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Deutsche Bank predicts sharp fall in property prices

TIGHT financial markets will likely aggravate the down cycle in the real estate sector and lead to a sharp fall in property prices and defaults by few developers, Deutsche Bank said. Reiterating its underweight rating on the sector, the investment bank forecasts further downside in realty shares, which have declined roughly 33% so far this year.

“We are yet to see a sharp fall in fundamentals for the sector in terms of a sharp fall in property prices, defaults by developers to banks, and a sharp decline in revenues and profits,” Deutsche said in a recent client note.

The investment bank opines that a severe down cycle in the sector now seems inevitable with the reversal in economic growth, low property prices, slump in mortgage rates and under-supply of units.

“We forecast major shortfalls in net cash flow, with asset-liability mismatches in a tight financial market environment and a currently cautious central bank. Most developers will not acknowledge a significant down cycle, but their financials (slowing growth, falling margins, rising debtors and gearing) and actions indicate otherwise,” Deutsche said.

The sharp rise in banks’ lending rates in the last couple of years has driven up the cost of acquiring property significantly, deterring prospective buyers to defer purchases. Sharp jump in land and raw material prices have made it all the more difficult for developers to make property more affordable.

“Despite the large equity raising and the sharp increase in sector profits, aggressive land chasing and the sharp increase in debtors have resulted in absolute debt levels increasing sharply in the last 18 months. Thus most developers have high gearing ratios,” Deutsche said, while assigning Indiabulls Realty and DLF ‘hold’ rating and Puravankara and Sobha Developers ‘sell’.

Drawing parallels to the state of Tata Motors, which recorded strong growth in the mid 90s until an economic slowdown with high debtors forced write-offs, resulting in a huge loss in 2000-01, the investment bank said India’s realty sector is reflecting trends similar to those experienced by the auto major in 1996-97.

The Tata Motors stock, according to the investment bank, climbed from a base of Rs101 in 1992-93 to peak at Rs564 in 1996-97 before falling to Rs40 in 2000-01. Deutsche notes, “ Despite weak demand and slow sales, developers have not yet been willing to reduce their property prices. It seems that they are prepared to hold properties rather than reducing their property prices since they have made significant profits during the last 2-3 years. However, the same is not true for the secondary market.”

India's largest real estate developer DLF has already anounced 20 - 25% rate cut accross india both for new and existing cutomers. In near future other players may also follw the same.

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