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CY22 ends on a high note; demand buoyancy here to stay

Commercial leasing recovery on track; high vacancy a challenge

* The residential real estate sector ended CY22 on a high note as sales in the top 8 cities surged to a nine-year high of ~313,000 units, as per Knight Frank. Launches increased to ~328,000 units in CY22, exceeding sales for the first time in the last nine years, aided by robust demand and low inventory.

* As per Knight Frank, residential real estate prices across the markets rose by 4-7% YoY in CY22. Higher prices and the impact of 225bp rate hikes on EMI reduced housing affordability (as measured by EMI to income ratio) for the first time since 2011.

* While unit sales for the top 7 cities grew 34% YoY on a low base, the top 12 listed companies reported 24% growth in pre-sales, leading to a market share of 23% in CY22. We believe healthy demand momentum is likely to continue for the medium term and expect our coverage universe to report 15% YoY growth in pre-sales for FY24.

* Commercial real estate also reported a strong recovery, with gross leasing of over 52msf, the second-best absorption recorded in the history. However, supply matched demand, leading to stable vacancy of 17%. With a weakening global growth outlook, office leasing is showing signs of deceleration; hence, vacancy is expected to remain elevated over the next 6-12 months, affecting rental growth.

* We continue to prefer players with higher exposure to the residential segment and reiterate LODHA, PEPL, BRGD and MLIFE as our top picks.

Residential sales hit nine-year high; supply exceeds demand in CY22

* As per Knight Frank, sales in the top 8 cities jumped to a nine-year high of ~313,000 units (up 34% YoY) in CY22. Demand momentum remained intact throughout the year despite a 225bp rise in the repo rate, as sales in 4QCY22 stood at ~80,000 units, which was in line with the average run rate for the year.

* Similarly, launches also increased by 41% YoY to ~328,000 units, exceeding sales for the first time in the last nine years. Sustained momentum in demand and low inventory across top cities led to a surge in supply.

* As a result, inventory increased by 4% YoY to ~453,000 units. However, the inventory overhang, as measured through trailing 12 month sales, declined to 17 months v/s 23 months in CY21, which provides comfort even if supply continues to exceed demand in the near term.

Prices up 4-7% across cities; affordability declines for first time in 11 years

* Low inventory and strong demand helped developers pass on the cost pressure, with 4-7% price increases across the top 8 cities.

* The RBI’s move to tackle inflation with a 225bp increase in the repo rate in the last eight months has led to a 200bp increase in mortgage rates and a corresponding increase in home loan EMIs.

* As per Knight Frank’s affordability index, higher home prices and an increase in EMI have led to a decline in affordability for the first time since 2011 as the affordability ratio (as measured by EMI/household income ratio) increased by 100-300bp across cities.

* That said, the affordability ratio across cities still remains below the threshold of 50%, except for Mumbai (53%), and is materially lower than pre-Covid and 2010.

Top 3 markets outperform industry growth

* The top 3 cities, MMR, NCR and Bengaluru, outperformed industry growth, posting 35%, 67% and 40% growth, respectively. Sales across the markets surged to a nine-year high.

* Correspondingly, launches across the markets exceeded demand, except for Bengaluru and Pune, leading to an increase in inventory. NCR reported a 3x jump in supply to ~63,000 units.

* The inventory overhang in most markets, except for MMR and NCR, was below the comfortable level of 18 months, which is conducive for price hikes.

Listed peer’s market share steady; coverage to report 15% growth in FY24

* While sales in the top 8 cities grew by 34% YoY in CY22 on a lower base, the top 12 listed companies reported 24% growth in sales volume, leading to a marginal drop in the market share of listed peers.

* Sales volumes in MMR and Pune exceeded the previous peak; however, sales volumes in NCR and Bengaluru were still 8%/27% lower than their CY12-13 peaks. As we remain watchful of further growth potential in MMR and Pune, we believe Bengaluru and NCR are expected to contribute a large part of growth hereon; hence, overall industry growth will be modest at 5-10%.

* Most of the listed peers are targeting at least two new markets apart from their home market (Exhibit 51), which will lead to a further pickup in the market share of listed peers. We expect our coverage universe to report 15% YoY growth in pre-sales in FY24, 500bp higher than the expected market growth.

Second best year for leasing but momentum decelerating

* As per Knight Frank, the top 8 cities reported gross absorption of ~52msf in CY22, which was the second best in history and indicates a strong recovery in the aftermath of Covid. Completions (~49msf) matched demand and resulted in a stable vacancy rate of 17%.

* While full-year leasing was strong, Q4CY22 did see some deceleration in absorption, with the weakening global growth outlook hurting expansion plans of IT sector tenants.

* Overall, the IT sector continued its dominant position and constituted 28% of total leasing in CY22; however, the contribution was at the lowest level since CY17 and 1000bp below the average contribution of 38% in CY15-19.

* Gross leasing in Bengaluru increased by 19% to 14.5msf; however, the city’s contribution declined to 28%, in line with its historical average of 27% during CY15-19. Pune witnessed significant increase in share of co-working along with others as their combined share increased to 73% in CY22 v/s 28% in CY21

CY23 outlook: Residential to outperform commercial

* With a weakening global growth outlook, we expect global IT and BFSI companies will remain cautious about their expansion plans, and hence office leasing may remain muted for at least next six months.

* On the contrary, we expect residential demand to remain unabated despite further rate hike expectations, as the industry continues to witness long-term pent-up demand and as affordability will remain better than the pre-Covid level.

* We believe listed real estate players will continue to outperform the industry as they target scale-ups in markets beyond their existing exposure, which will play out in the next couple of years. * We reiterate our positive stance on the residential sector and prefer LODHA, PEPL, BRGD and MAHLIFE as our top picks in the sector.

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