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The Rediff Interview/V Hari Krishna, CIO, Kotak Realty Funds

'We are headed for a distressed real estate market'

July 29, 2008

V Hari Krishna, chief investment officer, Kotak Realty Funds Group

V Hari Krishna, chief investment officer, Kotak Realty Funds Group, has reason to say so.

Actual home buyers have all but withdrawn from the property market because of unaffordable property prices. Add a slack in the employment growth of technology companies, fall in home loan disbursement by about 22 per cent on a year-on-year basis from 2006-07 to 2007-08, hardening interest rates on the back of spiralling crude prices, the reluctance of real estate developers to reduce property prices and you have a problem on your hand.

As if on cue, stock prices of real estate developers like DLF, Unitech, Omaxe, Parsvnath and many others have been pummeled by the market since January this year as it is believed that the sector is facing a downturn.

In an interview with Prasanna D Zore, V Hari Krishna discussed the real estate sector in India, how it will be impacted if interest rates increase from here, and when his realty fund will start investing in the property market here.

How much money have you collected since 2005? How soon will you start investing this money?

Our first fund worth $100 million was raised in January 2006. Subsequently we raised funds twice: we raised $400 million in August 2007 and then another international fund where we collected $220 million in September 2007. Cumulatively, we have raised $750 million since 2005.

While the first fund of $100 million has already been invested, of the new funds -- worth $650 million -- that we raised, we have already invested more than $100 million.

We made about three-four investments most of which were done in the second half of last year.   

Are current valuations in the real estate sector compelling enough for you to start investing?

Not at this point in time. But I think it will be a question of another four-five months before we actually start looking at opportunities in India's real estate sector.

Obviously, valuations have declined in the last six months. But given the numerous question marks over the sector today -- like inflation, interest rates and the fact that the job market is not looking all that attractive -- the current valuations will have to take into account all these variables.

I don't think the valuations currently fully reflect the view on these variables. They will hopefully get reflected in the next two quarters.

Where do you see the real estate sector, say, two quarters from today?

To give you a context. . . since January 2007 people have had these concerns about the real estate market. Since early last year most of the consumers have withdrawn from the market. This is reflected in the fact that when you look at home loan disbursements, (you find that they) have declined by 22 per cent on a year on year basis from 2006-07 to 2007-08.

The drop, in fact, would have been more had HDFC [Get Quote] and ICICI Bank [Get Quote] not increased their disbursement rate in this period. Ex-HDFC and ICICI Bank, the disbursements would have fallen by 50 per cent. This is obviously a worrying factor as it indicates that end users have withdrawn from the real estate market.

Real estate prices went up too high thereby making it unaffordable for end users to buy homes.

But has this led to a fall in residential real estate prices?

Today the quoted price at which there are no transactions happening has started to come down. Not visibly but through below the line discounts. It will soon translate into below the line discounts, plus actual price cuts where developers will be ready to do residential sales.

What was the reason behind the drop in loan disbursement?

High, unaffordable real estate rates were essentially the main factor behind this fall in demand from actual home users. Also, there was job growth and salary inflation in the market in 2005, 2006 and 2007. In most sectors employees were getting salary hikes in double digits. While purchasing power was being created interest rates too had started hardening but were sort of in a 10-11 per cent range.

In that sense there was no deterioration in purchasing power as wage inflation and employment were growing at a good clip. The quarter-on-quarter growth rate in employment of top 10 technology companies has been at 7-8 per cent per quarter.

However, the last two quarters have been exceptions with employee growth rate increasing by only 4-5 per cent in these companies. This, sort of, will put some pressure on demand for residential housing.

Do you see a 15-20 per cent correction in real estate prices in major metros across India?

Most definitely. The time in which we will witness this correction is a function of the market conditions. If not in the next three months, then probably in the next 15-18 months.

You are still sitting on cash of more than $500 million. Are you getting any proposals from the real estate sector or conversely are you in talks with any major player to pick up a stake?

Today most real estate development companies are more rational in their expectations than they were six months ago. But that rationality is yet to fully reflect the market conditions. We continue to be in discussions with various parties but our deal closure rate has really gone down in this calendar year (January 2008 till date). We have done only one transaction this year so far.

Apart from that we are always in 10-12 such discussions at any given point in time.

When do you see the real estate market improving going ahead?

To me the most important improvement requirement is in transaction volumes. Even if the prices remain stable transaction volumes should go up for the market (real estate) to improve.

However, if there is a correction that people are expecting then the recovery should happen in the next 18 months. But if you are looking at a phase that we saw in 2005-06 when prices were rising on a daily basis then you will have to wait till 2014.

Are we going to see a 1995 kind of a situation?

You will. Faster the price cuts and more quickly the developers realise what they have to do to move out of the inventory better will be the recovery in the transaction volumes.  

What's the sense that you are getting from international investors about the current Indian real estate scenario?

They are really frustrated. Precisely for the reason that current real estate market are not support any meaningful transactional volumes. India was an attractive market for them till last year.

Don't they find current valuations appealing?

No. Unfortunately in India we are neither in a growth market nor a distressed market. But given the current market scenario we are headed towards a distressed real estate market.

What are you telling your investors from whom you have raised millions of dollars?

We are telling them the India growth story is still intact. The question mark lies over the underlying valuations at which real estate assets are available. These valuations are not in line with businesses' purchasing power who want to buy space for retailing, office space etc or in line with home owners' purchasing power for residential purposes. So the relative valuations need to decline in the favour of consumers.

Once that balance is restored you will see markets stabilising and transactional volumes coming back into the market. However, even if the prices come down in the next 18 months a lot of consumers will not buy homes because nobody likes to buy in a falling market. End-users of residential homes start reacting only when the prices are stable or when they are rising.

What'd you advice to end users now?

I'd say once the property prices have declined rationally they should come back to the market. And that would be 15-20 per cent fall from the current levels across the country.

If interest rates keep hardening do you see defaults on loans rising in India?

Defaults will definitely rise in all kinds of retail loans if interest rates keep increasing. The only silver lining in the Indian story is that we don't have a secondary securitisation market and the banks here have no real incentive to start making risky loans or lower their underwriting standards as has happened in the US over the sub prime mess.

To that extent the risk of defaults is lower in India. At worse, default rates which are currently at around one per cent could increase to 2.5 per cent at the most.

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