India real estate: price correction looms

Gaurav Dalmia, founder and chairman of Landmark Holdings, an investor in India real estate projects, says that while property prices in larger cities are due for a correction, there are plenty of investment opportunities available.
What is your current portfolio of real estate assets in India?

Landmark has invested mostly in housing developments as we believe this is currently the best asset class in the country for private equity investors. There are no exit event risks since the housing stock is self-liquidating. Housing is a larger asset class than office, retail or hospitality. Revenue visibility is better. In some markets, office or retail may be safer but mostly housing trumps these, as many US investors, who were earlier focused on office buildings, are now discovering.

We have eighteen on-going developments, across large cities such as the greater Delhi area and Calcutta, to smaller cities such as Tirupur, Meerut and Bhubhaneshwar. We consciously trade off the liquidity characteristics of a large market for the higher margins in smaller city developments. On the whole, the portfolio is going well, though some aspects like licensing can be difficult. I do not believe these problems are unique to India though.

Has your approach changed since you forayed into this area a few years ago?

We are doing pretty much the same as before, which is housing-led, mixed-use developments. We have also invested in a few shopping malls.

In today's market, with raw land prices high, we are not doing any aspect of land banking, which we were doing some years ago. We are investing in projects with a definitive and a current market. We did only one deal last year, a 4500 acre, mixed-use development in an eastern suburb of Delhi, which is a long term project, but the land price justified that; also we figured we were going to create critical mass in this area and in previous investments such as these we have seen that the last 25% of the project may yield 50-75% of the profit.

Otherwise, we have invested in a two million square feet housing development in a populated part in the same eastern suburb of Delhi, bang opposite a neighbourhood where more than five million square feet of office space for information technology workers is going to be developed in the next five years. This site comes with its own traffic jam, that is how good the location is.

We are just concluding the redevelopment of an old textile mill in downtown Tirupur, which is the "Manchester of India", with $3 billion of apparel exports. This is going to be the best development in Tirupur and the only one of this scale and standard catering to the middle and upper middle class segments.

Real estate prices in key Indian locations have continued to rise, despite concerns that valuations are now unsustainable and housing especially is now out of reach of the majority of buyers. What is your comment?

I agree that prices are outside the reach of the middle class. This is just not sustainable. I see prices correcting, especially in larger cities. Sales of the large few years have been to speculators, and this stock is coming back into the market, putting pressure on prices. In the short term, price run ups may happen, but in the medium to long term, the prices will be determined by the wallet of the middle class Indian.

Where in India do you think opportunities to create value by investing in real estate still exist?

Even though part of me is very bearish, I see opportunities everywhere. The real estate sector is very inefficient, so one can have a huge range of returns even in deals of the same vintage. A great site and a great project is not necessarily a good investment because the land value may be too high. A cheap deal may be as bad because chances are the deal is cheap for good reasons. So these formulas do not work. We take a bottom-up view. In general, we prefer things that are below the radar screen of the typical institutional investor.

We are happy to invest in cities that an average US real estate fund manager has not heard of. We are happy to invest very early in a deal when there is nothing there except a dream. And we are happy to invest with an eight- to 10-year perspective.

Having said that, I see many promising opportunities in large cities. We just invested in a 17 million sqf mixed-use development in suburban Calcutta where the consortium is paying $400 million for the land alone. There is a five-year payment plan, and we are working with one of the top developers of the region to minimise implementation risk, so we expect a very healthy multiple on our investment.

Do you expect the stockmarket nervousness to spill over into other asset classes and specifically real estate?

Not really. The stockmarket fall is driven by hedge funds and foreign institutional investors pulling out money. These investment vehicles face redemptions and hence this flight. In private equity or real estate, investors do not - and cannot - enter and exit like they do in the stockmarket. So I do not see the nervousness spilling over into the real estate market.

The real estate market may see a correction for other reasons though: prices crossing the affordability threshold, developers buying assets with an eye on stockmarket valuations rather than development potential, delays and cost overruns.

Has the inability of some proposed real estate IPOs to come to market affected perception of real estate stocks?

I do not think failed IPOs are affecting the perception of real estate stocks. In fact, I think it is the other way round. The market's views on real estate stocks is getting tempered, which means otherwise solid companies like Emaar MGF have had to pull their IPOs. I have never understood how the market values these so called land banks owned by developers. There is an intrinsic belief that land banks automatically mean profits, while the truth is land banks have to be licensed, developed, built and sold, before we get to profits. Each of these has risks, costs and lead times. To me, land banks are like eye balls from (the dotcom boom of) a decade ago. It is marginally useful, over-simplified information, on which serious investment bets are being made in the stockmarket. Help!

What policy changes are necessary for India to attract more investment in real estate, both domestic and foreign?

Ownership of agricultural land by foreigners, even if it is inside the master plan of a city, is the only unnecessary deterrent I can see. Otherwise, issues that foreigners get spooked by are the opaqueness of the licensing process and the new unnecessary tightening of bank credit to the real estate sector.
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