Cost Escalation Threatens Realty Recovery & Growth

The real estate sector, especially the residential segment, which showed great resilience against the Covid pandemic to register a smart recovery, is now facing a double whammy. The long-drawn Ukraine-Russia war has led to a sharp increase in input costs, on top of which, the RBI has tightened its monetary policy with a sharp 40 bps rise in repo rate. All this threatens the ongoing real estate recovery and its growth prospects.
Vinod Behl

Real estate developers are facing a two-pronged challenge: on one hand, they have the challenge of reducing debt and improving their cash flow by clearing home inventory (still hovering over 6 lakhs), and on the other hand, they are pushed to the wall to increase home prices amidst steep rise in input costs and upward revision in interest rates, which are adversely impacting home sales and cash flows.

So far, despite multiple triggers in the past, the developers have been refraining from price increase. But now, the premier body of real estate - the Confederation of Real Estate Developers Associations of India (CREDAI) and the apex body of the construction sector - Builders Association of India (BAI), have raised red flags, seeking the government’s help to tide over the crisis.

Cost Escalation Threatens Realty Recovery & Growth

CREDAI has sent warning signals about the impending setback to business continuity due to the rising input costs, which have forced its member developers to effect 6-7% price increase, with another 5-8% increase in the offing. It has asked the government to provide relief by allowing input credit on building materials, reducing import duty on steel, subsidising homebuyers through stamp duty discount, and amending RERA to bring in a price escalation clause in the Builder-Buyer Agreement.

Cost Escalation Threatens Realty Recovery & Growth

On the other hand, BAI has drawn the attention of state governments to the plight of building contractors due to the abnormal rise in prices of raw materials, resulting in a sharp (over 75%) increase in built property prices. Raising the red flag, BAI has said that since contractors cannot absorb such a steep hike, and there is no price escalation clause in the contracts of contractors working on fixed rates, huge losses and even bankruptcy stare at them. The builders’ body has asked the state governments to pay the difference of rates of major controlled construction materials for the date of submission of tender till the date of execution of work, besides paying escalation and price variation to all the works having a time period of up to 12 months without any upper limit restriction. For future tenders, it has asked for mentioning star rate of cement, steel etc, to avoid further complications.

Ramesh Nair, CEO India & Managing Director, Market Development Asia, Colliers
Colliers has estimated that over the past one year, developers’ average cost of construction has risen 10-12 percent, owing to higher input cost. And with wholesale price inflation (WPI) and material cost, both seeing a double-digit rise, Colliers expects construction cost to rise by a further 8-9% by December 2022. “Construction materials account for a two-third share in the total cost of construction. With the developers already operating on thin margins, the rising cost will impact them, especially those operating in the affordable and mid-segment housing,” says Ramesh Nair, CEO India & Managing Director, Market Development Asia, Colliers. And now, with interest rates going up, the challenge for low-margin affordable housing business has further increased.

Sanjay Dutt and Pradeep Aggarwal
In view of this, Tata Realty and Infrastructure Limited (TRIL), a market leader in low-cost housing, changed its focus from affordable to mid-priced/premium housing. Sanjay Dutt, Managing Director, TRIL, says that amid higher land cost, increasing input costs and rising interest rates, it has become a challenge to keep price points affordable. Pradeep Aggarwal, Founder & Chairman of Signature Global, NCR’s leader in affordable housing, concurs with Sanjay Dutt, saying that in a high volume low margin business of affordable housing, the going will be tough to protect thin margins.

Despite the Covid disruption, the year 2021 ended on a positive note for the real estate sector, with residential real estate making a remarkable recovery. According to Anarock Q1 2022 report, all-time high housing sales (about one lakh units) were registered across top 7 cities, registering a 71% yearly rise. Even new launches clocked 43% yearly rise. And despite the induction of this fresh inventory, residential realty registered a 2% annual decline in unsold inventory - from 6.42 lakh units in Q1 2021 to 6.28 lakh units in Q1 2022.

The twin factors of stable property prices and an all-time low home loan rate (sub 7%) were responsible for the stellar performance of residential real estate. But now, both these driving factors have lost their sheen. The home prices have gone up and even the interest rates are on an upward swing after RBI announced 40 bps hike in repo rate. Private sector mortgage leader HDFC has raised its retail prime lending rate by 30 bps. With repo rate hike, floating rate loans will get costlier and all new loans are likely to get pricier, leading to increase in EMI for home buyers. Some private banks have raised interest rates for new loans by 40 bps. Of late, the interest rate hike transmission has been faster due to loans linked to external benchmarks. But now, the banks are quick to raise rates of home loans linked to MCLR, with HDFC Bank hiking it by 25 bps across tenors.

RBI is all set to affect another hike in June and the industry expects 100-150 bps hike in repo rate in this financial year. This, coupled with rising home prices, will adversely impact home affordability. According to Knight Frank Affordability Index 2021, except for Mumbai, all other key cities were well below the 50% threshold ratio of affordability. The rising interest rates over the coming months will further strain the finances of developers, making it really challenging for them to service debt. This will erode their financial capability to complete projects, thereby precipitating the problem of incomplete/stalled projects.

Harsh Patodia, President, CREDAI, believes that besides project delays, investments in affordable housing will be hit. The going will be all the more tough for projects which are facing cost overruns. Rezwan Razack, JMD, Prestige Estates says that it will be a challenge to deliver homes at the prices they were previously sold. Atul Goel, MD, Goel Ganga Group of Pune feels that due to rising cost, full-scale recovery will elude real estate.

Niranjan Hiranandani, Managing Director, Hiranandani Group

Rajan Bandelkar, President, NAREDCO, however, holds a contrarian view; he is of the opinion that the demand for homes will remain, and strong recovery will be seen in housing. Niranjan Hiranandani, Managing Director, Hiranandani Group, is equally optimistic. He hopes that the regulator will ensure that the inflationary pressure on individuals does not get exacerbated by the increase in home loan rates.

Going forward, the post-Covid trend of ‘home ownership over home renting’ will continue to drive demand and recovery. A favourable economy and business climate will support real estate growth. According to a FICCI study, India INC’s business confidence has risen from 63.9 to 67.6 on the back of favourable demand conditions. This bodes well for the commercial/office real estate. In fact, the year has already started on a positive note. According to Cushman & Wakefield Q1 2022 report, the top 7 cities have shown 65% yoy increase in leasing to 6msf. Analysts expect that due to lower rentals, investors will drive net absorption to 26.8 msf in 2022, and 30 msf in 2023. As per Savills India, flexible spaces will be a major demand driver, and Delhi-NCR, Bangalore and Hyderabad will lead the absorption.

The continuation of Modi government’s reformist policies promise good tidings for real estate. The Centre has made it clear that there will be no compromise on Capex in 2022-23 across sectors, including real estate. Last year, the Centre had spent ₹90.9 trillion, including the money spent on infra creation and affordable housing. The allocation of ₹48000 crore under PMAY in FY 23 and extension of interest subsidy for affordable housing till March 2023, holds promise for residential real estate.

Because of ongoing reforms, domestic and foreign funds continue to be bullish on real estate. Last year, funds like KKR, Xander, Piramal, HDFC Venture, Moti Lal Oswal, Ask Group, and Altico Capital, made huge investments in real estate. According to JLL, institutional investment into real estate since 2006, stands at $63 billion. HDFC Property’s ₹7200 crore fund is the largest domestic fund. HDFC also has a special fund for affordable housing. Global real estate investment and development fund HINES is looking to scale up its India exposure with a $500 million dedicated fund for office properties. GIC is picking up 3msf in Bangalore’s Bhartiya City for ₹2800 crore.

In light of all this, and despite the fresh hurdles of rising prices of property (due to increase in input costs) and hike in interest rates, the real estate sector could continue to charter a path of recovery and sustainable growth.

Industry Voices on the Cost Escalation

Rezwan Razack, JMD, Prestige Group
The abnormal price increase of raw materials like steel, cement, copper, and aluminium, has resulted in an unplanned increase in construction costs due to which it will be a challenge to complete the ongoing developments at budgeted costs. Unfortunately, the current laws do not permit the developers to charge escalation in prices to the buyers. As such, the bottom-line of real estate companies, due to disrupting balance sheets, is going to be severely hit. This will pose a big question mark on how to deliver the finished products at the prices our apartments were previously sold.

Boman Irani, CMD, Rustomjee Group & President, CREDAI-MCHI
The constant price rise in key construction materials like steel over the past one year, is impacting the entire spectrum of raw materials required by the real estate industry. Steel is one of the important construction materials. It is important to know that the price increase is witnessed only where the rising construction materials costs are impacting the very viability of the project. Developers have been bearing the price rise and holding the prices for a very long time. But they may not be able to absorb cascading costs anymore and may well have to pass on the burden to homebuyers. The enhanced input costs have induced developers to make 10% upward revision in home prices. Going forward, new project launches will see prices increase. The ongoing and the already launched projects will also see price increase in phases in 5-6 months as margins have shrunk dramatically and developers will no more be able to absorb the cost.

Anuj Puri, Chairman, Anarock
The adverse impact of the rising input costs is quite evident. We are already seeing 5-10% rise in property prices, largely due to hike in raw materials cost. Moving forward, we may see interest rates going up, thus increasing the acquisition cost for homebuyers. A price rise of over 10% will have a high impact on residential sales velocity, even impacting deliveries. On the other hand, a below 10% increase will have a moderate-to-low impact on sales.

Anand Gupta, Chairperson, Housing & RERA Committee, Builders Association of India (BAI)
Currently, the construction industry is passing through the most difficult time. Various projects, particularly housing, infrastructure, coastal roads, and metro projects are facing cost overruns. If the owners/authorities do not reimburse or find ways to compensate for the extra money spent on projects by the concerned contractors, then they might be left with no other alternative but to stop construction of the project. Fearing that stopping work may lead to encashment of performance of bank guarantees, besides other consequences, contractors have presently slowed down the work, instead of stopping it. The unprecedented rise in construction materials cost may lead to bankruptcy of a few companies who have taken large fixed rate contracts and do not have appropriate escalation clauses. All real estate players will be forced to increase their sales rate at least by 15-20% in order to compensate their contractors for the price rise.

Ashwinder R Singh, CEO - Residential, Bhartiya Urban, & Member - CII’s Northern Region Infrastructure & Real Estate Committee
Going by the thumb rule, material costs contribute two-thirds of the total cost of construction. If we consider the last one year, the cost of cement and steel spiked by 20%, in turn increasing the overall construction cost by 8-10%. The developers were little conscious of increasing the price just after the pandemic, especially in the price-sensitive affordable to mid-segment in view of the robust demand. But now, they are passing on the rising input costs to the customers, or are on the verge of doing it.

Harsh Vardhan Patodia, CMD, Unimark Group & President - CREDAI
For quite a few months now, the increasing costs of inputs have been worrisome for the real estate sector. As the developers are working on thin margins, they would have no choice but to shift the burden to the end users/homebuyers. With high inflation and rising interest rates, home buyers would be less inclined to invest in real estate. Affordable housing developers will face the maximum pain since the real estate prices are expected to rise further by 5-7% over the existing increase of 5-8% in many areas. The increase in cost of raw materials might also delay some projects since developers may well have to slow down the pace of construction due to the input cost pressures.

Ankit Kansal, Managing Director, 360 Realtors
The substantive growth in input costs, if not checked properly, can impact the current bull run in real estate. As market conditions are recovering, developers would like to absorb the rise in price to a certain degree. However, if the rise is unbridled, they would have no option but to pass on a part of the rise to homebuyers. Hence, governing agencies should try to wield certain control over the rising prices. While organic demand supply is pushing prices upwards, a part of surge might be rooted in factors such as cartelization. If that is the case, then it should be systematically dismantled.

Shalin Raina, MD - Residential, Cushman & Wakefield
Inflation has been lingering below the central bank’s comfort zone for over two months now and the impact is felt in the real estate sector as well. A recent analysis by CREDAI suggests that the rise in input costs could be around Rs 500 psf which may have to be passed on to residential consumers soon. However, this comes in the backdrop of an all-time high housing affordability and record low levels of borrowing rate in India. A rough calculation suggests that Rs 500 psf hike in prices will mainly have 5-7% impact on home prices across major metropolitan cities. That may not alter affordability levels significantly. Pro-active consumers may see this as an opportunity to buy immediately in view of the probable price hike in the future.

Atul Goel, Managing Director, Goel Ganga Group
The sharp rise in input costs, together with costlier credit, has led to reduction of wafer-thin margins of real estate developers. These rising costs will keep the real estate sector away from a full-scale recovery. The government must intervene and provide a relief package to the real estate and construction sector, besides bringing down GST rates.

Rajan Bandelkar, President, NAREDCO
While builders continue to maintain low margins despite the rising inputs costs, they remain committed to completion of the projects. Hence, developers are not likely to raise prices until their margins are maintained. As Gen Z home buyers prefer home ownership to renting, in short to medium term, more and more buyers will invest in this market, and this demand will result in a strong recovery of the residential market.

Saransh Trehan, Managing Director, Trehan Group
Rising construction costs, coupled with inflation is affecting the real estate recovery. The increase in construction cost (up to one third of the value of property) may well result in property becoming costlier, besides other adverse impacts like project delays and lowering of construction quality. Property prices may go up by 10-15%. Developers can absorb only a part of the increase and yet up to 8-10% cost revision appears certain. As the residential demand is picking up, many developers are refraining from effecting price rise, lest it impacts demand. Also, in ongoing projects which are partially sold, any price escalation would violate buyer agreement; therefore, most of the developers have refrained from increasing prices.
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