A Sneak Peek to Real estate Sector of India

” Now any bargain is merly an extravagance, unless one has a use for it.”

The Australian Traveler, June 1923

 

There are many questions investors are puzzled with while investing. Questions like buy low sell high but what is high or what is low? And in some case the so called experts change their views on any specific stock as soon as investors get into it, without any other material impact happened with the business.

These days if you look at business channels or reading your experts research paper you will notice that a lot of talk is going on about the Real Estate sector. Many businesses involved with real estate have nosedive in last one year. Investors and experts are debating on how much more it can fall?

Real estate business is a cyclical business and materially it is attached with interest rates directly. If interest rates are low then many people are willing to borrow and invest in this sector. Demand rises and then it’s all about supply. But when interest rates are at peak very few are keen to borrow and thus demand falls.

But we are talking about U turn of interest rate these days. Many economist and analysts are predicting that there might be increase of 0.25 basis point in interest rate this month and may be one or two more such hikes are expected and by early next year RBI will start cutting interest rate.

Because of this expected reverse cycle of interest rate, two sectors will be benefited most and they are Real Estate and Banks. So let’s see which Real Estate business is in best shape to invest with:

Companies

ROE (2011)

Gearing Ratio (2011)

10%

107%

13%

89%

11%

40%

2%

46%

5%

73%

11%

64%

5%

21%

1%

25%

By just looking at ROE I won’t be interested in buying any of above businesses. But that won’t be fair as all the above businesses are cyclical and that cycle is expected to reverse soon. 2006-07 financial year was the peak period of boom age for this sector. I thought to compare their inventory from peak of boom with bust period to get little more insight within this sector.

Companies

Inventory (2007)

Inventory (2011)

DLF

4281Crore

8389 Crore

Godrej Property

79 Crore

192 Crore

HDIL

1153 Crore

10086 Crore

Parsvnath Developers

1342 Crore

2471 Crore

Omaxe

1327 Crore

2099 Crore

Sobha Developers

378 Crore

973 Crore

Anant Raj Ind

9 Crore

713 Crore

Indiabulls Real

0

4722 Crore

After looking at the above table we can say that by average inventories have doubled in last 5 years for almost everyone. The companies with low gearing ratios have piled up their inventory levels by ten folds to take advantage of expected start of the boom period. But the question arises over here is whether they will manage to sell them? The biggest cost associated to maintain such high inventory is the interest expense. With increase in interest rate, the cost to maintain inventory also increases and thus operating and net profit margins are blown up. To maintain their liquidity these businesses require lot of equity to chip in during hard times. And this additional contributed equity damages its ROE. Warren Buffet mentions these kind of businesses as ‘inhibited business’ which means lot of funds required to keep them running.

None of the above businesses qualify for our A1 rating. We don’t see margin of safety in those businesses. It is important to invest in extraordinary businesses to create wealth. And characteristics of extraordinary business are high ROE, less or no debt and positive cash flows. We don’t see any of those within the businesses listed above. There are many other great extraordinary businesses available to invest with.

We are coming up with our A1 service where you have access to quality business names with their intrinsic values. Just by sticking to those extraordinary businesses will fetch you extraordinary returns on your investment. It will help you to cut the unwanted noise and spare time to do other things in life! You won’t be worried about where market is heading but will look for opportunity to buy those extraordinary businesses at discount. You won’t question again what is low and what is high? Last but not least it will help you to bring your anxiety attached to market go down!

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