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Residential market - a new dawn; Top picks: DLF, Sunteck and Macrotech

We believe that the stage is set for a multi-year upcycle in India’s residential real estate market given the improvements in 1) supply dynamics due to industry consolidation, and 2) housing demand due to enhanced affordability. Following multiple supply-shocks (GST, RERA, demonetization, ILFS crisis, Covid-19), India’s ‘active developer’ count in FY21 declined 35% from FY12, while new supply was at ~65% of total absorption in FY21. The inventory overhang is likely to decline further to 21 months (near previous-cycle lows) by FY24E, from 28 months in FY21 and a high of 37 months in FY17. On the demand front, home affordability is at a decadal high, aided by low mortgage rates, tax breaks and smaller unit configurations.

Based on new launches till Jun’21, we expect FY25 to see the lowest supply of completed units since FY09, and this may drive price-appreciation, reigniting investor demand. New launch absorption rate (key measure of buyersentiment) has been consistently improving since FY17, and reached a 10- year high of 42% in FY21 (+9pps YoY), indicating green-shoots. We believe we are in early-stages of a residential real estate upcycle. Our top picks are DLF (Dec’22 TP: Rs530), Sunteck (Rs740) and Macrotech (Rs1,250). Key downside risks are rapid increase in interest rate and excess/irrational supply.

* Industry consolidation: The funding squeeze following the ILFS crisis in 2018 has hastened industry consolidation. The 35% drop in India’s active developer count supports: 1) favorable supply dynamics—inventory overhang is likely to decline continually to near previous-cycle lows; and 2) market-share gains for listed developers—their share in new launches doubled to 8% in FY21 from 4% in FY12, matching their total absorption share.

* Home affordability aiding demand: Housing affordability is at a decadal high, aided by a combination of three factors: 1) mortgage rates are at an all-time low; 2) embedded tax breaks for first-time homebuyers are resulting in ~2% effective mortgage rate (ATS of Rs4.5mn), which is on par with prevailing rental yield; and 3) unit configuration is now smaller and avg. prices have been stagnant. Finally, weak real returns in alternative investments (such as FDs) and potential rejig of asset allocation from equities may also spur investor demand, in our view.

* Green shoots visible: India’s residential real estate market is at an inflexion point with a shift in demand from ready inventory to under-construction projects—pan-India new launch absorption rate surged to a 10-yr high of 42% in FY21, up 9pps YoY. The recovery has been broad-based, with MMR up 11pps YoY, Bangalore +7pps and NCR +5pps. Overall, the market sentiment has improved markedly, with demand outside of completed inventory gaining steam, as reflected in buoyant sales guidance (+30-50% YoY) of listed developers: Godrej (Rs100bn in FY23), Lodha (Rs90bn in FY22), DLF (Rs40bn+ FY22).

* Top picks are DLF, Suntech and Macrotech: Our stock preference is driven by: 1) favorable micro-market presence, 2) visibility on existing landbank monetization, and 3) demonstrated ability to expand beyond existing micro-markets. We initiate coverage on DLF, Sunteck and Macrotech with a Buy rating, and on Oberoi with a Hold. We introduce our proprietary ‘NAV premium’ framework, based on a ‘continuing business’ model, which implies a 10-35% premium over Development NAV for coverage stocks.

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