India Property Sector

● We assume coverage on the India real estate sector, with OUTPERFORM on Sobha Developers, Oberoi and Prestige. We prefer stocks with exposure to property markets with lower investor participation (south India), falling inventory levels in office and the ability to re-lever balance sheets in the current down-cycle. We are cautious on NCR-based developers, including DLF, due to high inventory overhang and investor demand in local market.
● We develop a framework to assess developer cash flow cycles and key indicators to help investors time the cycle better. We believe the residential cash flow cycle is nearing trough levels,
while the office and retail cycles are expected to enter a recovery phase from FY13E. The turn of the interest rate cycle, price cuts and asset sales serve as tactical indicators for real estate stock
outperformance.
● We recommend looking at through-cycle average ROEs for the longer term; stocks with lower delta of near-term ROE to the longer-term average (such as Sobha) appear good multiple rerating candidates, in our view.

Fundamentals approaching trough levels On residential demand, our analysis of RBI data suggests mortgage additions in key metros across India have been stagnant since March 2007 versus strong growth seen during FY02–07. While this makes a developers. Higher investor demand increases the amplitude of local property cycles and affects cash flow cycles of developers during low liquidity. South Indian residential markets appear at lower risk currently, as the proportion of investor activity is lower.

The office and retail segments, which account for nearly 40% of gross asset value (GAV) for larger developers, have been weighed down by rising vacancies since 2008. This, in turn, has affected rents and expanded cap rates. We expect office occupancies to trough in 2012 (2H FY13E) and the revival of the sector can reflate RoEs back to 2007 levels. Bengaluru appears the better positioned office market in the current cycle, in our opinion.

Tactical view: Positioning for recovery Our framework suggests that low liquidity and increasing residential inventory overhang point to an impending price cut, which can have a positive impact on developer cash flows as volumes begin to pick up. Tactically, price cuts in the residential sector and asset sales serve as inflection points for listed developer stocks.

India Property Sector Valuation metrics