Don’t bottom fish in real estate, construction stocks

Don't bottom fish in real estate, construction stocks

The real estate and construction industry are, taken together, the largest employment generators, outside agriculture. Both industries are arguably part of the service sector. Both have long value chains. These two related sectors generate the bulk of the demand for steel, cement, concrete, paint, timber among others.

 

Real estate transactions are also a massive component of the financial economy. Stamp duty from sales is a big contributor to the revenues of states. Mortgages are the major income stream for housing finance companies and also a major contributor to the income for banks, and other NBFCs. The marketing of real estate, with its large advertising component, is another big revenue source to the media. Real estate development is a vital component in revenue assumptions for the development of toll roads and metro construction systems.

 

Construction is dependent on real estate activity and in infrastructure projects. The bigger construction companies have become real estate developers, to build, operate and transfer (BOT) projects with long timelines. A lot of construction money is already stuck in projects which have stalled for various reasons (usually related to land acquisition and environmental clearances and other clearances).

 

Demonetisation will hit real estate very hard. In the short run, all secondary transactions are frozen and the lack of easy cash flow has led to a freeze on ongoing projects. Primary real estate sales in many cases are “near white” meaning the cash (or black component) is relatively low. But there are large cash expenses involved in project completion (black payments for the land; bribes to local government officials). So those projects are also stalled.

 

In the longer run, prices should fall significantly. However, this might be reflected in an odd way. The official white price of real estate might go up! That is, let’s say the black:white component was white 60: black 40 (which is quite common) for a property worth Rs 1 crore. Then the black component will be slashed down to say, 5% (to cover bribes to local government, and other “speed” payments), or Rs 5 lakh. But the white component will go up to Rs 65 lakhs. Overall, the price comes down to Rs 70 lakhs but as far as registration price is concerned, it is up.

 

If this happens, stamp duty collections may rise, once demand recovers and activity restarts. However, the chances are, the secondary market will remain frozen until there is a fair amount of cash currency back in circulation. This is due to behavioural reasons. Buyers will feel anxious until lives are back on even keel. If you are worried about paying Rs 100 in cash for the next auto-ride, you are very likely to lay off buying a house even if you have Rs 20 lakh in the bank (enough to fund a mortgaged deal for Rs 60 lakh). So a lot of consumers will wait.

 

While that freeze lasts, the entire value chain of real estate and construction will be hit and hit hard. The poorly capitalised businesses in those sectors; the ones with low reserves and high debt on their balance sheets will be in serious trouble. There could be a brutal shakeout and that should be reflected in share price dropping across the board.

 

Buying into these companies could be like trying to catch a falling knife for a while. But once the shakeout is done and dusted, the share prices of the better-organised and better capitalised among these businesses will be at very attractive levels. I’d be looking at the paints industry with great interest and at anything with a decent debt equity ratio in the construction/infra developer segment
[Source:-Business Standard]