Buy The Product Not The Shares

wealthymattersInvest in their apartments, and you will get rich. But invest in their shares and you will be poorer. Unlike in other sectors, values of shares of listed real estate companies do not reflect the growing value of their products. Sample this: Investments made in shares of real estate companies like Delhi-based Unitech and DLF, Mumbai-based Indiabulls Real Estate or Bangalore-based Purvankara in 2008 would have crashed to half or to a fifth of their value by now whereas in the same period, returns from investments made in homes built by the same companies would have risen anywhere between 50% and 150% or more. If one had bought an apartment in any Gurgaon-based apartment building of DLF — India’s biggest builder — in 2008, the investment would have, by now, appreciated 60-175%. Had the same money been used to purchase DLF’s shares the same year, that investment would have eroded to just 20%. Investors of Unitech, Indiabulls and other real estate firms would have a similar story to tell.

Stock prices are sensitive to a number of factors — negative news about industry, regulatory changes, interest rates for construction finance, home loan rates, future earnings expectations etc. On the other hand, home prices are a factor of demand in the market and state of the micro and macro economy. In the last few years, the rise in property prices in areas where trading of apartments is rampant — in the north of India — has been much higher because of a nexus between developers and investors.
Stock prices, on the other hand, reflect the financial stress of the entire real estate industry. For the top 25 listed real estate companies, the interest payments have multiplied four-fold in the last five years, but the operating profits have halved. Of these 25 listed firms, 10 have lost over 80% of their market value, eight over 50-80%, and only one company has given positive returns.

in the real estate space, almost every macroeconomic issue impacts the performance of the company. Even job losses in, say the IT sector, will impact a real estate company’s performance as sales will decline. Over-leveraging is another big reason for the current state of the developers. In fiscal year 2008-09 when liquidity led to a steep increase in real estate prices, developers thought prices will endlessly increase and borrowed ambitiously. They did not expect any slowdown in demand, but the slowdown hit immediately in the next three quarters and the fundamentals imploded.

But this is nothing new.Construction is largely a low margin commodity service,Being a developer is more lucrative,But it requires political and bureaucratic connections .Real estate is itself a very cyclical business running in 14 year cycles.The business is largely debt funded as it has heavy sunk costs and requires large capital expenses,Some innovations are possible to improve the financials,but the basic nature of the business can’t be changed.

So real estate and construction,like airlines,shipping,infrastructure,hospitality etc are generally sectors to avoid if you wish to buy and hold shares and grow your wealth.

And remember property is your friend just like gold when inflation is unremitting.

About Keerthika Singaravel

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