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Why real estate stocks are tumbling

Why real estate stocks are tumbling

Real estate is one of the most preferred investment options in India. But, its stocks have taken a beating. If you had invested in the Bombay Stock Exchange’s realty index in October 2009, when it reached its five-year peak, the value of your investments would now be down a whopping 70%. The index crashed 38% this year alone.

This is because, financial health of realty companies have been hit. “The real estate developers have been caught in a trap of ambitious expansion, decelerating sale, hardening interest rate, and weakening cash flow,” Knight Frank, a real estate consultancy firm, said in a report.

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Moreover, chances of revival seems bleak, according to the firm. Here’s why:

1)      Stress score: This indicates the ability of business operations to service debt and interest obligation. A higher ‘stress score’ number indicates an improving situation, while a lower number implies a worsening situation. The realty sector’s stress score has fallen to a five-year low of -132. Compare this to -32 in FY10 after a big stimulus package by the RBI. This shows the worsening financials of the sector.

2)      High debt: One of the key issues plaguing the sector is a rise in debt. Gross debt increased by 55% since FY09, according to the Knight Frank report. Some realty firms have also defaulted on their debt payments.

3)      Dry-up of funding options: Banks have been the key lenders for developers. A rise in non-performing assets (NPAs) or bad loans, depreciation in the rupee and a tight monetary policy have limited the banks’ lending abilities. They are shying away from giving money to real estate companies. Private-equity funds and foreign investors too have aren’t too fond of betting on real estate. Foreign Direct Investment (FDI) has plummeted from 9% in FY12 to 3% in FY14 so far. “This seems to be just the beginning of doom for the highly leveraged realty firms,” Knight Frank said.

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4)      Slowing rupee and high interest rates: The rupee has hit new lifetime lows, while inflation seems to be on the rise again. To combat these two issues, the RBI increased the short-term lending rates. This is a departure from its earlier lower interest rate regime. High interest rates and a rise in debt have pushed companies’ interest payments to over Rs 4,000 crore in FY13 from under Rs 2,500 crore in FY09. This means added cost pressures.

5)      Decline in sales: Prices have shot up in the sector. This has discouraged a lot of potential buyers, leading to a fall in sales. This can be seen in the 23% fall in absorption of residential projects in the top seven cities between FY11 and FY13. Absorption reflects how much people are actually buying. This slowdown in sales is impacting operating cash flows, which indicates the profitability of the business.


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