be on the quality (location, demographics/demand drivers of the micro-market) of land bank, cost of the land and execution skills. Similarly, a pan-India or a regional player who has bid aggressively to purchase land recently is worse-off than a player with existing low-cost land-bank.

Sport the winners

Reasonable expansion plans, quality of the management, low leverage etc are the key to spot the winners, apart from the quality of land bank.

Positive indicators for industry

• Lower interest rates

• Reduction in new launches i.e. matching supply with demand

• Further FDI relaxation (area and lock in period)

• Tax breaks for developers for residential development

• Increasing the tax sops for individuals in buying houses

• Introduction of REITs (Real Estate Investment Trusts)

• Relaxation from RBI on bank lending to developers

Effect of inflation

Historically, higher than anticipated inflation has had negative consequences for financial assets (both bonds and stocks being adversely impacted by unexpected inflation). In contrast, unanticipated inflation seems to have a positive impact on real assets. Why is real estate a potential hedge against inflation? There are a variety of reasons, ranging from more favorable tax treatment when it comes to depreciation to the possibility that investors lose faith in financial assets when inflation runs out of control and prefer to hold real assets.

Factors affecting the sector

• High interest rates

• US recession and hence lower IT/ITES demand

• Increase in construction cost; expensive raw materials

Bangalore Real Sector

Office sector

Demand in 2008 (1st half) = 7million sq ft compared to 6.6 million sq ft in the same period last year.

Central Business District (CBD)

It includes areas near MG Road, Vittal Mallaya Road, Residency Road and Richmond Road. sCBD remains the most attractive and suitable micro-markets for new companies entering Bangalore. The central locations offer ease of accessibility and visibility for these new companies and allow established companies to retain brand equity by being in the heart of the city. There is less supply of office space.

Non-CBD areas

It includes Indira nagar, Old Madras Road, Airport Road, CV Raman nagar, Inner ring road, Koramangala. The Non CBD area is being observed as the most preferred location for setting up office for high end engineering companies for setting up R&D centers/labs as well as high end support functions. High levels of absorption activity continued to be witnessed even in the Non CBD areas of the city where many corporates chose to relocate/expand due to availability of quality options offering adequate infrastructure and lower rental values compared to CBD. However, land bank is limited in these regions, which might put upward pressure on the real estate in near future.

Suburban and peripheral areas

This includes Whitefield, Outer ring road, Electronic city, Bannerghatta road and North Bangalore. The Suburban micro market is another zone that has witnessed high level of space intake by corporate over the year. Scarcity of space in the Non CBD area is furthering the case for location of corporate in the micro markets. The Peripheral areas remain preferred by the corporate for building their campus style facilities. Consequently these locations have witnessed frenzied construction activity from both developers and also individuals possessing large land banks.

Whitefield is now gaining favor as a viable micro market due to decongestion of the airport road, completion of the Marathahalli flyoverand availability of mid to low end housing infrastructure.

The area between Marathalli and Sarjapur on the outer ring road has a fair amount of STP, SEZ and grade-A office supply. The excess supply along with low occupancy has put downward pressure on the prices.

With development of BIA and coming up of Peripheral Ring Road (PPR), properties prices in north Bangalore look to go up in the near future. PPR will connect Tumkur road, Magadi road, Mysore road, Bellary road, Old Madras road, Hosur road and Kanakapura road. This region has seen interests from leading IT firms, property developers for residential areas and hospitality sectors to set up star hotels.


There has been a noticeable demand for prime residential properties and developers are targeting residential areas in the outskirts of Bangalore such as Whitefield, Sarjapur road, Banerghatta Road and Kanakpura Road. Demand is also high for leased apartments in prime areas of central Bangalore by company executives, due to limited supply there is upward pressure on rentals.

New developments are shifting away from the central Bangalore due to close proximity to IT and ITES areas and availability of land for lifestyle projects. Nearly six mega townships promoted by reputed developers are on the anvil in Bangalore. The proposed mega townships will have thousands of housing units and will be a mix of apartments, row houses and villas. Moreover the townships will include educational, commercial, retail and medical facilities.

Capital values for apartments in prime residential areas of Bangalore are in between INR 3000-4000 / Sq. Ft while rental values are in the range of INR 25-30/sq ft. p.m. Absorption rates for prime and quality residential apartments is very high thus demand is exceeding the supply in the areas of Outer ring road, Whitefield and Airport road. There is scarcity of luxury apartments thus in last one year capita; values in suburbs have increased around 35-50% due to high demand. Yield on Residential property in Bangalore is ranging between 6-7%.


To check the trend in the residential properties find out from the local authorities on the trend in stamp duty and registration fees.

Improved connectivity between Bangalore and Mysore has led to gradual development of residential properties in and around Bidadi (southwest of Bangalore)

• Upcoming DLF townships

• NICE corridor

• Upcoming BMIC (Bangalore-Mysore Infrastructure Corridor) project

• Planned theme parks and resort in Bidadi

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