Sucheta Dalal :The realty bubble: will it survive when reality bites?
Sucheta Dalal

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The realty bubble: will it survive when reality bites?  

Nov 27, 2006

It is now obvious. No matter what some experts say, India’s realty market is in the grip of a dangerous bubble. In fact, it is prudent to remember that the many celebrated experts quickly lost their perspective when they start chasing any excessively hyped sector of the economy; and this time they are chasing a completely unregulated, black money infested market that is being touted as India’s hottest new wealth machine.

Surely there is enormous irony in the fact that foreign investors and realty brokers, operating out of swish hotels and offices are ramping up the prospects of India’s realty, even though their frequent visits to Delhi ought to enlighten them about the devastating consequences of decades of lawlessness that make it impossible to verify a clean title to property.

The story is more or less the same all over India whether in the metros or emerging boomtowns. Property registration and clear titles are a serious enough problem in Kolkata for HSBC to ask the West Bengal Chief Minister to introduce on-line property registration. Before that happens, the municipal corporation must stir itself to issue proper occupation certificates. Mumbai does have on-line property registration, yet, harried apartment owners in a suburb discovered (only after receiving demolition notices) that their flats, financed by leading mortgage institutions, were constructed on illegally occupied forestland.

The situation harks back to the IPOs (Initial Public Offering) and mega issues of the early 1990s and the absurd global dotcom bubble at the turn of the century. Investigations into the dotcom bust revealed that celebrated analysts of blue chip financial conglomerates had deliberately misled investors about valuations. Many were subsequently sacked, punished or imprisoned.

If buying personal property is so difficult, how impossible would it be for ordinary investors to evaluate the convoluted disclosures and risk factors in the prospectuses of realty companies? At the same time it is unrealistic to expect them to stay away from a hot new sector. A few fund managers honestly admit that they are unable to evaluate landbanks claimed by realty majors either in terms of the legal validity of titles, property rates and post-development valuation claims (especially when it comes to holdings in smaller cities). Yet, many IPOs have already raised public money through expensive placements and continue to be quoted in the secondary market at astronomical prices.

This happens because of a convergence of vested interests to keep property rates and share prices at absurdly high levels. Yet, it is only the Reserve Bank of India (RBI) that has sounded the alarm bell so far and is making a serious effort to dampen the irrational exuberance in this sector. It has made it difficult for banks to lend recklessly to the realty sector by restricting Foreign Institutional Investment in realty IPOs and capping funding per individual for all IPO investment to Rs 20 lakhs.

The exorbitant valuation of realty stocks harks back to the Global Depository Receipts (GDRs) issues of the 1990s when foreign investment bankers actively encouraged price ramping and ended up duping their own investors. Most GDRs subsequently fell to a fraction of their offer price and some never recovered.

Can the Securities and Exchange Board of India (Sebi) do anything to protect investors in time? Yes it can. Past experience shows that investors usually lose money due to greed and hype by subscribing to expensively priced IPOs or through secondary market investment. But investors lose money just as fast when their well-paid fund managers are induced to buy expensive stocks either due to pressure from investment banks of the same management who lead manage these issues (officially, every financial conglomerate claims Chinese Walls and points to compliance procedures, but they have never worked during any manic phase) or their own greed. Investors lose money either way.

But Sebi now has a tested tool in IPO grading of 11 companies where there is clear evidence to show that institutional investors are forced to stay away from IPOs that get a low grade. Sebi must quickly extend IPO grading to every issue from the realty sector, which is fraught with every conceivable illegality in documentation, ownership, regulation and even simple measurement of constructed property. Sebi also has clear examples of issues such as Sobha Developers where the regulator allowed the IPO to proceed after enumerating a set of risk factors that are impossible for ordinarily diligent investors to understand; and where part of the land holding is in subsidiary companies controlled through employee directors.

In any case, it is unfair to expect ordinary investors to be able to verify landbanks claimed by developers, value them, assess the potential for future litigation or understand complications such as Transfer of Development Rights (TDR). It is a myth perpetuated by the financial sector that there is a common-sense approach to evaluating realty IPOs.

Developers such as the K. Raheja Group’s Ishaan Real Estate, Hiranandani and others are probably smart to list on overseas bourses such as Singapore or AIM of London. It is easier to raise money abroad and those investors are better placed to absorb the shock of a downturn whenever it happens. Many companies, however, prefer to raise money locally, not because of some nationalistic sentiment, but because the risk of litigation for false claims is higher abroad.

The Financial Times of London recently noted India’s realty boom saying, "Indian property developers are seeking to raise up to $4bn through domestic and international share offerings by the end of the first quarter of 2007 in a flurry of listings that will see the effective birth of a listed property sector in the country." It is up to the government and the regulator to ensure that the lawlessness of this sector does hold up the country to worldwide ridicule once the hype vanishes and reality begins to bite.

-- Sucheta Dalal