**[investwise]** Realty Check: Excessive Rentals Are Unsustainable (JPM); Sector Will Underperform

 

BSE Realty has witnssed a sharp sell-off over the last fortnight (10% vs. Sensex decline of 1%) despite newsflow turning positive on the policy front during the corresponding period (incidence of service tax reduced to 2.5% from 3.3% earlier and SBI's extension of teaser home loans). Momentum is building up in the office sector with April/May seeing closure of large ticket transactions. In the residential segment, we do not forecast a big jump in new booking levels in FY11 as decline in residential volumes gets compensated by higher price levels. Further, we think the debt levels to have peaked out in these companies and incrementally the same should start reducing FY11 onwards. • Key trends in the physical market: 1Q10 volumes are down 10-15% Q/Q, prices up 5-10% – Residential volumes after witnessing a strong revival over the last year have now started to come off (decline of 10-15% in 1Q10) as 1) pent up demand of 09 taper off and 2) Higher price levels start hurting demand.  1Q10 saw  prices increasing between 5-10% across markets. Mumbai market seems to be the most stretched in terms of affordability while Bangalore looks to be most attractive.  Through FY11, we expect wage growth (+10-15%) and improved hiring trends to offset concerns on mortgage rate increase. Office absorption continues to improve with key markets (BKC in Mumbai/Gurgaon) witnessing few large ticket transactions (~US$100) over the last month.  Cap rates across key markets have declined by 50-100bps over the last year. Despite positive absorption trends, rentals are likely to remain under pressure given an adverse demand supply gap (FY11 completions of 68msf vs. absorption of 28msf).  We estimate that if 30% of expected supply does not come up, market may reach a balance by FY11. Cushman in its latest 2010 outlook expects office recovery to gain firmer foothold by 2H2010. Retail rents to remain under pressure despite improving retailer sentiment–Most retailers are guiding towards positive sales trends and are looking at space expansion now as developers become accommodative in their asking rents and lease terms.  However, existing high vacancy levels and huge demand supply gap would keep rentals under check. 2010 is expected to witness the completion of 17msf (90% is at advanced stage) vs. estimated absorption of ~9msf. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.   Nothing in this article is, or should be construed as, investment advice.

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