Liquidity pressures in real estate could lead to shakeout

Declining internal cash generation has been accompanied by a progressive drying up of funding options. Stringent Reserve Bank of India (RBI) norms for bank loans to real estate, and high interest costs for most corporates, have made bank borrowings less attractive.

The restrictions on external commercial borrowings (ECBs) and classification of preference shares as debt, announced in May 2007, have cut down two other funding sources. Foreign direct investment (FDI) norms do not allow real estate investments below a certain size and value. Compounding the effect, the recent fall in equity markets has derailed the plans of many real estate companies to access the domestic or international market for equity issues.

These unfavourable real estate and financial market conditions have coincided with a sharp increase in the scale and size of projects executed and planned over the past two years. As a result, many builders—mainly small and medium-sized ones—are operationally at full stretch, besides being financially leveraged. Added to this, some projects have been funded through high-cost short-term borrowings, weakening the developers’ financial risk profiles even further. These developers will be the most vulnerable to the current slowdown in real estate, resulting in delayed or stalled projects.

Over the long term, CRISIL expects the sector to revert to its strong uptrend, and perform in line with the overall economy. In the short to medium term, the current slowdown creates a very real risk of a shakeout among medium-sized and small players.

The extent of the shakeout would depend upon the duration and depth of the current trough in the sector’s performance; CRISIL believes that it will also create opportunities for consolidation in this highly fragmented sector, and aid the emergence of operationally and financially strong players that have the resources and management capability to tide over the current crisis. Such strong players, CRISIL believes, will be able to acquire unfinished project assets or potentially distressed companies, and eventually emerge stronger from the present downturn.

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(This is press release of Crisil)

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