Real Estate Developers: India Vs China.

Recently I had the opportunity to read an article on Real estate sector in India & China. (Courtesy : CLSA). The article hits out at the Indian real estate players of being cloistered with politicians and sharing a cosy relationship and offering little value to property buyers. A season of discount on unsold inventories is soon going to be in the offing. The report expounds that Real Estate stocks in India are still exceptionally over-valued compared to their Regional counterparts, have a lot of weight to shed and so would the Banks backing these developers. Investors may rather buy the property than the Real Estate stocks and stay away from Housing Development and Housing Development Finance Companies and Banks.
To decipher the report in a nutshell, let me state the learning as follows:
The key real estate sector takeaways in China and India are:

• Chinese real estate companies have conservative accounting policies, lower land banking, lower gearing levels and lower office rentals in China.
• Indian companies score better on project level cash flows, lesser government interference and paucity of supply.
  
  In Detail:
  
• Property markets have weakened in both, India and China: Sentiments in the property markets have been adversely impacted and the consumers are postponing purchases in the anticipation of softer pricing trend going forward. The key difference however, is that the property prices in China are still considered affordable, whereas, one of the key reasons for lower volumes in India is adverse affordability, aside from sentimental issues.
• Government policies impact the sector much more in China: Chinese real estate development sector is more susceptible to regulatory changes than Indian property sector. Regulatory environment in India remains relatively benign towards the real estate sector. Property developers are 'friends' of policy makers in India, NOT in China: While the current regulatory environment remains relatively easy in India, we believe that it will remain so due to good relationship enjoyed by the real estate developers in India with the state / central government. In China, the real estate developers enjoy a similar good relationship with the provincial government, however, the policy maker i.e. the central government has been seen to be taking aggressive steps against the sector.
• Tight credit conditions for both, stricter regulations in China: Credit conditions for Chinese developers have also tightened with average cost of borrowing going up by 200 bps over the last six months, almost similar as that in India. But we observe that the Chinese developers are subject to tighter regulations such as mortgage payments by buyers have to be utilized for the particular project itself, etc.
• Indian developers have better project cash flow cycle: Due to regulations, Chinese developers can pre-sell a residential property only when the construction is 1/3rd or 2/3rd complete, depending on provincial norms. Indian developers can pre-sell even before starting to dig.
• Chinese developers are much less geared: The average gearing for the listed Chinese developers is about 50-60% (only one or two are 100%+), while that for Indian ones is 100% on an average and some viz. Unitech, Parsvnath and Sobha are close to 200%.
• Chinese developers carry relatively lower land bank: Usually 4-10 years of landbank (taking into account growth targets) is carried by Chinese developers as compared to 8-15 years of landbank. One of the key reasons for lower landbank for Chinese developers is that bulk of landbank is ready to develop with most of the approvals in place, whereas, a large chunk of landbank of Indian companies is agricultural / yet to be possessed. This puts the Chinese developers in a situation where they could buy incremental land in case of distress sale possibly, 6 months down the line. A similar landbank addition at distress valuations will be difficult Indian developers due to existing large land banks and larger leverage.
• Accounting policies of Chinese developers more conservative: In China and Hong Kong, the developers follow project completion method of revenue accounting i.e. revenue is recognized only once the project has been handed over to the customers. While the PoCM (Percentage of Completion Method) adopted in India implies that the revenue (and therefore profits) recognition of Indian companies is about 1-2 years ahead of Chinese counterparts - a point to remember while comparing PEs.
• Indian developers have better margin profile: Indian developers have significantly lower land cost as usually, large scale land aggregation by Indian developers - especially at city outskirts - is through direct purchase of agricultural land from farmers at a much cheaper price. Chinese developers have to buy land from the government through auction / tender at a market determined price. E.g. During 2007, China Overseas Land bought 94m sf of land at Rs1,604/sf, whereas average cost of land for larger Indian companies is typically about Rs300/sf.
• Chinese developers are largely residential only: Large developers such as Vanke, China Overseas, Agile properties and Country Garden etc are pure residential developers, whereas most of the Indian developments are mixed use. One of the key reasons, we believe, is better infrastructure in China reduces time to commute between office and work, thus, lowering the need to provide onsite job opportunities /entertainment, which requires a different skill set. Larger Indian companies viz. DLF and Unitech has acquired these skills which is a value add for these companies and also helps generate better margins for the Indian companies.
• Extent of full down payment higher in China: It is observed that about 20-40% of the buyers pay the entire house price through full cash down payment at the time of presale. The proportion of buyers paying full cash upfront would be significantly lower in India. This highlights riches in China, partially attributable to 2 earning parents helping out financially, a young couple (due to single child policy) as against usually 1 earning parent helping out a young couple in India (assuming only father earning and each family having two children).
• Scale of supply in China is much higher: Level of construction activities, even in smaller towns such as Shenyang, appears to be superlative by Indian standards. This town with a population of approx 7m had a new supply of 100m sf of residential properties in 2007 and probably a similar number in 2008. Knight Frank estimates that the total supply of residential properties in Mumbai including its suburbs, Navi Mumbai and Thane etc will be 85m sf over the next 3 years.
• Transparency of Chinese developers much better: While Indian corporates are generally considered better in terms of corporate governance and transparency level across Asia, property sector in India scores quite poorly vis-à-vis Chinese counterparts. The Chinese developers usually offer much better granularity in terms of land bank details and sales data.
• Office rentals in China lower: City centre office properties in Shanghai and Beijing are being offered at US$4-6/sf/month while the prime locations in Mumbai are going at US$6-8/sf/month.
• Property developers in China have already taken the bold step of price cuts : Developers in certain areas (dominantly southern China viz. Guangzhou and Shenzhen) have already lowered prices by 15-20% at the cost of irking the older buyers. In India, we have seen DLF offering products at lower than market prices but that's only in the new geographies and not in existing projects. Soon, Indian developers may have to Start lowering the existing project prices if volumes do not pick up.
• Retail rentals higher in China but much higher foreign brands activity: Prime retail rentals in Shanghai are nearly double those of price retail rentals in Mumbai and Delhi, then again, Shanghai boasts of outlets of some super premium global brands viz, Louis Vuitton,Hermes, Fendi etc.

Conclusion: The learning from the article is Indian real estate market will slow down further resulting in lowering of real estate prices. Also, do not get carried away by the top lines and bottom lines of these Indian real estate players coz these companies recognize revenue 1 - 2 years ahead on account of the percentage completion method. So the writing on the wall is clear " Careful Investing In Indian Real estate, Sharp Corrections ahead". Do not be surprised if the developer offers you better price now vis-a-vis the price offered during the earlier round of negotiations. Lets party, The Buyers market is ahead !!!!!!

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