There is a message for property investors from Dalal Street which is harsh with under-performers

In the last couple of months, the stock market has been dominated by the price movement in realty stocks. Unfortunately, unlike in the past, most companies have been in the limelight for the wrong reasons with corporate governance being the key issue for most of them. The property and infrastructure sector, which contributed significantly to the excellent performance of equity markets between 2006 and 2007, has been a drag during entire 2010. If the current trend is any indication, the scene is unlikely to change swiftly in 2011 and this could have a far-reaching impact on the sector as a whole.

Useful tips

For those looking to invest in property, the trends in Dalal Street can be useful tips as stock markets are generally perceived to be ahead of times. If stock prices of realty companies are bleeding due to lack of buying interest, a message is emanating from there.

If one had observed the performance of realty stocks during the last couple of years, it would have been evident that the industry was bogged down by a number of factors. After the boom till early 2008, the industry was caught on the wrong side because of its excessive borrowing. Every real estate developer focused on creating a land bank through borrowed capital and equity funds (some managed to acquire during good equity market conditions). Not much attention was paid to cash flow as anyway the demand for units kept coming in.

The global financial crisis changed a few things and for the property sector, it was a double whammy. On the one side, there was liquidity crunch due to RBI's restrictions on bank finance and on the demand side, the story changed due to uncertain turn of events in the light of the global financial crisis. Three years later, the problems have not disappeared completely but there is an addition to the list in the form of corporate governance issues.

Lack of transparency

If you talk to any mutual fund manager, he does not have nice words for listed property entities as he is not comfortable with the management practices of most companies. The problems have been due to a number of factors. The foremost has been the lack of transparency in the industry which does not account for a good chunk of its dealings.

As a retail investor, we all know as to how long it would take us to find a buyer or seller who wants to deal with the entire transaction through accounted money. The wait can run into months for most of us.

Extensive pledging

In recent times, what has added to the problems is the way real estate companies have gone about managing their capital needs. Those who have already listed their stocks have resorted to extensive pledging and in a downtrend in equity markets, this has boomeranged.

With interest being firm, alternative options of funding haven't been cost effective. If stock markets are giving the thumbs down for realty stocks it is also due to the changing scene on the supply front. The actions of 2008-09 have begun to have an impact on the industry where land was acquired at high cost resulting in higher average prices. Despite lack of buying support, developers have been unwilling to off-load at lower cost due to higher acquisition price.

While the above trend is loud and visible in markets such as Mumbai, it may not take long for other markets to follow suit.

Dalal Street believes that lack of cash flow from sale of units at an aggressive pace is a warning signal to drub the industry. Those who ignore the signs do so at their own peril.