An encouraging trend is the easing of liquidity pressures
India Ratings, a credit ratings and research agency has revised its outlook for the Indian real estate sector to negative to stable for 2013, from negative in 2012. According to a press release from the firm, demand remains subdued and EBITDA (Earnings Before Interest, Taxes, Depreciation and Amotization) margins low, leading to weak credit metrics for companies in the sector. The agency, however, sees signs of improvement, in terms of stability of margins and the easing of liquidity pressures, with free cash flows turning positive since H2FY12.
Demand for residential real estate stabilised in 2012, with year-on-year growth in home loans from banks showing an uptrend from May 2012. However, the sales of large players declined marginally in 2012. Economic weakness continued with the associated apprehension of employee downsizing and salary freezes, which adversely affected consumer sentiments. Persistence of adverse sentiments, high inflation and high interest rates which reduce affordability, coupled with high property prices, continue to hinder improvement in demand. Commercial demand will be hit by subdued job growth in the IT sector, where average quarterly net headcount addition in 2012 has been around 28%-32% lower than in the previous two years. Demand for retail space is likely to be muted in the near term.
EBITDA margins which had been steadily declining from about 55% in FY08 remained at around 30% during 2012.
With subdued sales and the lower level of profitability at which the industry seems to be stabilising now will keep financial leverage at elevated levels of around 6.5x in the short to medium term. To achieve a significant improvement in leverage, companies will need to rely less on debt financing and focus on buyer advances and internal accruals, a strategy which can only be adopted if there is an improvement in demand.
An encouraging trend noted by India Ratings is the easing of liquidity pressures. In FY12, companies generated positive free cash flows and the trend continued into H1FY13. Apart from stable demand, other efforts to improve liquidity included strategies like monetisation of land and non-core assets, exercising prudence in new launces and adopting the JV route to developing projects.
With funding options limited, the key to sustainability for real estate companies is growth in sales. During the first 11 months of 2012, banks’ exposure to the commercial real estate sector increased by just 1.7%. Private equity inflow into the sector has been moderate. The limited funding options imply a continuance of dependence on operational cash flows for funding growth and debt servicing. Commercial real estate developers, especially those with cash flow visibility through lease rentals, continue to have better credit profiles.