Reforms leading to higher expectations

In its year-end assessment of the Real Estate Sector, ICRA has maintained a negative outlook for the residential real estate (RRE) segment and a stable outlook for commercial real estate (CRE) segment.

Report by ICRA Ltd.

The RRE has witnessed a prolonged downcycle owing to high inventory, muted demand, weak affordability, and declining investor interest. However structural changes over the last two years in the form of Real Estate Development and Regulation Act (RERAD Act) and Goods & Services Tax (GST), along with increased government focus on affordable housing, have raised expectations of demand revival. While these expectations have played out to some extent in certain property segments and micro-markets, a broad-based recovery in demand across the country appears to be some time away. States such as Maharashtra and Karnataka which have seen relatively better implementation of the RERAD Act are benefiting from increasing confidence of end-users. Demand in the premium and luxury category of residential segment are likely to remain suppressed for under-development projects due to the increasing preference for completed properties under the GST regime.

New project launches had been severely curtailed in CY2017 due to the impact of demonetisation and transition issues in RERAD Act implementation. While certain cities like Bengaluru, Mumbai and Pune have witnessed a notable pick-up in new project launches during CY2018, markets like the NCR may take longer for major uptick in project announcement due to existing inventory overhang. Due to the high compliance obligations imposed by RERAD Act, new launches from small developers have reduced, thus market share is being garnered by the larger developers who are better placed to operate under the new regulatory framework. This process of market share consolidation is only likely to strengthen over the coming years.

The residential realty segment has been increasingly relying on non-banking financial companies (NBFCs) and housing finance companies (HFCs) to raise debt financing, owing to the risk perception attached with the segment by banks. The liquidity crunch faced by the NBFC and HFC segment towards the end of CY2018 has impacted the funding availability and cost for many real estate developers. If the current scenario persists for long into the start of CY2019 also, it may cause credit stress in developers who are reliant on refinancing to support balance sheets heavy on land assets or slow-moving inventory.

In the coming year, ICRA expects residential real estate developers to maintain a cautious stance towards new project launches and land acquisition deals, especially due to the constrained debt funding scenario. The upcoming elections in CY2019 may also keep the fresh project launches in check, considering the uncertainties developers may face relating to timeliness of regulatory approvals for projects. With RERAD Act limiting the ability of small-scale developers to launch projects, the industry is likely to see more of development management or joint development model of project implementation. The existing gaps in the implementation of RERAD Act in many states need to be corrected for customer confidence to be fully reinstated and the full benefits to be realised. Demand growth is likely to be sustained in the affordable and mid-income category of projects in Tier 1 markets, especially those where the fresh leasing activity of commercial office space continues to be robust thus creating fresh job opportunities.

As for the CRE segment, ICRA has given a stable outlook. In contrast to the residential segment, the commercial realty sector has been growing at a steady pace and has garnered the major share of the institutional investors’ interest in the real estate space over the last 4-5 years. Some of the factors that have supported the growth prospects for the sector include stable demand for office space from various multi-national and domestic corporations, calibrated supply of stock, a more organised industry structure and availability of adequate capital for projects, backed by healthy investor appetite for rental yielding assets.

Most of the tier 1 markets have seen stable levels of fresh leasing and supply additions, resulting in either a declining vacancy (in cities like Bengaluru and Pune) or a status quo in vacancy levels (in cities like Delhi NCR and Mumbai). The Hyderabad market is in the midst of a boom in office space absorption with resolution of earlier political uncertainties and relatively lower costs along with high quality of living indices. Nonetheless, with significant supply of stock lined up over the medium term, occupancy levels and rentals in this market may come under pressure if the current demand trends are not sustained. The upcoming sunset clause for SEZ units will result in some bunching up of SEZ stock completions during CY2019, which may temporarily create pressure on the vacancy in certain markets like Bengaluru and Chennai.

Some of the other key trends that have been witnessed in the commercial segment include strong interest from institutional investors in building commercial real estate portfolios, consolidation of office spaces by large tenants resulting in increased demand for large-format office parks, healthy rental appreciation in certain micro-markets in cities like Bengaluru and Hyderabad, which has encouraged some amount of speculative construction, rapid growth of co-working format of leasing, and the expected launch of the first Real Estate Investment Trust (REIT) in the country by Embassy and Blackstone.

Going forward, ICRA expects similar demand and supply levels to continue in the major cities, which will support a further expansion of the asset portfolios of the established incumbents. Developers and micro-markets which have more diversified sectoral exposure would be more resilient in weathering any near-term challenges due to the decline in demand from any particular sector, such as IT services. Apart from the broader macro-economic trends, a conducive political environment, continued favourable investment outlook and improvement in the quality of living indices in the cities would be the key monitorables for the sector. The response to the forthcoming first domestic REIT will be an interesting barometer for the appetite of domestic institutional and retail investors towards this asset class.