New real estate regulations will push prices up by 30-50%, says Vikas Oberoi

Image: Joshua Navalkar

The slew of reforms that the government plans to bring into the country’s real estate sector will lead to an escalation in costs for developers, and in turn, real estate prices, says Vikas Oberoi, chairman and managing director of listed real estate firm, Oberoi Realty.

In an interview with Forbes India, Oberoi, 46, says real estate prices may become costlier by 30 to 50 percent as a result of the direct and indirect costs (such as cost of capital) that developers will need to incur in the process of adhering to the new rules.

But the new regulations are a step in the right direction as they protect the interests of home buyers, who wouldn’t mind paying a premium for the transparency that the new rules will bring in, says Oberoi. Edited excerpts:

Q. How will the new regulations governing the real estate sector impact the industry?
The Real Estate Act and the constitution of the real estate regulator is a step in the right direction. I personally welcome it. The new regulations are skewed towards the buyer and rightly so. But everything comes at a cost. And when new regulations are applied to an industry, there is bound to be a cost escalation on account of adhering to these norms. Someone has to bear this cost and in the real estate sector’s case, the consumers will have to bear it.

Q. How will costs for real estate developers increase?
The new norms state that a new project can only come into the market once it has all the necessary approvals in place. While we as a company have always followed this practice, there are many other firms, especially smaller ones, who market projects without all the permissions in place and their trade-off against us is price. They sell houses cheaper than us, and not much could be done about that because that is the way the market worked.

With the new norms and the real estate regulator in place, projects that don’t have all permissions simply won’t be able to enter the market; that is a great thing because it will create a level playing field for companies. Now consumers can only buy something legitimate with all approvals in place; and of course, they will have to pay a premium for that.

This will reduce the flow of new projects into the market and the resultant supply, as not only will new projects need approvals from the government, they will also need approvals from the new regulator. It will take some time for the new regulatory framework and infrastructure to be set up and, consequently, there will be a huge drop on the supply side.

Even the remaining supply will be at a higher cost because companies have to service the cost of debt while they wait for permissions to come in and start selling a project. A company like ours typically borrows money at an interest rate of below 10 percent. But the average cost of borrowing for listed real estate developers is 16 percent and for unlisted companies, it can be as high as 25 to 30 percent. If these companies have to wait for two to three years till they get approvals and start seeing the colour of their money, their costs would have literally doubled; this will be passed on to buyers.

Finally, even when developers sell an under-construction project, 70 percent of the money received from customers has to be held in an escrow account and can only be used for the development of that project. This means that even after you sell units in a project, you haven’t immediately recouped the capital you have invested for your land and you cannot use that money to repay debt. So the interest cost is going to keep ticking and make the project more expensive. 

These regulations wouldn’t make much of a difference to us specifically because we follow a lot of these processes as best practices within our company in any case.

Q. What is going to be the resultant impact on real estate prices for home buyers?
Real estate is going to end up becoming more expensive. These regulations exist in developed markets like the UK and Singapore. But the cost of money in these markets is cheap when compared to India where cost of capital is very high. So clearly, a lot of real estate supply is going to be sucked out and the remaining supply is also going to come at a higher cost. In effect, prices could go up anywhere between 30 and 50 percent, especially with the cost of capital during the construction phase compounding.
 
Q. Do you see increased prices of real estate creating pressure on home sales, which are subdued already?
It is important to understand why sales aren’t happening in India. India is in a unique position, compared to the rest of the world. In Western markets, people are leveraged and companies have all the cash. In India, companies are leveraged and people have all the cash. Customers come to us with approvals to borrow up to 90 percent of the price of the house, but they never borrow more than 50 to 60 percent. They have the capacity to repay this debt over the next 15 years, but they cut other expenses and try to repay in four to five years since cost of debt in India is high. So the current market isn’t under stress because people don’t have money. It is under stress because the general economic environment is such. There is a lot of latent demand getting built up, which will unleash itself soon. Even at present, ready-to-move-in dwelling units are selling at a premium. So there are buyers.

Q. When do you expect the general economic environment to improve, which in turn, will boost real estate sales?
That is difficult to say. But as there are clear indications that supply of residential units will dry up due to the factors I mentioned, it may lead to a spurt in demand. This is what happened in the office space as well. A lot of developers converted their upcoming office projects into residential units as they didn’t have the money to finish these office projects. As a result, there is no new supply of office space in Mumbai coming in and once the existing office spaces are all taken up, those wanting to buy or lease new office spaces will have to pay a premium. This, in turn, will encourage developers to build more office spaces going forward.

Q. When can we expect the high existing inventory in the residential real estate segment to clear out?
Who says there is inventory? This entire concept of inventory came into being when real estate firms got listed. And as per accounting norms, the day a company buys land, the apartments that are meant to come up on that land are treated as inventory. The equity analysts pick up the number ascribed to such ‘inventory’ and the international property consultants compile the industry data.

By this definition, the new real estate sector regulations will only add to the level of inventory in the market in the future as developers will have to wait for approvals and it will be a good five-year cycle for even a reputed developer to build and sell a project.

But I want to say that buying land is not the same as creating inventory, in the real sense of the term, and the inventory levels that are spoken of in the market don’t exist.

Q. What is the future outlook as far as Oberoi Realty is concerned?
This [2015-16] has been the best year for us. We launched our projects in Borivali and Mulund and we haven’t seen such sales numbers just after a project launch before. These are all fresh sales. On the other hand, we are also recognising revenues from some of our existing projects where construction is ongoing.

We are just sticking to the basics of business and that is working well. We pick land parcels that are well-located and ensure that the designs of our projects are economically viable for the areas in which they are situated. Commerz II is a commercial building [in Goregaon], which was completed just as there was a slowdown in offtake for office space. But growth in demand for office space is now coming back with the overall focus on promoting India as an investment destination; and with a lot of developers having converted their office projects into residential ones, supply of new office space is limited. So Commerz II stands to gain from that.

In Goregaon, we have two residential offerings—Exquisite, where some apartments are ready, and Esquire [under construction]. Of a total saleable area of 3 million square feet across these two projects, we have already sold 2.2 million square feet. In Worli, we are building Three Sixty West [a luxury branded residential and hospitality project to be managed by Ritz Carlton]. The internal thinking was that we should first build this project [65 of the proposed 89 floors have been completed] and then bring it to the market by showcasing the superiority of our quality of construction and amenities on offer. These are expensive offerings and buyers feel more comfortable when there is progress to show on the ground. So we will be marketing Three Sixty West beginning this month. We have another project in Worli [a plot of land that Oberoi Realty acquired from GlaxoSmithKline] where we intend to do a mixed-use [residential, commercial and office space] development.  
    
So our strategy has been to fill the bucket faster through multiple taps. We have projects that are ready, semi-complete and at the pre-launch or launch phase; and there are buyers at every level.

Q. Oberoi Realty’s return on equity has declined between 2010-11 and 2014-2015. Is this a cause of concern and when do you see the trend reversing?
Not really. It depends on the business cycle we are in. Our operating profit margins remain very high. We have sold a lot of units in Mulund and Borivali, but we can’t recognise that on our books yet [revenues from real estate projects are typically recognised in the profit and loss account after crossing a certain threshold of sales]. The best way to look at the company is to see its net asset value, and we are doing very well by that parameter.

Q. What is your outlook for the real estate sector in 2016-17?
There is bound to be consolidation in the sector and the new real estate regulations will act as a catalyst. There will be a complete change in mindset on the part of developers who will need to be more upfront and transparent. Regulation is always good for companies that are well-managed as they get rewarded in the long-run.