>India Property (MACQUARIE RESEARCH)

How deep does this rabbit hole go?

We foresee a turnaround in the second half of 2009
Covering the property sector makes us feel like Alice tumbling down the rabbit hole, not really sure when, where and how it will end. More importantly, is there really a ‘wonderland’ of multi-baggers at the bottom and is it time to start chipping away? We think so. We believe the Indian real estate stocks will bottom out in 6–9 months’ time. The key reasons for the sell-off in the property names were the unprecedented tightness in liquidity and demand destruction. We expect to see some capital flow back (selectively). We foresee physical market prices staging a recovery in late 2010 but do not expect stocks to wait that long.

Capital scenario likely to get better – at the margin
The four primary sources of capital for developers have dried up. Debt is very expensive (if available at all), while the equity markets have no appetite for new paper. Residential volumes are down by over 25% YoY. Availability of capital has remained completely frozen since it reached its worst point in 4Q 2008 (even while the situation in most of Asia is slowly improving). Having said that, we believe all trend reversals start with anecdotal evidence. We spent a few days in February
visiting property companies, brokers, banks and private equity players. Our conversations suggest that there is likely to be some relief for individual developers and projects in the next six months as lenders take on more risk. This should partially be driven by policy initiatives. We are already seeing some asset sales and instances of banks willing to refinance obligations.

Stocks won’t wait for physical market to bottom
Analysing past cycles in India is very tough, as most developers have been listed for less than three years. We try and draw parallels from past cycles in Hong Kong. While the physical market dynamics in the two locations are clearly very different, we can derive some striking and relevant conclusions. In every one of the past four cycles, stocks recovered 6–9 months before GDP growth. This (in turn) preceded a recovery in rents by another 6–9 months. A late-2009 recovery in property stocks should therefore not surprise us. News flow should improve due to the low base effect in volume and price growth, but we do not foresee a smart recovery. We continue to expect that prices and rents in India will bottom in late 2010, 6–9 months after Macquarie’s forecast of a recovery in GDP growth.

Lesson from the tech bust – stock picking is essential
The last three years saw property stocks form a bubble very similar to that seen by internet stocks early in this decade. The bubble burst was as stark. Having said that, we point to an important lesson. While some internet companies (such as Excite @ Home) went under, companies that we believe to have a ‘real’ business model and balance sheet became multi-baggers. For eg, Yahoo delivered 11x returns in the next four years (but was still down 63% from its peak). Similarly, we do not expect cap rates of 13–14% and cost of capital of 16% to persist in a mid-cycle scenario in
India.

To see full report: INDIA PROPERTY