Why are property prices rising but Real estate prices falling?

BSE Sensex Vs. BSE Realty Index

As we can see, BSE Realty Index has fallen by almost 80% since Q4 FY08 whereas Sensex has risen by almost 20% in the same period. And we all envy the fact that prices in real estate are raising leaps and bound. There is no denying the fact that realty investments is one of the major investments to have in one’s portfolio. The question is “why are Realty stocks prices falling despite the magnificent rise in property prices”? Is there a flaw in the strategies used by these real estate companies which is not allowing these realty companies benefit from the rise in real estate prices. Or is it that these real estate stocks are simply undervalued. 

Useful Read: Comparing Real Estate Market and the Stock Market of India

Now let us look at the consolidated revenue, EBITDA and PBTs of the top real estate companies of India for FY13.  

Company	Consolidated Turnover (in cr)	EBITDA (in cr)	PBT (in cr)	Finance Charges (in cr)	Interest / ebitda ratio
DLF	9095	3150	839	2314	73%
Oberoi	1147	712	683	37	5%
Prestige	2011	642	425	148	23%
Mahindra Lifespaces	772	276	136	31	11%
Unitech	1526	576	231	304	53%
GPL	1047	296	288	3	1%
IndiaBulls	1486	471	222	228	48%
Sobha Dev	2093	553	323	170	31%

The ratio of interest paid to EBITDA is a clear indication that these companies shell out a major percentage of their profits as interest on the loans taken. DLF, Indiabulls & Unitech shell out more than 50% of their EBITDA as interests. Higher prices and profits in real estate are obviously not accruing to the investors. No doubt, these companies have to work at a very high IRR (Internal Rate of return) thereby pricing their products at a very high end. I always wonder what if government were to waiver their loans just as they did for farmers back in 2009 (to the tune of Rs. 70,000 crore), will it promote lower prices for the properties!! Though, I am personally against it.

But the whole point is that the stock prices of these companies are not rising because they have to shell out a hell lot of money as interest costs.

Secondly, almost all real estate companies depend on PE investors who expects a return of 20-30% in a short span of time. To accommodate for their margins, Real estate companies jack up their prices so their own margins do not get hit. This leads to a further rise in prices of real estate properties. Now at these jacked up prices, it is difficult for end users to buy a property when it is still under construction. On the other hand, investors with a large chunk of money buy these properties by paying a small token money. As a result, when you see in Gurgaon, especially the belt of Dwarka Expressway and New Gurgaon, almost all properties are selling at phenomenal prices which is not supported by the infrastructure development. Developers are increasing their prices without any logic, and investors are still ready to buy. There is zero consumption by the end user. Prices are rising based on speculation. The builders are forced to delay the construction of these properties until there is some incentive in the form of infrastructure that would enable resale to end users. This delay in construction further jacks up the prices.

Sometimes I wonder, what is the need of PE capitals in residential construction. Developers charge on the basis of construction linked plan where a buyer has to pay based on the construction done till then. This money is sufficient to sustain the construction activities, nullifying the need for any PE investment. With margins for PE investments gone, it should enable to bring down the prices considerably. This should in turn help increase the end-consumer demand as well which is the need of the hour.

We talk about corporate social responsibility, what better than being responsible for this cause for any real estate developer. Please give your thoughts!!