Reuters
IT is common wisdom that you can’t lose money in real estate, given that land is always in short supply. But then, how does one explain the humongous wealth destruction by real estate companies that are listed on the stock markets? If real estate can only go up, how come real estate shares only go down?
Take the case of DLF, the biggest daddy of them all. According to Firstbiz calculations, from its all-time high price of Rs 1,205 a share in January 2008, DLF has plunged more than 90 percent to Rs 109 today (27 October). This means in six years, just one real estate company has destroyed shareholder wealth to the tune of Rs 1,86,000 crore, falling from a high of Rs 2.06 lakh crore to just Rs 19,502 crore now.
Firstbiz added up the wealth destroyed by six listed realty companies from their peak prices and today’s values, and the total loss to investors adds up to Rs 3,30,792 crore. Clearly, realty companies are not worth investing in at all.
Of course, measuring share prices from their peaks may sound unfair, but it is worth noting that the stock market as a whole has not only regained its peak, but is heading for new peaks now. So, the real estate sector – at the very least – should have regained at least its old values. Far from it, it is destroying further value.
What explains this anomaly?
The answer has to lie in the peculiarities of the real estate industry, including the following.
One, most of the wealth is created in cash, and thus the listed shares do not participate much in any of the wealth created during the boom years of the realty industry.
Two, the real estate industry simply does not follow the best accounting practices and may, in fact, be doing funny numbers. As this Firstbiz report in 2011 noted, the reported cost structures of any two real estate companies are so divergent as to be meaningless.
A Citigroup report on Oberoi Realty and DLF in June 2011 showed widely divergent cost structures, that it made no sense. According to the Citi analyst, steel and cement accounted for 40 percent of DLF's total construction cost. Adding labour, we arrive at 70 percent as the total civil construction cost as a proportion of the total cost (excluding land, one presumes).
But in the case of Oberoi Realty, a Mumbai-based realtor, the Citi report mentions steel and cement cost as just 16 percent of the total, and overall civil construction costs at 46 percent. Assuming that steel costs cannot vary so much across the country, why does a builder in Mumbai have far lower costs than DLF in Delhi? Is it only the higher land cost that explains it all?
One can only speculate that at least one of these numbers is not quite what it seems.
Three, it is also obvious that realtors make money at the expense of the consumer by changing delivery schedules, reducing carpet areas, and generally loading the purchase contract against the interests of the consumer. But this is now being challenged by the regulators, with the Competition Commission of India (CCI) coming down heavily against DLF for cheating home buyers in Gurgaon. In August, the Supreme Court asked DLF to pay up Rs 630 crore as penalty while it heard the company’s appeal. Sebi has also come down on DLF for allegedly not making full disclosures at the time of its IPO.
Four, realty prices have less to do with real demand and supply and more to do with political manipulation of prices, given that real estate is where crooked politicians, businessmen and bureaucrats stash their wealth. This was demonstrated clearly during the last elections, when realty prices mirrored political need for money during election-time.
The same point came through in a recent Times of India report, which noted that builders in Mumbai pay “anywhere between Rs 5-30 crore per multi-storeyed building…bribe demands in the island city are a whopping Rs 1,200 per sq ft, Rs 800 per sq ft in the Bandra-Andheri belt and up to Rs 600 per sq ft in the city's eastern suburbs. Compare this with basic building costs of Rs 2,500-3,000 per sq ft.”
Since all these payments are outside the balance-sheet, it is highly unlikely that the correct costs and revenues are captured by listed real estate companies.
So it is caveat investor: it is simply too risky to invest in listed realty companies. Stay away.
by R Jagannathan: FP :27 Oct 2014
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