Rising building material prices hurting developers' profit margins

The pandemic proved to be a silver lining for the realty sector as well as home-buyer in India. With complementary factors such as low mortgage rates, reduced stamp duty, realty developers are offering affordable housing and luxury homes keeping in mind the new WFH culture. Sharad Mittal, CEO, Motilal Oswal Real Estate Fund, speaks with Bizz Buzz in an exclusive interview on the emerging investment trends in the realty sector, scope of REiT and why rising commodity prices should be a matter of concern for both developers and homebuyers.

We manage to close Rs 4,300 crore now, we manage private equity funds. We are on the way to raising our fifth private equity fund. The new fund that we are currently raising is focusing on development stage where the money goes into the project for the purpose of construction. But largely we have full stack of solutions starting from land to construction

Commodity prices across the board are going up and it will impact the construction cost. Given that the long dry spell the residential real estate has seen, developers are probably looking to sell at a price at which consumers are finding it favorable. But if the steel, cement and other commodity prices keep rising, I think developer will eventually have no choice but to pass on part of it.

Real Estate is enjoying an upward trend thanks to low bank interest rates and change in consumer preferences. Is it an indication that realty is being preferred for consumption than as investment product?

There are four primary reasons for real estate recovery and all the reasons have come in together post lockdown. Firstly, the low interest rates, right now they are firmly around 6.75 percent which is a big deal. This has helped with sales and recovery in the real estate. The second reason being property prices have been stagnated for long. Peak properties prices were in March 2013. During this (pandemic) period, incomes have gone up, the GDP has grown, and that makes property prices affordable. People are looking at this as an opportunity to buy houses, knowing that they will get a good deal. The third, I would believe, is the lack of opportunities for the investors to invest. Equity market is at an all-time high, debt returns have collapsed during lockdown as the RBI cut the interest rate and the banks are flushed with money, FD rates have gone down to as low as three percent. There is lack of opportunity and some bit of reallocation. Debt instruments are giving lowest return in the last 16 years. And the fourth reason is Work From Home (WFH). There is a practical need of owning a larger space now or customizing the space which you already have. Combination of these factors is giving sales a green shoot. I would like to see this momentum continuing for next six to twelve months and probably we can say this is a full-scale recovery.

Post-January 2021, realty stocks on stock exchanges are in a negative trend. How is this going to impact the segment if the negative trend continues in the upcoming financial quarters well?

On the commercial property, I have not closely followed the leads you are referring to here. But it plays down on all how this WFH and getting employees back at work plays out. The other thing you must keep in mind is that the IT companies are still growing at a very good pace. Even if it doesn't go into full normalcy, they will still require office spaces. The only scenario which has not been envisaged is complete destruction where this WFH becomes too normal. I don't think that is going to happen. But one should wait for some time before we see how WFH plays out.

Motilal Oswal also launched schemes as part of property fund management. What kind of investments are you looking into?

We manage to close Rs4,300 crores now, we manage private equity funds. We are on the way to raising our fifth private equity fund. And we largely focus on development strategies and we have done investments at land stage. The new fund that we are currently raising is focusing on development stage where the money goes into the project for the purpose of construction. But largely we have full stack of solutions starting from land to construction and predominately we are focusing on residential.

The new fund that we are raising is focused towards more construction finance. We look forward to deploying this fund in the next financial year. We are hoping to raise little over Rs 1,000 crores and out of that we have already raised Rs 600 crores. We are actively looking at transactions to deploy this money.

How's the response of the investors towards fractional investments in office spaces or commercial space?

In my view, any fractional ownership is not suggestable. We don't recommend it because we believe when an investor, especially the retail and HNI investors, they are best placed to play to do investing into commercial real estate through needs. They are diversified, they have liquidity on the click of a button, they are tax efficient, and you become a part of very large pool of assets. Will certainly believe that REiT is a better vehicle than fractional ownership. For fractional ownership, I'm also not fully sure whether all the boxes around regulation are completely taken care of.

The primary focus has been on unsold inventory. With raw materials such as steel prices hitting an all time high, how will this impact real estate companies to undertake new projects?

Why only new projects, this is affecting the existing projects as well. So, this is something the commodity prices across the board is going up and it will impact the construction cost. Right now, given that the long dry spell the residential real estate has seen, developers are probably looking to sell at a price at which consumer are finding it favorable. But if the steel, cement and other commodities prices keep rising the way they are doing, I think developer will eventually have no choice, but to pass on part of it. Eventually it will play out through the demand supply equation. But if it becomes unmanageable, then a part of it needs to be passed. I don't think we have reached that stage, but this is hurting the margins of the developers.

Do you think we might hit that stage were realty prices will go up because of commodities rising prices?

I don't know. It depends on the commodities cycle, how it goes. Frankly speaking, the way we are in the residential sector real estate cycle, cash flow is more important than looking at the absolute profit. After a dry spell of eight years, last six months have been extremely good. I think developers around this time acting very maturely seizing the moment and the consumers coming forward, ensuring that the sales take place.

With Covid case surging again throughout the country, do you think the realty sector is prepared incase another lockdown takes place?

I would put low probability on that kind of a lockdown. The (nation-wide) lockdown happened because of uncertainty at the point. As a country, we were not sure about the challenges we are going to witness. But as a country, as an industry we are much better prepared for any kind of lockdown now in comparison to last year. So, we are far better placed both as a country, administration and the industry. Our medical infrastructure is better prepared and the entire vaccination roll-out. But overall if a lockdown does takes place in specific cities, or micro-markets, I think we are far better placed. As far as Motilal Oswal is concerned, we have built in fair bit of stringent processes and put in place buffers when we do underwrite of our projects. We built in this kind of uncertainties which were earlier not there. It was unimaginable to think a year ago that everything would come to a standstill.