Seeking Alpha in Indian Real Estate

As U.S housing prices come down to more sustainable levels after a prolonged boom, one can only wonder if we can expect the same story to be played out in other economies. Maybe there is some alpha waiting to be picked up. One place that stands out from a sustainability perspective is India, where real estate, whether residential or commercial, seems to have completely disconnected from local economic fundamentals.

Imagine the dusty suburbs of Bangalore, Delhi and Mumbai. Imagine neighborhoods with high rises that have no reliable power or water supply, battered roads if at all, no public transport and a shadow of crime such that locked houses aren’t safe even for a day. Now imagine these houses commanding prices that match prices in expensive New Jersey suburbs. Go figure. Or have a look here. Or if you have time, here. Perhaps there are positive returns to be had in a bet on these. But as John Paulson was quoted in the WSJ , “you can’t short houses”. But maybe we can short some of the companies that build and sell these houses.

The Indian equity markets have enjoyed a tremendous bull run over the past few years. In 2007, the Indian markets were up 47%. Real estate was up even more on a frenzy that makes New York and London decidedly tame. Seeing the time to cash in, multiple ‘mega-issues’ or IPOs from real estate developers came out in 2007. Exorbitantly priced to begin with, they did not disappoint their investors. These IPO stocks outperformed the index (the one that was up by 47%!) by a handsome margin. We look at how some of the larger public offerings have done since they were listed. Terrific!

Which brings us to the point of this post. How sustainable are half a million dollar apartments in a country with an average wage of about $1000 (a year)? Sure there are rich people in poor countries. Maybe enough to keep things going merrily forever. But maybe not.

Most people do believe that this is a bubble that is bound to burst. Perhaps it is only a question of when, and not if. But as said Keynes – the market can stay irrational for longer than you can stay solvent. There is no shortage of alpha seekers (and of academics and economists ridiculed on television) that were hurt calling a false top to the real estate market in the US. The same can happen anywhere, but given the fizz going out of the global markets, the Indian bubble may probably be short lived too.

Sourcing alpha

One bet may be to short some or a diversified portfolio of these real estate companies. The Indian markets have already seen a correction in 2008, and that may or may not continue. These stocks do contain significant beta, so to guard against the risk of the general market going up, perhaps a market neutral short position in some of these companies may be desirable. As is the nature of the game, many of these companies have not been listed for too long, so betas that I calculated in the table below are probably unreliable but perhaps not a bad starting point for making an estimate for the future.

Here are some tickers (on nseindia.com, or add .ns after the ticker for Yahoo Finance) with some data. All information is approximate, US dollar conversions have been done using a single rate of Indian Rupees 40 = USD 1. Notice the volatility in the stocks, they go up and down fast for sure. Also look at their fantastic profit margins. Who cares about EBITDA when net income to revenue ratios are straight out of wonderland!

click to enlarge

Profiting from the strategy

For investors in the US, it is not easy to gain non-systematic exposure to a particular company or sector in India. There are a few funds such as The India Fund (IFN), Morgan Stanely India Investment Fund (IIF), iPath MSCI India (INP) and more recently, WisdomTree India (EPI), that provide broad based exposure to the Indian market, but nothing that would specifically target a particular stock or a sector.

However, there are a number of Indian stocks that are listed either on the NASDAQ or the NYSE as ADRs. Many of them are also included in the broader Indian S&P Nifty-50 market index (referred to above). These include the following:

List of Indian stocks listed in the US that are also a part of the S&P Nifty-50 market index:

• Dr Reddy's Labs (RDY)
• HDFC Bank (HDB)
• ICICI Bank (IBN)
• Infosys (INFY)
• Satyam (SAY)
• Satyam Technologies (SIFY)
• Sterlite (SLT)
• Tata Communications (TCL)
• Tata Motors (TTM)
• Wipro Ltd (WIT)

The list above covers industry, banking, communications and technology, but does not include any exposure to the real estate sector - except probably with the exception of HDB and IBN that have mortgage lending operations in India.

This opens up an interesting possibility - consider building a synthetic portfolio where one goes short on the entire market using IFN, IIF or INP and simultaneously going long on a portfolio of individual stocks listed above in a way that the net exposure is only to real estate or related stocks. Unfortunately, real estate stocks currently comprise only about 4% of the Indian stock market capitalization, and as of the date of this post only Unitech is part of the Nifty-50. That makes this strategy a bit tricky to achieve but in the coming days, as DLF and other Indian companies get included in the Nifty-50, it would be possible to create a portfolio that is strongly correlated (positively or negatively) to the Indian real estate sector.

If someone has any ideas or suggestions on how this strategy could be refined to target the desired exposure, do send me your comments.

Comments

[ikkyu]

Quite interesting. Thanks!

[DeepakShenoy]

Prices are already going down in India (though urban real estate and condos are hugely valued and people tend to pay huge premiums as compared to the US, even in a slump). Specifically, in Bangalore panic pricing is setting in. Even in Delhi and Mumbai prices have slowed down and there aren't too many transactions happening - both in commercial and residential real estate.

I'm in India and I can short them all - but I just don't think it's right to do it now. The national budget, usually a big important thing here, is up on the 29th and could contain sops for the sagging real estate sector, or for real estate investments in general. 29h is also the first day after the current month's futures expiry so if I had to short, I'd choose the end-of-day of the 29th to start.

[sasian]

why cant Indian real estate lending be converted into CDOs without the junk element.. the market could then finance low cost housing for the millions and offer decent returns to investors..

[Mukul]

Most originators of mortgages are flush with funds and are happy to hold the mortgages and earn a return instead of securitizing and getting it off their books. Even if they were to do that and do more originations with the money raised, that would only push up the prices of existing real estate. I don't know of anywhere where CDOs are used to "low cost housing for the millions"? There are poor people in the US too - the most developed market for collaterized securities - but have you seen CDOs being used to "low cost housing for the millions "?

[Zyx]

Calling a top in real estate is always a challenge, but afforability and real estate valuations are totally out of sync in India. The real estate market will correct severely at some point of time, though the valuations that compaies like DLF, Unitech, etc. enjoy is based largely on land banks that they purportedly own (limited transparency) based on hyped valuation of these land banks

[Yogesh]

Real Estate prices are held up artificially in India by builders. There aren't any actual buyers at the moment. A walk down an area like Bandra/Khar in Mumbai is proof enough. Several new malls are empty and so are the newer buildings.

In 1997 real estate prices corrected by over 70% in parts of Bombay. The same thing is going to happen.

[manish]

superb article! the real estate mkt is still not as transparent and liquid as the stock market is and the dd/ss gap is still so significant that while one will have corrections the trend continues to remain UP

[mariyam j]

An excellent article. I live in Cochin, Kerala, where the real estate prices have shot through the roof. Expecting an IT boom, villages surrounding Cochin have had their prices up in the last 2 years from Rs. 15,000 to Rs. 700,000 per cent! And every other villager is a property dealer. Many people do multi deals simultaneously, all precariously balanced. But all factors which contributed to Kerala boom are negative now. Interest rates are up, Gulf remittances are at an all time low, uncertainties in the IT sector and an in-fight ridden and incompetent state government prevents thriving industries, new mosquito-spread diseases like Chikungunia etc. threaten tourist inflow. In short everything is negative for real estate in Cochin, which, I guess, is a microcosm of Indian real estate market.

What is happening now is that prices have not fallen significantly, but there is a great tension. There are no buyers, but sellers are not giving in. I think it is a matter of a few weeks before the crash begins. And I was thinking of a good way to short Indian real estate market. Your suggestion has given me some food for thought. Will work on it. Thanks again.

[ani]

Mariya, keep you money you will witness a break down in cochin real estate market as these builders and brokers manipulated the common man for 2 years. Now it has come to a stage where these builders on going projects are almost dead!! After the sub prime banks are very much critical about the applicants repaying capacity. Inflation will really squeese the average person who invested in realestate because these people spend 80% income for repayments.

wait and see...there is Ups and down. I have witnessed same fate years back where builders pushed the apartment with huge loss!

[EclecticInvestor]

I know of villagers who have become instant millionaires and brokers who have become builders. I think cycles occur, and if you are present in a cycle at the right time, you ride the crest. Nonetheless, I see in Mangalore, gulf-based Indians, are starting to pick apartments for Rs 3000 per sq ft, in a place, where electricity is hard to come by. These were rates that existed in 2005 in Mumbai suburbs. I have been given a quote of 3900 psf in a place like Bajpe, with stories of 4 -lane highways and new airport etc. Well, Im not saying these things dont work. they do, but entering at the top of any cycle doesnt. Today, we are at the top!

[EclecticInvestor]

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