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India real estate research

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Sharad Jhingan
, Director at Inegra Global
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Published on Feb 11, 2011
Research Paper on Indian Real Estate Industry
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Published in: Business, Education
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India real estate research
1. 1. LANCASTER UNIVERSITY Growth Strategy, IPO & Performance Of INDIAN REAL

ESTATE COMPANIES RESEARCH PAPER For MA in Practicing ManagementBySharad
Jhingan 1
2. 2. Contents Page No: 1. Introduction and Purpose 3 2. Chapter 1: Background 6 3. Chapter 2:
Methodology and Performance Analysis of Sample Companies 20 4. Chapter 3: Strategic
Comparison and Case study of DLF Limited 42 5. Chapter 4: Trend Analysis, Conclusion &
Need for Regulator 48 6. Bibliography 70 7. Annexure – 1 Share Price Movement Chart 71 8.
Annexure – 2 DLF IPO : The Untold Story 77 2
3. 3. Introduction and PurposeReal Estate Industry in India witnessed a historic boom during
2002 to 2007. Record number ofprojects were launched and sold during this period. Real
Estate Developers in India grewmultifold very fast. Land and property prices skyrocketed.
Many developers went for publicissue of shares at very high valuations. Attracted by
liberalization of foreign investmentregulations, International investors invested billions of
dollars in Indian real estate sector. Theglobal economic boom, easy availability of money,
crazy jumps in asset valuation and mad rushto go for the IPOs and desire to claim very high
company valuation typically characterized realestate industry at that time.A number of real
estate companies went for IPOs between 2006 and 2008. Some companiesapproached
International Markets, like Alternative Investment Market of London StockExchange or
Singapore Stock Exchange, using innovative structures for raising funds. Innovativemulti-
tiered structures, using off shore tax shelters like Mauritius and BVI/Panama, were createdto
ensure tax efficiency and help getting subsidiaries listed in overseas market without having
togo through regulatory rigor with SEBI in India.All these IPOs and fund raising exercises
had one thing in common, they all valued real estatecompanies on the basis of NAV (Net
Asset Value) models. Expected future free cash flows fromdifferent projects were discounted,
and liabilities netted off against such discounted NPVs (NetPresent Value), to arrive at
company NAVs, which formed the basis of issue pricing. Interest inReal Estate, availability
of cheap money and dearth of quality stocks made it possible forcompanies to get away with
such highly probabilistic valuation models for IPOs. In their zeal toachieve highest possible
price for their shares; companies also included NPVs of projects forwhich the land
acquisition had not even started. Such questionable practices were overlooked byinvestors,
riding the global asset price boom, assuming that the growth and profitability of
thesecompanies would continue to skyrocket due to insatiable demand for housing and
commercialproperties.This paper examines the growth of real estate industry in India and
attempts to test sharevaluations made by real estate companies. Taking a sample size of six
publicly listed real estate 3
4. 4. development companies and their published accounts over a five year period, I have
analyzed thehistorical and recent performance data of these companies, claims and promises
held out in theirprospectus, as filed with the market regulator (SEBI), at the time of going for
the IPO. Actualperformance of the companies and movement of their stock prices from the
time of listing is alsocompared.While comparing the strategies of the sample group of
companies, we find that there is very littleto differentiate between the companies. Except for
size and geographical focus, none of thedevelopers distinguish themselves from the other in
any significant manner. We also find thatthey resorted to similar tactics in respect of fund
raising and financing of projects. They are allhighly leveraged companies with very high
interest cost incidence. All these real estatecompanies issued a very small part of their
shareholding, at a very high price, to the public byIPO. On analyzing performance of these
companies, by comparing the 5 year performance data,we find that none of these companies
were able to maintain the profitability or income levels. Assoon as market became aware of
the fact that growth rates or profitability of these companies arenot sustainable in the long run,
it withdrew support. Consequently, the share prices of thesecompanies fell to record lows and
have not been able to touch their IPO price level, even acouple of years later.This paper
argues that opportunism and creative valuation methods do not, in the long run,support share
prices or company valuations; instead, consistent authentic performance over time,creates
value for all stakeholders and differentiates good companies from other market players.
Itfurther analyses the performance and identifies factors which contribute to value creation in
realestate business. This paper also looks at growth strategies adopted by six Indian Real
EstateCompanies in an effort to identify effective strategies for real estate developers. Indian
real estateindustry operates in a dynamic and high risk environment. It is susceptible to
changes inmacroeconomic environment. Real Estate Developers will have to mitigate the risk
bydisciplined and close monitoring of cash flows. Their ability to create and maintain
selfsustaining cash flows from projects will determine strength of corporate cash budgets.
Moreover,each project should be viewed as an independent cost/profit centre also responsible
forgenerating its own cash, once seed capital in the form of land, licensing, mobilization
capital etcis put in place. 4
5. 5. I further felt the need for a strong regulatory framework to provide a level and fair playing
field.In an ambiguous and opaque environment, property buyers and investors suffer alike;
hencethere is strong evidence in favor of some kind of regulatory framework. Consumer
action groupsand industry insiders also demand policy action by the Government towards
establishing aproper regulatory regime to govern the sector. Laws relating to property
registration and transfer,zoning and approval of construction plans and subsequent marketing
and disclosure of utilizationof advances collected from customers should be made mandatory
to remove some of the hazesurrounding the whole development process.In the next chapter
we will review the literature and take a close look at the background leadingto the boom and
crash thereafter. Economic factors behind the boom and development of realestate industry in
India, its relative importance and business practices adopted by Real Estatedevelopers, are
discussed to enable proper appreciation of the backdrop. In chapter 2 we take aclose look at
the six companies, their performance and share price movement over a 5 yearperiod. In
chapter 3 we compare and contrast the strategies of the 6 companies in our samplegroup and
look at a case study of DLF Ltd‟s IPO. We further analyze the performance trends
onimportant parameters and draw our conclusions in Chapter 4 and examine the need for
aregulatory framework to regulate real estate development industry in India. 5
6. 6. Chapter – 1: Background1.1 Review of LiteratureIn his well known doctrine of
Competitive Advantage and Five Forces Model, Micheal Porter(1980), argues that businesses
should strive to create and sustain competitive advantage, either interms of lower cost of
production or in terms of product differentiation, which can providejustification for the
existence of the firm. In his lecture on application of competitive strategy andfive forces
model for development of strategy for real estate development companies (1989), hepointed
out that this industry in America was characterized by low barriers of entry, identicalcost
structures and high degree of competition. In his opinion the companies engaged in
thisindustry should try to deliver customer value by differentiation. He also pointed out that
thedifferent segments which comprise real estate industry e.g. housing, retail, and
commercial,hospitals and hotels are in fact different industries, with their own separate and
distinct businessmodels. Customers and investors in each of the above respectively, have
different valueperceptions and needs. Therefore, real estate industry is virtually a sector of
economy anddifferent segments e.g., retail, housing and commercial offices should be
independentlyevaluated, and business models for each of them should be created keeping in
mind specificclient and investor requirements. The umbrella strategy of doing everything and
being all thingsto all people, adopted generally by real estate developers, does not contribute
any real value. Hefurther underscored the absence of long term strategic vision and
prevalence of “Deal Mindset”in minds of American Developers.This research draws
inspiration from Porter‟s thoughts. I have tried to look at Indian Real EstateIndustry through
Porter‟s prism of competitive advantage and long term value creation. To thisend, I have
evaluated the performance of six listed real estate companies, to understand theirgrowth and
performance historically; their strategies to become large pan India companies andpromises
held out by them in the IPO document. I have also analyzed their performance after theIPO;
to look at actual delivery made on their promises, and whether the valuations claimed at
thetime of IPO were justified. Lastly I have attempted to identify factors helpful in
formulating longterm strategy for real estate developers in India. 6
7. 7. In his book “Housing Sector and the Economy: Global Experiences”, T R Venkatesh
echoessimilar thoughts. R. Venkatesh (2008), in his article, Recent Trends in Real Estate
Marketing inIndia, writes about the contribution of IT Sector to fast growth of real estate
sector in India. Hehighlighted that the expansion of Indian IT industry impacted profoundly
the real estate industry.Highly paid young IT professionals led the boom by buying into high
priced apartments in majorIT centers across the country. The consequential rise in prices and
boom leaves him wonderingabout the sustainability of the whole growth rate.Mintzberg‟s
(1987) Emergent Strategies model also underscores the need to balance the past,present and
future. Predominance of Grass-root Strategies in the portfolio increases the risk andlong term
value creation becomes contingent upon the growth of the larger economy. In case
ofcompany valuation for the IPO, the entire value was driven by Grass-root Strategies. Large
landbanks and land purchase agreements, future development potential and calculation of
NAVs onthe basis of future cash flows; operations being funded almost entirely by debt and
very smallproportion of company valuations coming from Emergent or Deliberate Strategies
or „projectsunder different stages of implementation is indicative of this.This paper finds that
in India all the developers are doing almost everything, across the boardprevalence of deal
mindset; lack of specialization or efforts towards creating a niche market, anda rush for
unrestricted geographical expansion without factoring in economic benefit or evenlong term
sustainability.1.2 Evolution and MetamorphosisRight from independence (15th August 1947),
land has been an intensely emotional issue inIndia. In order to correct the imbalances in
society, symbolized by large hereditary land holdingsbeing concentrated in the hands of few
feudal families, successive Indian Governments followeda socialist path. „Right to Property‟
was classified as “Legal Right” as opposed to “FundamentalRight”. Poor landless peasants
and sharecroppers constituted majority of people across thecountry. It was considered critical
for the development of the country to mitigate the problems oflandless and poor peasantry.
Land reforms were implemented to redistribute land for mitigatingpoverty following
adoption of socialism as the guiding principle for development of the country. 7
8. 8. Zamindari System (a system of right to collect land revenue over large tracts of land)
wasabolished and Land Ceiling Acts were enacted by various State Governments, prescribing
thelimits of land holdings of individuals. Separate limits were prescribed for agricultural and
urbanland holdings. All extra land holdings were compulsorily vested in the Government.
VariousUrban Development Authorities and State Housing Boards were formed and
entrusted with thework of acquiring the extra land and developing the cities and towns across
the country.Government, through its urban development arms and housing boards and
municipalcorporations, thus became the largest and most organized player in Real Estate
Sector. It still isthe largest player in terms of land holding, size and spread of projects and
impact. Private sectorwas always a much smaller, fragmented and extremely local presence
for decades. It was only in1980s that we saw emergence of larger companies focused on
providing housing anddevelopment of commercial space. DLF, Ansal‟s and Unitech in North
India; Hiranandani,Raheja and Tata Housing in West and Purvankara, Sobha etc in South
India emerged as largerdevelopment companies with project development and execution
capabilities. This alsocoincided with growth of housing finance providers like HDFC, ICICI,
and LIC HousingFinance etc.With growth in economy, gradual opening up of society and
spread of media networks,consumer sophistication, demand and expectations also changed.
Favorable demographiccomposition, phenomenal growth of IT industry and general
economic growth placed hugepurchasing power in the hands of youth. This provided the
boost to real estate sector and laid thegroundwork for the real estate boom of 2001 to
2007.1.3 Industry Characteristics Observed in Last Decade:Indian real estate industry
witnessed a historical boom during the period 2002 – 2007. Revenues,volume, profitability
and prices of properties skyrocketed. Developers announced a chain ofprojects and expanded
operations exponentially across the country. Foreign investment wasvirtually locked out of
this sector, Government of India liberalized direct foreign investmentpolicy for real estate
sector, and billions of dollars were invested in projects across the country. 8
9. 9. Interest in Real Estate and dearth of quality stocks resulted in companies adopting
highlyprobabilistic valuation models. NAVs were computed by factoring present value of
potentialprofits expected from projected sales of built up areas on land being held under
purchaseagreement and which was yet to be paid for.Valuations were extremely stretched,
and it was evident that a major correction was in the offing.Yet driven by collective greed
and supported by massive injection of cheap global liquidity,people throw caution to wind
and invested in real estate for short term capital gains, so much sothat residential and
commercial units were booked and position liquidated, within a couple ofmonths, for profit.
Prices were rising almost on a weekly, if not on a daily basis.Some developers went and
listed themselves on London Stock Exchange. The timing of boomcoincided with the global
liquidity surge. Cheap money sloshed around the system driving assetprices to unprecedented
levels. With this backdrop, after financial crisis, real estate stocks arebarely a pale shadow of
themselves.All these excesses came to nest when the global financial crisis started unfolding
in late 2007.The resulting crash in stock market and its reverberations are still being felt. Real
estatecompanies have not been able to creep back to their issue prices even almost three years
aftertheir IPOs. In a span of three years, events have reversed the course for real estate
developers,thus erasing the gains made by the industry. In the next section we will try to
analyze theeconomic factors leading to the boom and fall thereafter.1.4 The Indian
EconomyThe annual GDP Growth Rate, Personal Disposable Income Growth Rate and
Growth inFinancing, Insurance and Real Estate Sector in percentage terms from the fiscal
year 2000-01 to2008-09 are given in the table below: 9
10. 10. Table-1 Indian GDP, Personal Incomes and Sector Growth Rates Year GDP at GDP
Growth Growth in Growth in Constant personal Financing, Prices %age terms disposable
Insurance and Year on Year incomes (%) Real Estate (Million Rs) Sector2000-01 18643010
4.35% 9.6% 4.06%2001-02 19726060 5.81% 10.21% 7.28%2002-03 20482860 3.83% 5.60%
7.98%2003-04 22227580 8.51% 10.52% 5.57%2004-05 23887680 7.47% 9.32%
8.69%2005-06 26161010 9.52% 12.48% 11.39%2006-07 28711200 9.75% 13.41%
13.78%2007-08 31297170 9.00% 12.87% 11.74%2008-09 33393750 6.69% 7.81%(Source –
Handbook of statistics – Reserve Bank of India)As seen from above table, a consistent 8-9%
growth rate was returned by the economy during theperiod 2003-04 to 2007 -08. Personal
Disposable Incomes grew at correspondingly higher rateover this period. As a result growth
in Financing, Insurance and Real Estate Sector was also veryhigh. In fact as evidenced in the
chart, this sector mirrored the growth in personal disposableIncome. We can see that there is
a marked decline in Growth Rates after 2006-07. GDP Growthrate fell from a high of 9.75%
in 2006-07 to 9.00% in 2007-08 and further to 6.69% in 2008 –09. Smaller but visible
decline was also observed in Personal Disposable Incomes. However, therate of growth of
Finance, Insurance and real Estate Sector declined quite sharply from a high of 10
11. 11. 13.78% in 2006-07 to 11.74% in 2007-08, and further to 7.81% in 2008-09, pointing to a
coolingdown of the sector.In terms of relative weight of Real Estate Sector to the GDP, we
do not have official data.However some studies have tried to estimate the contribution made
by this sector to the GDP.The report of „Expert Group on Informal Sector Statistics‟ (2006)
constituted by NationalCommission on Enterprises in the Unorganized/Informal Sector, India
had estimated thecontribution of this sector to the economy to be anywhere between 5% to 7%
of the GDP, instudy carried out by G Raveendran in 2006. CREDAI (Confederation of Real
Estate DevelopersAssociations of India) puts the contribution of housing sector to be almost
5% to 6%% of theGDP. We have tried to look at total Market Cap of BSE and compare it
with total market cap ofBSE Realty. The market cap of BSE Realty, as recently as on 4th
March 2010 was almost 2% ofthe total market cap of all stocks listed on BSE on that date
(Table - 2).Therefore if we assume these that the Real Estate Sector comprises about 5% of
the economyand is capable of growing by say 25% to 30% as claimed by Industry
Associations, this sectorcould add at least 1% extra growth to the Indian GDP and is
extremely important from thepoverty alleviation perspective.This spurt of growth, from fiscal
2003-04 until 2006-07, was supported by a number offavorable economic and demographic
factors including huge inflow of foreign funds, growingreserves in the foreign exchange
sector, both an IT and real estate boom, and a flourishing capitalmarket. Growth in IT and
ITES industry created unprecedented number of skilled jobs, and largenumber of young
Indians started earning high salaries. In almost all the IT / ITES locations, thisemployment
generation caused upsurge in demand for housing and commercial space.The growth rate of
the IT/ITES led service sector was 11.18% in the financial year 2006,whereas the industrial
sector experienced a growth rate of 10.63% in the same period. Thegrowth rate of the
manufacturing sector rose steadily from 8.98% in 2005, to 12% in 2006. Thestorage and
communication sector also registered a significant growth rate of 16.64% in the sameyear. 11
12. 12. This period also witnessed high investment and high savings rates. Gross capital
formation inGDP rose from 22.8% in the fiscal year 2001, to 35.9% in the fiscal year 2006.
Further, the grossrate of savings as a proportion to GDP registered growth from 23.5% to
34.8% for the sameperiod. Chart – 1: Indian Real GDP Growth Rate(Chart Source: The
Economist)1.5 Reforms in Real Estate SectorRealizing the acute shortage of housing and
commercial space in Indian cities, and potential ofreal estate sector in creation of jobs and
alleviation of poverty, Government of India decided toopen real estate sector to foreign
investment. To encourage transparency and competitionfollowing major reforms were carried
out: 1. Government of India supported repealing of Urban Land Ceiling Act (ULCA); by
2007 nine States had already repealed ULCA. 2. Modification in Rent Control Acts to give
more protection to home owners to encourage rental housing investments. 3. Property tax
rationalization. 12
13. 13. 4. Large scale computerization of land records. 5. Liberalization of foreign direct
investment (FDI) guidelines, enabling large scale fund flow to the realty sector.1.6 Real
Estate Project Development ProcessIndian Real Estate Industry operates in a complex
environment. Land is controlled by StateGovernments and land laws are enacted by every
State Government differently. Majordifferences exist in land laws of different States.A
residential project takes anywhere between 2-4 years for development from the date
ofreceiving the license from the zoning authorities. If we include the time required for
aggregatingland and/or obtaining the CLU (change in land usage), this period can easily
stretch by a coupleof years.Fragmented land ownership makes the process of land acquisition
cumbersome and problematic.Absence of digitized land ownership records, and multiple
owners belonging to the same family,further compounds the process.Large capital is required
to carry out following activities before a project can be sold in themarket and developer can
collect advance payment from customers: 1. Acquire land or enter into a “Development
Agreement” with the landowner, which entitles the developer to develop the land. 2. Get the
land use changed if it is not within a „zoned‟ area i.e., beyond urban limits. 3. Prepare a
development plan and get it approved. 4. Once the plan is approved the developer can start
marketing the project. 5. Appoint contractors and start construction activity. 13
14. 14. 6. Once the construction is complete, hand over possession and executes registration
documents in favor of the buyer.Since this process takes anywhere between 2 – 5 years,
entire initial costs and any funding gap(not mitigated out of sale receipts) thereafter, are
required to be invested by the developer.Proper management of cash flow cycle for each
project is extremely important. Any delay inconstruction results in additional costs on
account of interest, overheads etc. etc.Reserve Bank had imposed restriction on financing of
real estate projects by banks. Provisioningnorms for extending bank finance for real estate
activity were high. This sector thereforeprimarily relied on private financing and advances
received from customers. During the highgrowth phase ingenious methods were adopted by
developers to sustain growth.1.7 Accounting PracticesPrior to 2005-06, revenue from real
estate projects was recognized once the property wasregistered in the name of the buyer or
the possession of the property was handed over. Therefore,developers could book sales and
profit in their books only at the time of handing over thepossession. This is known as the
completed contract method of accounting. Under this system,all moneys received from
customers against sale price, were treated as Advances from customersand appeared in the
liability side of the balance sheet. The total cost incurred was charged towork-in-progress
account and shown on the asset side of the balance sheet till the date ofpossession, when it
was charged to revenue.Subsequently, new Accounting Standard - AS-9 was issued by
Institute of CharteredAccountants of India (2006). AS-9 allowed the developers to recognize
revenue and profits fromreal estate projects, on percentage completion basis, like long term
construction contracts. It wasargued that the transaction of sale effectively takes place at the
time of entering into anagreement to purchase the property and the risk and rewards of
ownership passes on to the buyeras soon as he signs that agreement; Developer virtually
becomes a contractor, to carry outconstruction, on behalf of the buyer.Introduction of this
Accounting Standard allowed developers to recognize revenue of a projectover a number of
accounting periods; thus reducing the fluctuation in revenue and profits from 14
15. 15. year to year in their books. By implication, it also meant that any slowdown in Real
Estate saleswould not be immediately reflected in the quarterly results of Real Estate
Companies. Typicallyassuming a three year project period, it takes three years or 12 quarters,
for revenue from aproject to be fully recognized. By implication this meant that if a slow
down begins, it may be acouple of years before the quarterly results actually reflect the effect
of such market slowdown.We can test this fact by looking at the revenue/profit trend lines of
our sample companies.Slowdown actually started in 2007 however; the numbers fully reflect
this trend only in 2008-09.1.8 Residential Real Estate DevelopmentResidential real estate
market grew very fast during this period due to rising disposable incomes,rapidly growing
middle class households, low interest rates, fiscal incentives (tax deductions) onpayment of
interest and repayment of principals on home loans, increased urbanization anddisintegration
of large families. Large scale migration of highly educated young Indian workers,to work in
Information Technology (IT) / Business Process Outsourcing (BPO) outfits in majorcities,
provided a boost to housing demand. Cities like Bangalore, Gurgaon, Mumbai,
Noida,Chennai, Hyderabad developed into major IT centers‟, causing a sharp rise in demand
forhousing and commercial space.RBI further relaxed provisioning norms for loans against
property. Home loan availability anddevelopment finance for commercial properties were
easily available. Banks were providing 20year mortgages at interest rate ranging from 6% -
7%, whereas a few years earlier homemortgages were not available for less than 12%,
moreover the procedure for sanctioning suchloans was also simplified. All these measures
reduced cost of borrowing, increased ease ofprocessing and availability of home loans.FDI
(Foreign Direct Investment) guidelines for investment in real estate projects and
repatriationof profits were liberalized by Press Note-2. For the first time international
investors could investin small real estate projects in India, earn profits from his investments
and repatriate the profitsin accordance with specified rules. 15
16. 16. Driven by fast growing Indian Economy, demand for housing and commercial real estate
grewmulti-fold over 2002 - 2006. Real Estate Consultant Jones Lang La Salle highlighted
theincrease in India‟s housing shortage from 19.4 million units in 2004 to 22.4 million units
in 2005-06 stating that is expected to rise further. They further mentioned that the retail
market formortgages grew by 30% in second quarter of 2004 and is further expected to grow
at a CAGR of17% from USD 16 billion in 2006 to USD 30 billion in 2009. Indian Council of
AppliedEconomic Research has estimated that the number of households with annual
incomes betweenRs 2 million per year to Rs 10 million or more per year is expected to
increase by 23 % to 28%,between fiscal 2002 and fiscal 2010.1.9 Commercial Real Estate
Development and Special Economic Zones (SEZ)The growth in commercial real estate
segment followed the growth pattern of services sector ledby IT/ITES and BPO growth. In
the twelve year period between 1994 and 2006, Services sectorgrew fastest. As per estimates
of Centre for Monitoring Indian Economy, during this periodAgriculture grew by 35%,
Industry by 123% and Services by 157% (Monthly review of IndianEconomy – April
2006).The commercial segment comprises of Office Spaces, Retail Malls, Multiplexes
andEntertainment Facilities. With growing urbanization there is a spurt in growth of all of
thesesegments. Organized retail requires modern retailing premises. New housing colonies
drivedevelopment of Malls and neighborhood shopping centers. New format of retailing
e.g.departmental shops, supermarkets and hypermarkets have come to India. Restaurant
chains, hotelchains, brand marketers, large format stores and mixed use integrated
development are majordrivers of commercial real estate.This segment also saw the
introduction of Special Economic Zone concept by the Government ofIndia. Modeled on the
Chinese experience, idea behind the SEZs was to provide a fillip toexports, by creating
islands within the domestic tariff area and providing incentives to unitslocated within the
SEZ. In order to enable large scale private sector participation, and ensurerapid development,
lots of incentives were announced for SEZ developers. Almost all the realestate developers
made a beeline and obtained a number of licenses. Some even sought 16
17. 17. Government help to acquire land from landowners unwilling to sell, and the whole
experiment was ultimately politicized and became subject to lot of land acquisition related
controversy. 1.10 Industry Characteristics: The Indian real estate industry at present has
following characteristics: I. Most of the development typically takes place around existing
urban agglomerations, akin to clusters or pockets of projects. These projects may be
promoted by different developers but are typically located in close proximity to each other
with very little to differentiate. As a result in normal times the developers chase customers
and only in good times we find the reverse happening except for some exceptionally good
projects. II. Entry barriers are low and anyone having access to land can develop a project.
Only real difference being the specific location of a project and the class of development. III.
Brokers have a very strong say in the market and can influence the market greatly, hence
marketing the project typically requires close co-ordination with the broker community. IV.
Construction activities are funded in major part by the client who is required to make cash
advances on various points of time during the course of development and construction of a
project. V. Generally commercial projects were yielding higher margins than residential
projects. However ROCE was higher in residential projects due to the fact in case of a well
located project it was possible to finance almost entire construction from client advances. VI.
Commercial properties can either be sold or rented/leased. Lease rentals are then securitized
to monetize income. Whereas, in case of residential properties leasing option is not
available.VII. Developer carries huge contingent liabilities on account various performance
guarantees and construction contracts.VIII. Large number of approvals required to start
construction process. This is an extremely cumbersome process. 17
18. 18. IX. Peculiar nature of risks associated with the industry, economy risk, price risk,
customer preference and some degree of credit risk is also associated with this industry.1.11
Financing Strategies:Real Estate Developers adopted various strategies to finance this
extremely high growth phase.In our discussions about individual companies later in this
paper, we will see that all of them hadgrown very fast in the run up to 2006-07. In fact not
only the projects under execution, at thetime of going to IPO, were many times larger than
what they had historically completed; thenumber and size of the projects which they had
planned, was exponentially larger still, and theland banks which they proposed to acquire for
their future projects could probably out last anentire generation.In this process all these
companies leveraged to the maximum extent possible and their balancesheets were almost
entirely funded by debt. Additionally, they entered into a number ofstructured deals with
foreign investors to finance projects. Return expectations were extremelyhigh due to
galloping property prices. Large capital gains on land holdings made the transactionslook
very simple and extremely lucrative at that time.Banks unwittingly supported large scale
speculation in land banking by providing liberal financeto developers for construction of
projects and easy home loans at zero margins to home buyers.Another strategy adopted by
developers and supported by banks was to disburse upfront tohomebuyer, by making
payment directly to the developer, 100% of home loan sanctioned topurchase a property. In
such a case the EMIs would start only from the date possession and thehome buyer would not
have to pay any interest during construction period, interest being paidout by the Developer
to the lender by way of subvention payments.The entire revenue was thus received upfront by
the developer who could then utilize this cash toacquire more land and announce more
projects. The flip side of this was huge interest cost beingloaded on to the development
process and balance sheets of companies. The liability of thedeveloper, to pay interest on
such loans, was unlimited in case of construction delays. Anothercause of concern was very
low stake of buyer in this whole process. An investor couldpractically speculate by paying
small margin money (0% to 15%) of the cost of house property to 18
19. 19. the developer, balance 85 % disbursed by the bank upfront, the developer servicing the
interestfor the period of construction. Therefore, in case of declining prices, the investor
would opt forbacking out of his commitment to take delivery by forfeiting the margin money.
This practice,instead of helping the genuine buyers, increased the risk inherent in such
deals.The catch being that although it was the developer who was liable for payment of
interest duringconstruction period, the loan never appeared in his books, because the investor
was the borrower.In such cases, investors acted as the agent of developer to enable very high
over all leverage inindividual projects.International real estate investors and funds, hedge
funds and private equity funds raised lot ofmoney from investors for investing in Indian Real
Estate Market. Due to rapid price rise in landand property prices, there was a rush to
participate in the market. Investors were pressurizingfund managers to quickly close deals in
Indian real estate. As a result a number of unwise,inadequately evaluated, and improperly
valued investments were made by these global investors.Global private equity funds and
investment banks invested billions of dollars in Indian RealEstate Projects. This created a
situation of excess liquidity chasing few good deals in the market.Many Indian companies
went and listed themselves on Alternative Investment Market (AIM) ofLondon Stock
Exchange and raised billions of dollars. Prominent names which went to AIMmarket are:
Hiranandani Constructions (HIRCO), Raheja Developers (ISHAAN), Unitech, andIndiabulls.
The valuations were again driven by NAVs and hence suffered erosion of values to agreat
extent. This virtually shut the AIM market for Indian paper. AIM market was establishedby
London Stock Exchange for alternative investments i.e., for such companies which
wouldneed relatively smaller amounts of capital and which would find it costly and
cumbersome toapproach the main market. AIM market was primarily meant for institutional
investors andprovided some liquidity to the investors. Indian real estate developers raised
billions of dollarsfrom that market when the interest in India was at its peak. As soon as
markets corrected afterthe crisis the valuations evaporated. As a result investors virtually
turned away from Indian paperbeing offered on AIM market. 19
20. 20. Chapter – 2 Methodology and Performance Analysis of Sample Companies2.1 Research
QuestionIn this paper we will attempt to analyze the growth strategy and performance of real
estateindustry through a prism of six listed real estate development companies. We will put to
test;their claims about huge company valuations, and justification of high share prices on the
basis ofNAV (net asset value), calculated by monetizing the development potential of their
land banks.We will also analyze the extent to which, if at all, these companies actually
delivered on theirIPO promise. We would also test the growth strategy adopted by these
companies and look atactual performance to draw lessons in strategy formulation.2.2
MethodologyThe real estate industry in India is large, extremely diversified and fragmented.
On one hand wehave large pan India multi-billion dollar corporations like DLF, whereas on
the other hand wehave tiny local developers trying to develop very small land parcels in a
locality. The problemwas of availability of information, reliability of data and creating
comparable performancemetrics for a representative sample. Therefore I decided to focus on
listed companies. I looked atthe market capitalization of the BSE and compared it with the
market capitalization of BSERealty Index and market caps of different realty stocks. A
representative sample of six real estatedevelopment companies was chosen, each of these
companies were strong in at least one or twothe regional markets of India. This enabled me to
create a representative sample which capturednearly 3/4th of the total realty market cap and
which covered the entire country. I have analyzedfollowing six companies for this paper. 1.
DLF Limited 2. Parsvnath Developers Limited 3. Sobha Developers Limited 4. Purvankara
Projects Limited 20
21. 21. 5. Housing Developments and Infrastructure Limited (HDIL) 6. Unitech LimitedEven on
the basis of current market prices the market cap of the sample companies covers morethan
71% of the realty market cap (Ref: Table -2). Table – 2: Coverage of Sample Market
Capitalization of BSE on 04.03.2010 (Rs Millions) 56725658 Market Capitalization of
Realty on 04.03.2010 (Rs. Millions) 1109149 Market Capitalization of Six Companies
04.03.2010 (Rs. Millions) 793637 Percentage of Realty to BSE as on 04.03.2010 1.96
Percentage of Six Companies to Realty as on 04.03.2010 71.55We can see from the above
table (Table-2) that Realty comprises almost 2% of the market cap ofall listed stocks. The
sample companies comprise almost 72% of the BSE realty index. Thismeans that we are able
to cover nearly 3/4th of the realty sector by analyzing performance ofthese companies.I
decided to study last 5 years performance data of these six companies. Long period of
timeenabled me to look at the long term performance, and helped in identifying common
trends. Inaddition to analysis of numbers, the Draft Red Herring Prospectus (DRHP) of each
of thesecompanies (barring Unitech, since it was listed some time back) were also studied
and importantpoints related to their strategy compared. Line charts were plotted to highlight
and comparetrends displayed by these companies. This in turn was compared with stock
market prices andsample average trend line to draw inferences and conclusions. 21
22. 22. 2.3 DLF Limited:2.3.1 HistoryThe largest real estate development company in India in
terms of total area of completeddevelopments, DLF Limited was a listed company until 2005,
when it got itself delisted. DLFtraces its route back to 1946. Initially its real estate business
was focused in the Delhi/NCRregion. DLF has developed almost 3000 acres of integrated
township in Gurgaon. It wasresponsible for bringing GE to India and subsequent
development of Gurgaon as an IT hub. Asstated in their prospectus; DLF has developed a
cumulative aggregate Saleable area of 224million sq. ft., comprising of 195 million sq. ft. of
Land as plotted developments, 19 million sq.ft. of Residential, 7 million sq. ft. of commercial
properties and 3 million sq. ft. of Retailproperties.The turnover of the group increased from
Rs 2858 million for the year ended 31st March 2003 toRs 38390 for the year ended 31st
March 2009. PAT increased from Rs 262 million (year ended31-03-03) to Rs 15478 million
(year ended 31-03-2009).A real estate developer, the DLF franchise over time came to
include Cinema, Retail Malls,Hotels, Clubs, commercial office buildings, power, insurance
etc.; the footprint of the companyis spread across India. They launched/planned or were
planning projects in almost all large citiesin India.2.3.2 Performance IndicatorsMajor
performance parameters of DLF over five year period are given in the following Table-3.The
same data is charted (Chart-2), to obtain the trend lines for DLF, to see whether there is
anycorrelation between the parameters. 22
23. 23. Table -3 DLF Performance Data DLF LTD (Rs / Millions) 2005 2006 2007 2008 2009
Total Debt 6332 30139 67693 83864 96150 Income 4798 11450 14295 60584 38390 PAT
677 2275 4057 25746 15478 Book Value 4.27 67.82 72.66 (Rupees per share) 1425.43
170.21 Interest cost 331 1461 3563 4476 8099 EBIT 1300 4940 9766 35655 26207 Share
Price (Rs.) 0 0 0 687 162 Chart – 2: DLF Performance ChartWe can see from the DLF
Performance Chart (Chart – 2) that the Income and PAT went upsharply between 2005 and
2008 (IPO Year), declining sharply thereafter. In 2005 the Incomewas Rs 4798 Million
which went up to Rs 60584 million in 2008 and declined sharply to 38390million in 2009.
Total debt and interest however continued to rise the total debt in 2005 was Rs 23
24. 24. 6332 million which went up to Rs 96150 million and the total interest cost went up to Rs
8099million in 2009 from Rs 339 million in 2005. The sharp decline in Income and PAT
highlightsthe degree of uncertainty regarding achievability of future projections related to
very highgrowth and unreasonable profit margins.2.3.3 DLF’s IPO and Share Price
Performance Table 4: DLF’s IPO & Share Price DLF LTD. DATE OF IPO LISTING 11-
Jun-07 ISSUE PRICE : 525 TOTAL NO OF SHARES ISSUED : 175000000 TOTAL
EQUITY HELD BY PROMOTERS BEFORE IPO 97.42% 1490478440 AFTER IPO
(WITHOUT GSO) 87.43% 1490478440 TOTAL MARKET CAPITAL OF THE
COMPANY ON BASIS OF ISSUE PRICE (In Millions) (Economic Times) (As on
11.2.2010) 52110.18 ALL TIME HIGH PRICE 15-Jan-08 1225.00 ALL TIME LOW PRICE
4-Feb-09 124.15 CURRENT MARKET PRICE 11-Feb-10 301.75In June 2007, DLF Limited
issued 175 million shares of Rs 2 each at a price of Rs 525 per sharecomprising of 10.26% of
its fully diluted share capital after the issue. The issue wasoversubscribed 3.23 times. Rs.
Total amount raised was Rs 9187.5 million. It was the largestpublic issue of shares by any
company in India till then. The share opened at a strong notedelivering 25% gains to
investors, and in January /February 2008 touched a high of Rs 1225 pershare. Thereafter it
has been a story of consistent underperformance. The current market price isin the range of
Rs 300 to Rs 350 per share. The share price trend line can be seen in „Chart no.18‟ in
Annexure -1.In the preceding table-4, the key data related to IPO, market price of shares and
marketcapitalization can be seen. The current market price almost 3 years after the IPO (Rs
302 pershare) is almost 60% of the issue price (Rs 525 per share). 24
25. 25. 2.4 Parsvnath Developers LimitedHistoryParsvnath Developers was incorporated in 1990;
their initial focus was marketing of Real Estateprojects. Subsequently they started
construction of residential projects.Till the date of DRHP, a total of 17 projects were
completed by Parsvnath, these comprise of 9housing and 8 commercial projects. Parsvnath
has built approximately 3.01 million sq. ft. ofresidential Projects comprising of 2249 Units
and 0.38 million sq. ft. of commercial projectscomprising of 544 units. Most of these projects
are located in Noida, Greater Noida and Gurgaonin NCR Delhi.Total Income grew from INR
272.95 million in fiscal 2002 to INR 6537.67 million in fiscal 2006(CAGR of 121.23%) ;
during the same period PAT increased from INR 32.97 million to INR1069.89 million
(CAGR of 138.67%).The company went into an aggressive expansion mode, and planned
projects in Gujarat, MadhyaPradesh, Uttaranchal, Maharashtra, Karnataka, Andhra Pradesh,
Kerala.; a total of 13 states and37 Cities. This was a huge expansion of footprint in a drive to
carve out pan-India identity.Although, at the time of going to IPO, they were present largely
in Delhi NCR, Punjab, Haryana,U.P. and Rajasthan, they further broadened their focus to
include non-metro cities in India; likeLucknow, Moradabad, Greater Noida, Pune, Agra,
Dharuhera, Gurgaon, Bhiwadi, Dehradun,Faridabad, Amritsar, Ahmedabad, Hyderabad etc.
etc .As part of their portfolio diversification they planned to develop 19 Integrated townships,
26commercial complexes including Malls, Multiplexes, office space, metro station; 24
residentialprojects, 13 hotels, 3 IT Parks, 9 SEZ projects.Parsvnath had decided to focus only
on development of projects and consequently outsourced allnon core activities like
Architecture, design and construction activities. They only retainedmarketing, project
management and quality control.Parsvnath is engaged in development of residential projects,
malls, multiplexes, commercialproperties, integrated townships, construction contracts.They
further improved their profitability by taking advantage of tax breaks announced
undersection 80IB of Indian Income Tax Act for development of small dwelling units located
25 Km.outside metropolitan limits of metro cities.As per DRHP filed with SEBI, Parsvnath
had identified 11 projects under development to befinanced out of issue proceeds. These
projects were located at Lucknow, Greater Noida, Agraand Moradabad in Uttar Pradesh;
Gurgaon & Rewari in Haryana; Pune and Shirdi in 25
26. 26. Maharashtra. Total Land Area of these projects was approximately 486,686 Sq. Mts or
120Acres.Including the above mentioned 11 projects, the DRHP mentions a total of 24
Residential projectswith a total saleable area of 18.93 million sq. mts., and capital outlay of
INR 25963.54million. Inaddition to the residential projects a total of 15 Commercial projects
with a total saleable area of2.17 million sq. ft involving a capital outlay of INR 5536.53
million; 11 DMRC projects in Delhiinvolving construction of Malls having a saleable area of
1.77 million sq. mts. and capitaloutlay of INR 5796.71 million; 19 Integrated townships with
a total saleable area of 74.10Million sq. mts involving capital outlay of INR 74461 million;
13 Hotel projects having asaleable area of 2.06 million sq. mts and capital outlay of INR
6329 million; 3 IT Parksinvolving a saleable area of 3.08 million sq. mts. and capital outlay
of INR 4077 million.In addition to foregoing, two residential projects in Delhi and Faridabad,
involving Saleable areaof 1.7 million sq. mts (50% interest in JV), and 9 proposed SEZs
comprising of a total area of20 million sq. mts., was also proposed to be developed by
them.2.4.1 Performance Indicators Table 5: Parsvnath Performance 2005 2006 2007 2008
2009 Total Debt (Millions) 1207 2358 10118 17023 18367 Income (Millions) 3068 6538
12610 17922 7626 PAT (Millions) 656 1062 2718 4087 1130 Book Value (Rupees per share)
127 20.31 79.06 97.65 103.76 Interest cost (Millions) 11 27 194 391 734 EBIT (Millions)
740 1484 3673 6254 2119 SHARE PRICES (Rs.) 0.00 0.00 260.50 217.50 34.50 26
27. 27. Chart 3: Parsvnath Performance ChartWe can see from the Table-5 and Chart-3 that over
the five year period the total debt increased15 times from 1207 million to 18367 million,
whereas the Income did not grow commensurately.In fact, while the total debt continued to
increase between 2008 and 2009, income went down byalmost 60% in the same period. The
Company witnessed a sharp decline in income, PAT, EBITand share price. Debt and interest
cost however rose sharplyThe numbers clearly demonstrate that growth rates and profit
margins can fluctuate greatly fromyear to year depending upon market forces. In good years
the company can return extremelygood performance however, high interest cost and rising
corporate debt, implies low margin ofsafety. 27
28. 28. 2.4.2 Parsvnath’s IPO and Share Price Performance Table 6: Parsvnath IPO and Share
Price PARASVNATH DEVELOPERS LTD. DATE OF IPO LISTING 6-Nov-06 ISSUE
PRICE : 300 TOTAL NO OF SHARES ISSUED : 36325800 TOTAL EQUITY HELD BY
PROMOTERS BEFORE IPO 100% 148370400 AFTER IPO (WITHOUT GSO) 81.70%
148370400 TOTAL MARKET CAPITAL OF THE COMPANY ON BASIS OF ISSUE
PRICE (In Millions) (Economic Times) (As on 11.2.2010) 23786.59 ALL TIME HIGH
PRICE 7-Jan-08 598.00 ALL TIME LOW PRICE 24-Mar-08 70.20 CURRENT MARKET
PRICE 11-Feb-10 119.40In November 2006, Parsvnath Developers issued 33.238 million
shares of face value Rs 10 eachand share premium of Rs 290 per share, at a price of Rs 300
per share, aggregating Rs 9971.4million, comprising of 18.30% of its fully diluted share
capital after the issue. The issue wasoversubscribed 56.2661 times. The issue also included a
Green shoe option of 3.087 millionshares issued at Rs 300 aggregating Rs 926.4 million. The
total issue size was Rs 10897.74million. After a strong opening the share touched all time
high price of Rs 598 in January 2008.Thereafter it has been a story of consistent
underperformance. The current market price is in therange of Rs 100 to Rs 150 per share. The
share price trend line can be easily seen from the Chart-19 in Annexure 1, the movements
mirroring those of DLF Ltd. 28
29. 29. 2.5 Sobha Developers LimitedHistorySobha Developers was incorporated in August 1995;
they launched their first residential projectin 1997. This project was completed in 2 years.
Thereafter, in 1999 they began their firstcontractual construction of the corporate block of
Infosys Technologies. Till Sept-2006 theyhave completed and delivered 21 Residential
Projects in Bangalore comprising of 1552apartments and 2.98 million sq. ft. of super built up
area.They completed their first construction project in Sept-2000. Till Sept 2006 Sobha
hadcompleted 75 Contractual Projects covering 8.42 million sq. ft. and 2 commercial projects
inBangalore aggregating 0.11 million sq. ft.Sobha Developers‟ revenue (including other
income) grew from INR 1177.10 million in Fiscal2003 to INR 6284.36 million in fiscal 2006
(CAGR of 74.78%). PAT increased from INR 12.26million in fiscal 2003 to INR 892.30
million in fiscal 2006 (CAGR of 317.52%)Sobha is predominantly present in Bangalore as
Residential Property Developer. However, theyhad executed contractual Projects in 8 states
in South and North India till the date of DRHP.As part of their declared corporate strategy
they decided to expand into 12 major cities of India.They also decided to diversify and do
residential projects, townships, malls, SEZs and retailcommercial projects. They further
proposed diversification of portfolio by developing Hotels,Integrated townships, multiplexes
and shopping complexes. It was mentioned that they wanted toenter into development JVs
with other private sector entities to undertake large developmentalprojects. Expand corporate
relationship and execute contractual projects for more corporateclients.As on June‟ 2006
declared Land Reserves of Sobha were 2593 acres of land, with potentiallydevelopable area
of 118 million sq. ft. in 78 locations in 7 cities across India. Additionally, theyhad also made
land arrangements aggregating to 3456 acres of land representing a developmentpotential of
117 million sq. ft., over 13 locations in 3 cities across India. 29
30. 30. As per Cushman & Wakefield, as on July 2006 the NPV of the Land Reserves was
between INR70356 million to INR 77762 million and after deducting the Developer‟s
margin, the land valueof the Land Reserves was between INR 39717 million and INR 43898
million; and the NPV ofthe Land Arrangements was between INR 43478 million and INR
48054 million, and afterdeducting developer‟s margin, the land value of the Land
Arrangements was between INR 23060million and INR 25487 million.2.5.1 Performance
IndicatorsWe can see from the following 5 year performance Table-7 that like its peers,
Sobha displayssharp increase in the amount of Debt and interest cost. Income and PAT
increased between 2005and 2008, falling sharply thereafter. Table 7: Sobha Developers
Performance 2005 2006 2007 2008 2009 Total Debt (Millions) 2233 4231 5837 17631 19122
Income (Millions) 5912 6912 12911 14363 9917 PAT (Millions) 347 886 1615 2283 1097
Book Value (Rupees per share) 21.87 45.63 111.71 135.38 149.25 Interest cost (Millions)
109 208 481 615 1052 EBIT (Millions) 594 1276 2347 3324 2507 SHARE PRICES (Rs.)
0.00 0.00 722.00 710.50 81.50 30
31. 31. Chart 4: Sobha Developers Performance ChartIn 2009 the numbers virtually went into a
tail spin. The fall in Income and PAT numbers and risein total debt and interest cost
increased the vulnerability of the Company. It further placed a bigquestion mark on future
growth prospects of the Company. Markets realized that it would beextremely unlikely to
increase the growth rates to levels which would sustain momentum inshare prices. This fact
is also reflected in the share price numbers. 31
32. 32. 2.5.2 Sobha Developers’ IPO and Share Price Performance Table 8: Sobha Developers
Performance SOBHA DEVELOPERS LTD DATE OF IPO LISTING 20-Dec-06 ISSUE
PRICE : 640 TOTAL NO OF SHARES ISSUED : 8893332 TOTAL EQUITY HELD BY
PROMOTERS BEFORE IPO 99.09% 63421380 AFTER IPO (WITHOUT GSO) 87.00%
63421380 TOTAL MARKET CAP OF THE COMPANY ON BASIS OF ISSUE PRICE (In
Millions) (Economic Times) (As on 11.2.2010) 25937.89 ALL TIME HIGH PRICE 8-Jan-07
1128 ALL TIME LOW PRICE 14-Jan-09 67.45 CURRENT MARKET PRICE 11-Feb-10
267.25Sobha Developers went public in December 2006, issued 8.89 million shares of Rs 10
each at aprice of Rs 640 per share including a premium of Rs 630 per share, comprising of
12.20% of itsfully diluted share capital after the issue. The issue was oversubscribed 113.93
times. Totalamount raised was Rs 5691.73 million. The share opened strongly and in January
/February 2008reached a high of Rs 1128 per share. Thereafter it has been a story of
consistent decline andunderperformance. The current market price is in the range of Rs 200
to Rs 250 per share. Theshare price trend line can be easily seen from the Chart no 20 in
Annexure -1; the broad trenddisplayed by DLF and Parsvnath is also reflected by this stock.
32
33. 33. 2.6 Purvankara Projects Limited Incorporated in 1986 in Mumbai the operational base of
Purvankara was subsequently shifted to Bengaluru. Till the time of filing the DRHP it had
completed 14 Residential Projects with a total saleable area of 3.59 million sq. ft. and 1
Commercial project comprising of approx 0.18 million sq, ft of saleable area. Revenues
increased from INR 1510 million in 2005 to INR 4581 million in 2007 (CAGR of 78%) and
PAT has, increased from 380 million (year 2003) to 1166 million (year 2007) (CAGR of
111.69%) (Ref : Table – 9)The company has presence in South Indian states of Karnataka,
Kerala, Andhra Pradesh and Tamilnadu.Specifically the cities of Bengaluru, Chennai and
Kochi,Purvankara Projects focused on development of residential and commercial/retail
properties. Theyannounced different steps that they would take, in pursuance of their growth
strategy, in their DRHP theseincluded inter-alia; Increase land bank in strategic locations
across India(as of July 2007 MOUs/JointDevelopment Agreements entered for 43.56 million
sq. ft of land near Chennai, not included in the landbank); Promote and expand the Brand by
focusing on quality and innovation; Increase the scale ofoperations by proposing to develop
more than 30 million sq. ft land in JV with Keppel; diversification bydeveloping Hotels,
commercial projects and going into other locations across India; enter into JV
andPartnerships, expand overseas operations, and in the process they had taken up project in
Colombo, SriLanka.The company held approximately 874 Acres or 38.07 million sq. ft of
land at 8 cities in India and inColombo, Sri Lanka. The total saleable area on this land would
have amounted to 106.80 million sq. ft. Outof the above the company was, at the time of
filing the DRHP, developing 12.20 million sq. ft. saleablearea in Bangalore, Chennai and
Kochi. Balance 94.60 million sq. ft saleable area being located acrossBangalore, Chennai,
Kochi, Hyderabad, Mysore, Coimbatore, Kolkata and Colombo. 2.6.1 Performance Indicators
We can see that the trends of rising incomes and profits till 2008, and a sharp fall in income
and profitability thereafter, is consistently returned by all the companies. Total debt and
interest cost display a rising trend over the 5 year period. (Ref: Chart – 5) 33
34. 34. Table – 9: Purvankara Performance 2005 2006 2007 2008 2009 Total Debt (Millions)
1007 1622 6761 5823 7195 Income (Millions) 1510 2804 4581 6570 5451 PAT (Millions)
380 724 1166 2109 1329 Book Value (Rupees per share) 135 282 10.9 54.98 61.59 Interest
cost (Millions) 61 72 424 814 994 EBIT (Millions) 465 898 1749 2990 2349 SHARE
PRICES (Rs.) 0 0 0 242 41 Chart – 5: Purvankara PerformanceAfter displaying a rising trend
from 2005 to 2008, the Income EBIT and PAT numbers dippedsharply in 2009. Total Debt
however kept rising; it reached Rs 7195 million in 2009 from 1007 34
35. 35. million in 2005. If we look at Debt in relation to turnover; in 2005 Income was 1.5 times
morethan the total Debt whereas, in 2009 the total Debt reached almost 1.4 times of Income.
Thisimplies huge fixed cost burden on the bottom-line and high leveraging on its Balance
Sheet.2.6.2 Purvankara’s IPO and Share Price Performance Table – 10: Purvankara’s IPO
and Share Price PURAVANKARA PROJECTS LTD. DATE OF IPO LISTING 30-Aug-07
ISSUE PRICE : 400 TOTAL NO OF SHARES ISSUED : 21467610 TOTAL EQUITY
HELD BY PROMOTERS BEFORE IPO 99.99% 191997840 AFTER IPO (WITHOUT GSO)
89.95% 191997840 TOTAL MARKET CAPITAL OF THE COMPANY ON BASIS OF
ISSUE PRICE (In Millions) (Economic Times) (As on 11.2.2010) 20403.37 ALL TIME
HIGH PRICE 13-Dec-07 535 ALL TIME LOW PRICE 2-Dec-08 28.00 CURRENT
MARKET PRICE 11-Feb-10 95.55Purvankara projects issued 21.467 million shares of Rs 5
each at a price of Rs 400 per shareincluding share premium of Rs 395 per share comprising
of 10.03% of its fully diluted sharecapital after the issue. The IPO was oversubscribed 1.9233
times. Due to poor response theoriginal price band of Rs 500 to Rs 525 was reduced to Rs
400 to Rs 425 per share. The shareswere allotted in August 2007 and total amount raised was
Rs 8562.75 million. 35
36. 36. The share reached its peak of Rs 535 in December 2007. Thereafter it has been a story of
decline.The current market price is in the range of Rs 100 per share. The share price trend
line can beeasily seen from the Chart No 21 in Annexure -1. Purvankara‟s share price trend
also mirrors theprevious three companies.2.7 Housing Development and Infrastructure
Limited (HDIL)Incorporated in 1996, HDIL had developed 24 projects comprising of 11.287
million sq. ft. ofsaleable area till the time of filing its DRHP, this includes Residential Area
of 2.07 million sq. ft.Commercial Area of 0.667 million sq. ft., Retail area of 0.533 million sq.
ft. Land developmentof 5.7 million sq. ft. Slum Rehabilitation of 2.2 million sq. ft of under
slum rehabilitation schemeof Slum Rehabilitation Authority (SRA).Total Income has
increased from INR 337.07 million for the year ended 31st March 2003 to INR20964.22
million for the year ended 31st March 2007 and PAT has grown from INR (-28.64)million
for the year ended 31st March 2003 to INR 5481.72 million for the year ended 31stMarch
2007 (Ref Table-11). The company is focused almost exclusively in MumbaiMetropolitan
region. They are doing residential, commercial, retail and slum rehabilitationprojects.HDIL,
as part of its broad strategic initiative disclosed in DRHP the following initiatives:Continued
expansion of land reserves and development rights, expanding geographically intoKochi,
Palghar and Hyderabad, expanding the project portfolio to include Hotels, SEZs, andMega
Structures for mixed use development and enhancement of slum rehabilitation business.Total
Land reserves of the company comprise of 2574.2 Acres (112.1 million sq. ft.) of land witha
potential developable area of 112.1 million sq. ft. The total saleable area of ongoing is
112.1million sq. ft. comprising of Residential (86.55 million sq. ft.), Commercial (0.013
million sq.ft.), Retail (18.994 million sq. ft.), and Slum Rehabilitation (6.426 million sq. ft.).
Out of theabove 82.8% area is concentrated in Mumbai Metropolitan Region, 2.2% in
Palghar, 6.2% inKochi and 8.8% in Hyderabad.2.7.1 Performance Indicators 36
37. 37. Like all the other real estate companies HDIL also shows rising incomes and profit till
2008,sharp correction in both these indicators in 2009. Debt and interest cost continue to rise
all thewhile. Table – 11: HDIL Performance 2005 2006 2007 2008 2009 Total Debt (Millions)
914 1965 3757 31127 41433 Income (Millions) 749 4402 12165 24323 18146 PAT (Millions)
147 1139 5414 14103 7212 Book Value (Rupees) 71.10 37.00 39.37 169.89 162.46 Interest
cost (Millions) 166 106 445 1385 5782 EBIT (Millions) 340 1397 6627 16064 8733 SHARE
PRICES (Rs.) 0.00 0.00 0.00 666.00 76.00 Chart – 6: HDIL Performance Chart 37
38. 38. It is interesting to observe from the above Table-11 and Chart-6 that in 2008 Total
Debt(Rs31127 million) surpassed Income (Rs 24323 million). While the Income dipped
sharply toRs18146 million in 2009, the Total Debt reached Rs 41433 million, with
proportionate increasein Interest Cost. In 2009 the Interest cost was Rs 5782 million i.e. 31.3 %
of Income. The impactupon share prices was catastrophic.2.7.2 HDIL’s IPO and Share Price
Performance Table -12: HDIL IPO and Share Price HOUSING DEVELOPMENT &
INFRASTRUCTURE LTD. DATE OF IPO LISTING 28-Jun-07 ISSUE PRICE 500 TOTAL
NO OF SHARES ISSUED : 34155000 TOTAL EQUITY HELD BY PROMOTERS
BEFORE IPO 73.08% 131772000 AFTER IPO (WITHOUT GSO) 61.45% 131772000
TOTAL MARKET CAPITAL OF THE COMPANY ON BASIS OF ISSUE PRICE (In
Millions) (Economic Times) (As on 11.2.2010) 108075.84 ALL TIME HIGH PRICE 10-Jan-
08 1432 ALL TIME LOW PRICE 9-Mar-09 62.50 CURRENT MARKET PRICE 11-Feb-10
307.10 38
39. 39. HDIL issued 29.7 million shares of Rs 10 each at a price of Rs 500 per share including
premiumof Rs 490 per share, comprising of 13.86 % of its fully diluted share capital after the
issue. Theissue was oversubscribed 5.58 times. Total amount raised was Rs 17078.0
million.The share opened modestly and in January 2008 touched a high of Rs 1432 per share.
Thereafterit has been a story of consistent decline. The current market price is in the range of
Rs 350 to Rs400 per share. The share price trend line can be easily seen from the chart. This
chart alsoreflects the same trend as in the case of previous four companies.2.8 Unitech
LimitedUnitech is the second largest real estate developer in India after DLF. It started as a
constructioncompany and then diversified into real estate development. It has a large
presence in Delhi NCRregion. It is also developing projects in Kolkata and Mumbai.Unitech
was listed for quite some time; therefore we do not have as much information aboutthem,
unlike for their peers who filed DRHP with SEBI containing history and
operationalbackground.Unitech has executed residential projects, integrated townships,
commercial buildings, retailmalls, entertainment parks, SEZs. It further listed its subsidiary
on Alternative InvestmentMarket of London Stock Exchange and raised USD 750 million
dollars.2.8.1 Performance IndicatorsUnitech was able to repay some of its debt in 2009 by
selling majority stake in its telecomsubsidiary. Except for this fact, all the other trends like
income and PAT rising till 2008 andfalling thereafter are displayed by Unitech as well. 39
40. 40. Table – 13: Unitech Performance Indicators 2005 2006 2007 2008 2009Total Debt 0
6382 31578(Millions) 72162 67757Income(Millions) 0 6747 25996 29697
24548PAT(Millions) 0 696 9835 10307 7396Book Value(Rupees per share) 0 2.76 14.3
13.21 17.62Interest cost(Millions) 0 325 1588 3584 6854EBIT(Millions) 0 1406 15036
17239 16420SHARE PRICES(Rs.) 0.00 0.00 0.00 301.50 31.00 Chart -7: Unitech
Performance 40
41. 41. We can see from the Table-13 that Income increased from Rs 6747 million in 2006 to Rs
29697million in 2008 and then went down to Rs 24548 million. PAT also went up from Rs
696 millionin 2006 to Rs 10307 million in 2008, declining thereafter to Rs 7396 million in
2009. Debthowever went up to Rs 72162 million in 2008 declining to Rs 67757 million in
2009. We canclearly see that although Unitech was able to marginally improve its leverage in
2009, theindebtedness remains critical in relation of its level of activity.2.8.2 Share Price
Movement Table-14: Unitech Share Price ALL TIME HIGH PRICE 29-May-07 623.60 ALL
TIME LOW PRICE 28-Nov-08 21.80 CURRENT MARKET PRICE 11-Feb-10
72.15Unitech shares touched all time high price of Rs 623.60 in May 2007 again making a
peaksometimes in January 2008 as can be observed in the following chart, falling thereafter
to an alltime low of Rs 21 in November 2008. Currently the share trades in the range of Rs 65
to Rs 75per share.Chapter Summary:We can see from the foregoing chapter about the six
companies and their performance over a 5year period that all these companies display similar
trends. Their market prices peaked atvirtually the same time and have corrected greatly to fall
substantially below their issue pricelevels. In the next chapter we would look at the trend
displayed by these companies on majorparameters and compare and contrast their strategies
to help draw conclusions and learning fromthe entire exercise. 41
42. 42. Chapter – 3: Strategic Comparison and Case Study of DLF Limited3.1 Strategic
Comparison:On reading through the Draft Red Herring Prospectuses of all these companies,
we can easilyobserve a few common characteristics displayed by all these companies.
Moreover, all theDRHP‟s were identical with very little to distinguish between different
offerings.3.1.1 Market Segment: Residential, Commercial and Retail development activities
are carried out by all these companies. In addition Sobha does lot of contractual work and
HDIL is engaged in Slum Rehabilitation Business. Slum Rehab is peculiar to Mumbai. DLF,
and to some extent Parsvnath, is also present in the business of entertainment. DLF has
further listed „clubs‟ and „power‟ as additional lines of business. These Real Estate
Developers therefore are what can be called „Umbrella Developers‟. They are engaged in all
kind of development activities. In fact except for Sobha, all of them are doing almost
everything. Sobha also signified its intention to diversify into other types of development. In
advanced countries generally there is a clear segregation between residential and commercial
developers. This allows specialization and institutional/public ownership through REITs. In
India however the market is yet to attain maturity and hence it is possible for a developer to
engage in all kind of activities.3.1.2 Key Locations: We can see that the focus of DLF and
Parsvnath is predominantly in North India. More specifically in NCR and major towns near
to NCR Region, e.g., Chandigarh, Amritsar, Jaipur etc. Sobha Developers is concentrated in
Bangaluru; Purvankara in southern states of Karnataka, Andhra Pradesh, Tamil Nadu and
Kerala, HDIL focuses exclusively on Mumbai Metropolitan Region. In addition to this DLF
had announced ambitious Pan India plans as part of its DRHP document. It acquired large
land parcels in almost all major cities across India including Mumbai, Chennai, Bangalore,
Pune, Kolkata etc. This trend of expanding to other towns and cities across India to acquire
what was termed as “Pan India Presence” is clearly demonstrated by all the developers in our
sample. Similar ambitious expansion plans to other locations were announced by other realty
players as well. 42
43. 43. Experienced Management 43 Better located projects  Extensive Land Reserve  Brand
Name and goodwill 3.1.3 Milestones and Project Execution: Some interesting
commonalities emerge on careful scrutiny of this parameter. When we look at the total
quantity and numbers of projects completed by the developers to the projects which were
under execution at the time of going public, we find that almost all the developers had
expanded substantially and were executing at least three times of what they had completed in
last five years. All the real estate developers were executing large number of projects at the
time of going to public. The cumulative size and number of the projects under execution was
many times more than what they had completed historically. The CAGR displayed in income
as well as profits was abnormally high. Actually we can see a virtual „hockey stick‟ pattern
being displayed by all these companies. As on April 2007 DLF had 7 million sq. ft. of
residential properties, 27 million sq. ft. of commercial properties and 10 million sq. ft. of
Retail properties (cumulative total 44 million sq. ft.) under development. Whereas, till then
i.e. over more than a 15 year period they had delivered a total of 30 million sq. ft. comprising
of 19 million sq. ft. of Residential, 7 million sq. ft. of commercial properties and 3 million sq.
ft. of Retail properties. The consolidated income of DLF increased from INR 5266 million
for the year ended 31st March 2004 to INR 40341 million for the year ended 31st March
2007. PAT increased from INR 538 million for the year ended 31st March 2004 to INR
19413 for the year ended 31st March 2007 (Ref: Table -16). It is evident from the
comparison chart (Chart-8) that similar rapid exponential growth was observed in all the
sample companies.3.1.4 Competitive Strengths: Almost all the companies listed the
following attributes as their major competitive strengths-
44. 44. In addition to the above some also listed their existing partnerships and contractual
relationships as their strengths. Sobha Developers talked about Backward Integration as their
additional advantage. One can see that in absence of any specialization a few generic
qualities were claimed by all these developers.3.1.5 Business Strategy: In terms of business
strategy, we do not see anything special, the common strategic theme underlying all the
DRHPs is of exponential expansion: expansion of land reserves, geographical expansion
across the country, expansion into new lines of business like retail, multiplexes, hotels, SEZs
and township development. The lines were eerily similar.3.1.6 Land holdings and
Development Potential: All the sample companies have claimed to have acquired thousands
of acres of land banks across country; with hundreds of million sq. ft. of potential
developable area. If we carefully compare the development potential of these land banks with
historical performance growth data, we can easily see that all these companies grew at
phenomenal speed over a three – four year period prior to IPO. They claimed control over
huge tracts of land, in a large number of locations, spread over all across the country. The
potential developable area being many times more than what any company can reasonably
hope to exploit over a 10-12 year period. When we compare it with their historical
performance numbers. Therefore irrespective of all claims about capability of development,
none of these companies could be assumed to continue expanding, at a rate which would
enable development and hence monetization of the land banks over a reasonable period of
time. In addition to this the land holdings, in large part, were comprised of development
rights flowing through “Agreements to Purchase”. Another substantial chunk was that of
partly paid property. 44
45. 45. 3.1.7 Promoter’s Shareholding Table-15 Promoter’s Shareholding Company
Holding %age before IPO Holding %age after IPO DLF 97.42 87.43 Parsvnath 100 81.70
Sobha 99.09 87 Purvankara 99.99 89.95 HDIL 73.08 61.45 We can see from the preceding
Table-15, that all these companies were closely held by promoters and/or their close family
members. These were virtually one man or one family company, irrespective of their size or
scale of operations, and they diluted only marginally in the IPO process. Even the most broad
based of these, HDIL, had issued shares to close business associates. Thus we have DLF in
which promoters K. P. Singh and family held 97.42% shares before the IPO and HDIL in
which Promoters held 73.08% of shares at the time of going for the IPO. All the other three
companies were almost entirely held by promoters at the time of going to the IPO. Due to
small divestment, after the IPO, promoters continued to own more than 75% of shareholding,
outside shareholders relegated almost to being a fringe minority. The concept of shareholder
democracy and corporate governance was, therefore, almost entirely dependent on the
intentions of promoter group. 45
46. 46. 3.2 Note on DLF’s IPOWe have analyzed DLF as a special case, being representative of
the larger problem afflicting theentire Real Estate Sector. Each issue gets greatly magnified
due to sheer scale of operations andsize. DLF is perhaps the only developer which was able
to create a pan Indian foot print; itfurther diversified into all the related verticals. Due to a
few peculiar issues connected with it, itsimportance, and sheer scale and size, it deserves to
be looked as an independent case study. DLFLimited is the market leader and largest player
in Indian real estate industry. In May 2006, itfiled a Draft Red Herring Prospectus with SEBI
(the market regulator). Amongst other detailsabout the company, the prospectus also carried a
certificate from a multinational real estateconsultant certifying the NAV of DLF to be about
USD 28 - 30 billion. This valuation was basedon estimated discounted cash flow values of
potential land banks owned by the company. Acouple of other real estate developers also
filed similar offer documents, proposing to raise hugeamount of money, claiming high
valuation of their land banks.The stock markets crashed in 2006, realizing that it would not
be possible to come out with theIPO, DLF withdrew and filed its prospectus again in 2007.
The valuation of the company hassuffered at least 30% erosion over 18 month period. Even
today almost three years after thelisting, the market price is at least 40% below the issue price.
After the IPO, the Chairman andthe Vice Chairman had to issue statements reaffirming their
commitment to corporategovernance and to ensure protection of the interest of minority
shareholders. This, to me, is amajor illustration of how, ethically questionable business
practices, affect future valuation of abusiness in a real life situation, even in case of a market
leader like DLF. (Please refer toAnnexure -2 for a news paper report on this IPO which
corroborates the major points)3.2.1 Shareholding and Ownership IssuesOriginally DLF was a
listed company. Promoters held almost 85 % of shares; they decided tobuy the outstanding
stock, from the market, without making the mandatory open offer to thepublic. This buy out
violated the then existing share buyback guidelines. As a consequence, DLFLtd. was
penalized by market regulator. Even after delisting, a few minority shareholders chose 46
47. 47. not sell their holding and continued as shareholders. Subsequently, after some time,
themanagement decided to issue convertible bonds to existing shareholders however, the
minorityshareholders did not get the application forms in time and majority group could buy
all the bondsso offered by the company.This issue was raised in courts by minority
shareholders aggrieved at being denied the right tobuy convertible bonds, in what was clearly
a very valuable company. DLF pleaded that the shareapplication forms were posted to
shareholders well within due dates. However this waschallenged by postal department, who
contested claim by the company and declared thesupporting receipt a forgery. In this case
(denial of opportunity to minority shareholders to buybonds) the company was directed to
come to some kind of settlement with minority shareholders.It, subsequently, issued
equivalent shares to minority shareholders in settlement of the case.3.2.2 Land Bank and
ValuationQuestions were also raised about the correct status of land bank of the company. It
was arguedthat most of the land was under agreements to purchase, and titles were not in the
name of thecompany. The projected profits were based on estimates without considering
absorption capacityetc. SEBI (regulator) objected to such practice, and asked clarifications on
the valuation.Subsequently, company filed an updated draft offer document from which the
land valuation wasdropped. It was further declared that the company owned only to the
extent of 10% of claimedland bank, and the balance land was under acquisition or purchase
agreements. It further used asale transaction, which creatively generated very high profits, by
selling properties to its sisterconcern in order to justify P/E ratios. All these aspects were
thoroughly discussed in the media,analyzed and deliberated upon. The result was that the
largest ever IPO (this was the largest IPOtill then) in the Indian markets, at a time when stock
markets were booming, could not get fullsubscription for the retail portion of the issue (the
retail portion was subscribed only to the extentof 97%). 47
48. 48. Chapter 4: Trend Analysis , Conclusion and Need for Regulatory Framework4.1 Trend
Analysis: I have carried out trend analysis on various important parameters asdisplayed by all
the six companies and charted the same. Major findings are discussed hereafter:4.1.1 Income
Table-16: Income INCOME 2005 2006 2007 2008 2009 DLF LMITED 4798 11450 14295
60584 38390 UNITECH 0 6747 25996 29697 24548 PARASVNATH 3068 6538 12610
17922 7626 SOBHA DEVELOPERS 5912 6912 12911 14363 9917 PURVANKARA 1510
2804 4581 6570 5451 HDIL 749 4402 12165 24323 18146 SAMPLE AVG. 3207 7771
16512 30692 20816 Chart – 8: Income 48
49. 49. We can see from Table -16 and Chart - 8, that for all the six companies Income trend is
secularand common. The incomes rising fast till 2008, sharply falling thereafter. This mirrors
theeconomic trend displayed by the economic growth numbers of RBI. It also points to
asignificant fact that it is impossible for a company to maintain the „hockey stick‟ pattern
ofgrowth for a very long period of time, and sooner or later, the averaging out will take place
in theform of a correction. The IPO pricing and company valuation therefore has to factor in
theeconomic risk inherent in every business.New Accounting standards introduced in 2006
allowed the companies to recognize revenue onthe basis of percentage completion of projects.
This essentially implied that sales from a projectwere reported as income from the accounting
year in which at least 30% of the project wascompleted. Therefore, the spike in income that
we notice in 2008 is due to spurt in sales during2006 and 2007. Most of the projects which
these companies marketed in 2006 and 2007, wereunder construction and advance bookings
made during these two boom years were reportedpartly in 2007 and in 2008(after 30%
construction was completed), hence the spike in Incomenumbers in 2008 and fall thereafter.
This is further reinforced by falling receivables in 2009. Wewill look at receivables later in
this chapter.4.1.2 Profit after tax Table – 17: Profit After Tax PROFIT AFTER TAX CHART
(RUPEES IN MILLIONS) 2005 2006 2007 2008 2009 DLF LMITED 677 2275 4057 25746
15478 UNITECH 0 696 9835 10307 7396 PARASVNATH 656 1062 2718 4087 1130
SOBHA DEVELOPERS 347 886 1615 2283 1097 PURVANKARA 380 724 1166 2109
1329 HDIL 147 1139 5414 14103 7212 SAMPLE AVG. 441.40 1356.40 4961.00 11727.00
6728.40 49
50. 50. Chart – 9: Profit After TaxPAT also mirrors the Income trend. We can notice the sharp
spike in numbers between 2006 and2007 (Refer Table – 17, Chart – 9). In fact 2006 - 2007
was probably the best year for propertysales and marked high point in property market. The
profit numbers are also important becausethe cost structures remained either same or
increased due to higher interest cost. The cumulativeimpact on bottomlines of these
companies was greater. In fact, new accounting policies pursuantto new guidelines pertaining
to revenue recognition (Percentage Completion Method) created arevenue overhang, which
compounded the problem by making the correction appear steeper thanwhat it would have
been.4.1.3 NET Profit after Tax (%age): Table – 18: Net Profit (After Tax)%age NET
PROFIT (AFTER TAX ) PERCENTAGE CHART 2005 2006 2007 2008 2009 DLF
LMITED 14.11 19.87 28.38 42.5 40.32 UNITECH 0 10.32 37.83 34.71 30.13
PARASVNATH 21.38 16.24 21.55 22.80 14.82 SOBHA DEVELOPERS 5.87 12.82 12.51
15.90 11.06 PURVANKARA 25.17 25.82 25.45 32.10 24.38 HDIL 19.63 25.87 44.50 57.98
39.74 SAMPLE AVG. 17.23 22.19 34.04 41.20 32.09 50
51. 51. Chart – 10: Net Profit (After Tax) %ageThe Chart No 10, is prepared on the basis of net
profit expressed as a percentage of totalincome. It is a chart which displays profitability as
opposed to profit as a number. We can seethat the profitability for each of these companies is
different. If we analyze and compare thenumbers (Ref: Table - 18) it is clear that Sobha,
Parsvnath, Purvankara, Unitech, DLF and HDILare increasingly more profitable. In fact if we
compare the profitability with sample average wefind that other than HDIL almost all the
other companies are below average. Some like DLF,HDIL and Parsvnath display sharper
spikes and troughs, whereas other like Unitech, Purvankaraand Sobha did not fall that sharply.
The main reason for the sudden spurt in profitability is sharpincrease in land prices which,
when factored in prices of apartments and built up spaces, allowedthese companies to report
above normal profit percentages. The historical cost of acquisition ofthese land banks was
very low, and due to rise in price of properties, the companies were able torealize these
capital gains. The increase in cost of construction was marginal in comparison toincrease in
land price. This is also the reason why HDIL is more profitable than the others.Unlike other
companies HDIL is exclusively focused in Mumbai region. The cost of properties 51
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India real estate research

Published on Feb 11, 2011

Research Paper on Indian Real Estate Industry

India real estate research

1. 1. LANCASTER UNIVERSITY Growth Strategy, IPO & Performance Of INDIAN REAL

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