This sector was for long considered an extension of the Construction sector. However, several changes have taken place over the last few years:
- Introduction of RERA ensured that wide-spread delays and incomplete projects would be reduced. This ensured quality and the organized sector gained market share steadily – thereby also increasing investor/buyer confidence.
- COVID-19 had multiple effects on the public. One of the major ones was the priority placed on having more space at home, if possible. According to data from property consultant Anarock, the average size of new houses offered by builders in India increased to 1,300 square feet in 2023 from 1,050 square feet in 2019, as the COVID-19 pandemic increased demand for larger living spaces.
- The luxury segment of the Indian real estate market has significantly outperformed the value segment in recent years. It has seen strong growth in demand, average home sizes, and new project launches. This trend appears to be driven by changing consumer preferences and the growing middle class in India.
- Our interaction with builders and prospective home buyers reflected one more key change. Earlier a person wanting to buy a 2-BHK house looked for 800-1,000 sq ft space, while ensuring availability of parking, electricity, water and gas. Now, in the aftermath of COVID-19, the society, location, club house, amenities have started playing a major role in decision making. As one of the buyers nicely put – “I want to buy 1000 sq ft but want full access to an operational 25,000 sq ft club house”. This is a major change in mindset.
The above factors and their potential structural nature, make us believe that the Real Estate sector in India is steadily morphing itself into a Consumer Discretionary sector – where brand, pride of ownership, pricing power, and barriers to entry are all important ingredients.
The medium-term Real Estate upcycle is anticipated to continue strong. Strong structural factors are driving India’s housing demand:
- 2.4% annual growth in the number of households (although population growth is slowing, average household size is shrinking) (Source: Axis Securities);
- growing average house size, which is still much smaller than in China and the US; and
- rising construction value per square foot.
Between 2012 and 2021, home building was slow, with its share of GDP falling by almost 6 percentage points and its annual growth being slowed by about 1 percentage point. This has recovered over the past two years and will probably continue to be strong for a few more years. In the top 8 cities, demand has increased, and inventory levels have decreased due to lower sales-to-income ratios. According to a report by Jefferies, low inventories and mid-cycle affordability should support ~20% residential sales growth in 2024.
with the current BSE500 Index market cap share of 1.6%, real estate stocks are significantly less than their peak of 6.2% in 2008.
Moreover, the cohort of stocks in January 2008 is not the same as the cohort of stocks today. Furthermore, operating cash flow has replaced land banks as the primary valuation metric. Regulations and accounting procedures have also changed in the industry. With the advent of RERA, the entry barriers have become quite stiff as the delivery timelines are strict. A catalyst in the transition came in the form of COVID-19, which made people in general realize their priorities and required space per family started inching up.
In the past two years, 12-month forward earnings for the current set of NSE200 Real Estate stocks have almost doubled. Moreover, the high growth rate is expected to continue for a few more years. The consensus earnings estimates suggest an earnings CAGR of 28% over the next 2 years, despite a high base. This is significantly higher than the 16% earnings growth estimates for the market in itself. Despite a strong run in the last one year, the sector has significantly underperformed the broader markets since January 2008 peaks.
Volumes in the Indian housing market doubled in the last three years, with a YoY increase of about 25% in 2023. A seven-year weak phase for residential implies a large headroom for medium-term volume increases. In 2024, when the housing boom enters its fourth year, volume growth may slow down but still register a 10% YoY increase.
Changes in the pattern are visible with premium segment leading the housing upcycle. Since 2019, the share of premium residential houses has increased by 14 percentage points. The affordable segment was hampered by rising rates and income losses, but those days are gone. A benefit could be potentially lower mortgage rates in 2024.
With low rental yields, disciplined price increases (5–10% p.a.) are necessary for the residential cycle to continue. Sharp price increases, however, cause end users to flee as affordability drops and also result in a lower-quality supply. It might also run the risk of drawing regulatory attention; the RBI’s recent tightening of its regulations on consumer lending is one such example.
Disciplined expansion by developers is crucial for multiples. Developers are finally becoming more willing to take on more risk as they place bets on the strength of the market and possible consolidation. In 2023, a few large developers expanded geographically – success in this expansion may improve visibility for a number of them.
Though still about 6-7 percentage points higher than pre-COVID, the leasing uptick for offices in late 2023 is driving down vacancy levels. NCR and MMR, the domestic demand-driven cities, are expected to fare better in 2024 due to robust local demand as opposed to IT outsourcing and rising underlying land prices. Large office holders should have more flexibility as a result of SEZ rule relaxation.
While the outlook is quite positive, a word of caution comes from the fact that the Nifty Realty Index rallied about 136% in FY24 (Source: Bloomberg). Good development discipline and growth are encouraging, but there is little room for disappointment due to high expectations.
(The author iAlok Agarwal, is Head – Quant & Portfolio Manager, Alchemy Capital Management.)