Residential: High debt building up on account of slow-moving inventory; sustainability of recent sales uptick and improvement in cash flows remain key look-out areas
The Indian residential real estate segment has been witnessing a prolonged downcycle owing to high inventory overhang, muted demand, weak affordability and declining investor interest. Covid-19 served as a double whammy, with overall housing sales volumes recording a YoY decline of 50% in H1 FY2021, across the top eight cities of the country. However, post a sharp decline in Q1 FY2021, sales bounced back considerably with a QoQ growth of 60% in Q2 FY2021, primarily driven by a gradual unlocking of the economy, pent-up demand, and improved affordability on the back of reduced home loan rates and attractive payment schemes/discounts. Sustainability of the recent uptrend, however, remains to be seen, as sales are likely to settle at more sedate levels post the festive season. Thus, despite the uptick, ICRA expects overall sales volume to decline by 35-40% in FY2021. FY2022, however, is expected to witness some normalization, resulting in YoY growth of 40-45%, which would take overall sales close to 85-90% of pre-covid (FY2020) levels. Collections are also expected to largely return to pre-Covid levels by FY2022, which, combined with some moderation in project spend and curtailed overheads, is expected to result in net operating cash flows for the year returning to/slightly exceeding pre-covid levels.
According to Mr. Shubham Jain, Senior Vice President and Group Head, Corporate Ratings, ICRA Ltd., “even upon subsequent recovery to pre-Covid levels, timely liquidation of the high unsold inventory, particularly in over-supplied regions such as MMR and NCR, would still remain a challenge. Adequacy of operating cash flows to meet debt obligations would be a key look-out area, with residential developers having built-up high debt levels on account of slow-moving inventory or high investment in land assets. Although overall debt levels are expected to remain in line with pre-Covid levels over the near-to-medium-term, since many companies availed moratorium to bring down debt repayments, and also benefitted from an automatic reduction in collection-linked prepayments, absolute debt levels would remain high, keeping Net Debt/Fund Flow from Operations (FFO) at almost 4 times. FFO/Interest is expected to remain at just above 1 time in FY2021 for investment grade players and despite expected improvement in FFO in FY2022, coverage levels are likely to remain modest at under 2 times. Overall, established developers with adequate balance sheet strength, available liquidity, financial flexibility, refinancing ability and a well-diversified project portfolio are expected to be better positioned to absorb disruptions in operating cash flows during FY2021 and witness recovery to pre-covid levels by FY2022. Consequently, the trend of market consolidation is likely to accelerate, with range-bound prices and low home loan rates expected to continue supporting sales for established players.”
Office leasing: Cash flows resilient in office leasing segment; but recovery in new leasing activity critical
The cash flows in the office leasing segment has been among the least affected by the Covid-19 pandemic. For YTD FY2021, there has been limited revenue loss for developers of Grade A office space while the occupancy in existing leased portfolio has not witnessed any material weakening till date. However, the segment has witnessed lower incremental pre-leasing and absorption of completed supply during FY2021, compared to the earlier years. The economic impact of Covid-19 on various corporate sectors, business travel restrictions and scenario of extended work-from-home adopted by many tenants had considerably slowed down new pre-leasing during H1FY2021. Thus, while occupancies in operational assets were largely intact, pressure on overall occupancy in the market may arise as newer properties become operational over FY2021 and FY2022 without adequate pre-leasing.
There are many factors which could support a healthy bounce-back in leasing activity – including easing up of travel restrictions, widespread vaccination programmes which can enable workforces to come back to offices safely, as well as expectations of strong economic recovery once the pandemic eases up. The demand for Grade A office space in India is driven by global corporations to a large extent and hence economic recovery in global markets will also influence the expansion plans of occupiers in India’s office leasing market. In this context, the cost competitiveness of Indian commercial real estate and large pool of qualified manpower are strong supportive factors for continued growth in demand for office space.
Mr Shubham Jain added, “questions remain about whether incremental leasing activity can recover to the buoyant levels witnessed earlier as some of the economic impact of Covid-19 may persist or as companies incorporate work-from-home permanently into their business plans in some form. The extent of recovery in leasing activity and consequent changes in market vacancy levels will be a key monitorable in FY2022”.
Due to relatively stable cash flows and limited impact on occupancies in existing properties, the credit profile of most of ICRA’s rated issuers in the office leasing segment is expected to be stable. However, credit profile of developers with large portfolios that are getting commercialized in FY2021 and FY2022 may be under pressure in case of slow leasing progress along with high refinancing requirements. The extent of financial flexibility, as measured through leverage in the existing operational portfolio will be a key determinant of the credit profile in such scenarios.
Retail: Credit risk profile of the segment to improve gradually in FY2022; reduction in pandemic fears and high vaccine coverage will be the key driver
Retail segment witnessed significant impact on the revenue during FY2021 on account of closure of operations for two to five months and consequent rental waivers offered by mall operators. Most of the mall developers opted the moratorium benefit and the interest during moratorium was capitalised by lenders cushioning the impact on the credit risk profile during FY2021. Post resumption of operations, the footfalls and trading densities in malls have been gradually improving. The improvement is also supported to some extent by pent up demand and festive season during Q3 FY2021. However, sustainability of improvement in operations critically hinges on reduction in the pandemic fears going forward. Improvement in vaccine coverage will also be essential for continued improvement in the operating performance of the segment. New leasing is expected to improve gradually after weak performance in FY2021. However, vacancy levels are expected to increase intermittently as weak tenants are expected to accelerate shut down of the loss-making stores.
“ICRA expects the profitability and coverage indicators to improve to near normal levels in FY2022 as the mall operators will get the minimum guarantee rentals for the entire year. However, the ability of the mall operators to generate revenue share income is expected to be constrained. Any second wave of the pandemic and closure of operations may pose significant downside risks to the estimates. Additionally, the pandemic has forced a large population to adopt e-commerce as the preferred mode of shopping. Even after the pandemic fear subsides, some of the consumers may permanently shift to e-commerce platforms due to convenience and safety. This is an emerging trend and impact of the same on trading densities of malls remains to be seen in the medium to long term.” Concludes Mr. Jain.