Softening inflation and better-than-projected monsoon have raised hopes of another rate cut by the Reserve Bank of India in the next monetary policy review due on August 4.
While it augurs well for the overall growth of the economy and for kicking off the investment cycle, a further cut in rates can also be beneficial for the interest-sensitive real estate sector — both in terms of pushing demand for housing and reducing the debt burden of the developers that has been mounting. But will it be enough to turnaround a sector that desperately needs help? Experts don’t feel so and say that it may take at least two years for developers to recover from an over-leveraged position to a more comfortable one.
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Though the RBI has already cut the interest rates thrice, by 25 basis points each, over the last six months, not much has percolated to the ground level in terms of reduction in lending rates of banks. While the RBI has been urging banks to be more transparent in passing on the interest rate cuts into lending rates in order to provide relief to consumers and push credit demand, experts feel that the central bank will have to do more than the symbolic rate cuts.
“The rate cuts of 25 basis points have been more symbolic in nature and this industry needs a sudden and clear shift. The demand needs to pick up in a big manner for the condition of developers to improve,” said Gulam Zia, national director, research, Knight Frank. Higher GDP growth rate along with structurally low inflation is expected to result into further rate cuts by the RBI and according to rating agency Fitch declining rates will benefit real estate developers.
“The property development sector will be a key beneficiary of reductions in housing loan interest rates by several domestic banks in April 2015,” said the rating agency in a statement. Even after the RBI’s announcement of a 25 basis point rate cut on June 2, several banks brought their base rates down only by 10-15 basis points.
Is it enough to deleverage them?
A look into the interest expense and operating profit of 20 real estate companies over the last two years shows a decline in their aggregate operating profit and a rise in their interest expenditure, thereby showing a decline in their interest servicing ratio.
While for the group of companies interest expenditure rose from Rs 711 crore in FY14 to Rs 764 crore in FY15, their operating profit declined from Rs 1,259 crore to Rs 1,087 crore. So, while 56 per cent of their operating profit went into servicing loan in FY14, over 70 per cent of the operating profit went into debt servicing in FY15. Dried up project launches and deteriorating cash flow for developers have squeezed their ability to service and reduce debt.
The phenomenon of delay in delivery and inability of developers to complete projects is mostly a result of their weak financial situation and if the report prepared by Fitch is to be believed, it is not going to improve soon. A number of real estate companies have witnessed slower than expected deleveraging because of weak operating performance and their cash collections have declined due to weaker demand and slower construction of some of their projects. The Fitch report points that domestic property developers will “deleverage meaningfully” by the end of 2016 with pick up in growth and improvement in the investment climate in the country. While a majority of real estate developers are facing issues of high debt and have not witnessed any significant decline in the same, the report points that the process of reducing leverage got stalled in 2014 and needs to be revived.
Over the last two years-2013 and 2014 – as the demand for residential housing declined following weak macroeconomic environment, high interest rates and political and policy uncertainty in an election year, buyers postponed their purchases, which drove up inventory levels steadily during the last 12 months. Developers followed this by introducing easy payment plans for buyers that included: 20 per cent of the property price to be paid up front and the remaining to be paid at the end of the construction. And this has further piled up their debt.
“This has lengthened cash collection cycles and contributed to higher leverage. The agency (Fitch) estimates that around 20 per cent of the sector’s sales over the last two fiscal quarters were financed by easy payment plans. The longer cash collection cycle will continue to weigh on developers’ balance sheets in the near term,” said the Fitch report. But there are others who feel that it may take more time. “As of now there are no signs of sudden change in deleveraging. The industry is in a bad shape and is burdened. They are forced to borrow money from high net-worth individuals (HNIs) at interest rates above 20 percent. I don’t think their situation will improve in two years. You need a sharp shift in demand because their revenues have dried up,” said Zia.
In April, the rating agency had raised its forecast for India’s growth to 8 per cent for the financial year ending March 2016 and to 8.3 per cent for FY17. A higher growth rate and pick up in economic activity is expected to push new job creation and thereby generate fresh housing demand which may revive the sector.
Who will benefit from a rate cut?
Since high-end residential projects are unaffected by interest rates and price of the property and are less dependent on the state of the economy, it is unlikely that developers operating in the high-end category will see any change for themselves. “We expect developers with a greater exposure to the middle and lower income segments to benefit more from lower domestic interest rates. Developers with a greater mix of high-income customers, will be less impacted because their customers are less sensitive to market interest rates,” said the report.
Citing specific instances, the Fitch report said that while Lodha Developer’s leverage (measured as the ratio of net debt to the sum of inventory and land bank net of customer advances) increased to 84 per cent at end-2014 from 77 per cent at end-March 2014, IBREL’s leverage increased to 61 per cent, from 50 per cent over the same period. The rating agency expects both companies to meaningfully deleverage by end-2016.
But some within the industry doubt the ability of developers across cities to bring down their debts in two years.