The revival of the real estate sector over the past few years since the pandemic was nothing short of miraculous. The sector was in the doldrums for many years because of multiple reasons like inventory build-up, rising debt, high rates, and muted demand due to higher prices. Before the pandemic, commercial real estate experienced strong growth and remained in the top position as the leading asset class in the real estate industry, while the residential market struggled amidst sluggish demand and funding crunch.

However, the dynamic changed over the past 2 years, primarily influenced by the impact of covid. Both residential and commercial real estate developers were adversely affected by the pandemic. But the recovery has been quicker in the residential real estate, while the commercial segment is growing, but hasn’t still reached its pre-covid levels

In residential real estate, affordable housing (ticket size of Rs 45 lakh or below ) got a huge push over the past decade, but it’s taken a back seat to luxury housing. The high ticket size of luxury housing (Rs 1.5 crore and above) is a little deceiving because you may not find housing units in large Indian cities below the threshold. If there are exceptions, it is mostly because such properties come up in suburbs surrounding large Indian cities.

After a decade-long rough ride, the Indian realty sector seems to have finally found its footing. Sales of residential units in Q4FY23 in India’s top 7 cities were at 15-year highs. The prices in various markets have also seen notable growth, with Bengaluru, Mumbai, and NCR growing 7%, 6%, and 3% YoY, respectively.

The surging demand has put a smile on promoters of real estate companies, especially listed ones because their stock prices have gone through the roof. The share prices of leading developers like DLF, Prestige Estates, Godrej properties rose more than 25% over the past 3 months. This in turn has led to these companies raising funds by selling shares or raising funds through share sales, like in the case of Lodha (Macrotech Developers). Some real estate companies have taken the REITs route to deleverage their balance sheets. Prestige sold some of its mall properties to Blackstone, which was eventually listed under the umbrella of Nexus Select Trust (Prestige). K Raheja Group sponsored Mindspace Business Parks REIT and Embassy Group sponsored Embassy REIT also listed on the stock exchanges over the past 3 years.

But it’s not just residential real estate that’s booming. Commercial real estate is seeing the crack of dawn before its moment in the sun.

Commercial real estate picked up pace in H1FY23

Office leasing saw a rise of 40% to almost 56.6 million square feet in 2022, marking the second-highest growth in leasing after the peak observed in 2019 according to CBRE.

Also, the net absorption, which indicates the change in tenant demand compared to market supply, exceeded the 5-year pre-pandemic average (2015-2019) by 3.1. The surge in office occupancies was due to occupiers honoring their pre-existing commitments as the return to the workplace gained momentum across all industries post the pandemic.

Listed real estate players have also posted their best-ever financial results, with increasing top line, declining debt and lowest inventory levels since 2013. Nifty Realty has been one of the top performing sectoral indices with 30% and 38% return over the last 1- and 2-year period, respectively.

While these figures indicate a bull cycle for the sector, it is important to note that they may state only a fraction of the overall story. This is because the share of listed developers is less than one-third in the total addressable market.

Luxury housing gets a leg up due to the pandemic

The Covid-19 pandemic gave a boost to the real estate sector which was down in the doldrums because of legacy issues like introduction of the special law to regulate the industry. Then came the demonetisation and GST, which hurt the sector even more as more transactions started moving to non-cash modes.

After all economic activities ground to a halt during the first wave of the pandemic, the reopening of the economy saw the Centre and state governments introduce various measures that helped boost the realty sector. The reduction in stamp duty for affordable housing projects led to a surge in property transactions, particularly in Maharashtra and Karnataka. Additionally, the liquidity boost of Rs 30,000 crore for NBFCs and housing finance firms provided significant relief to distressed lenders facing liquidity constraints. Another crucial factor has been the series rate cuts announced by RBI since February 2019, which resulted in historically low home loan rates and a subsequent upswing in housing demand.

The unlocking of wealth in the startup space also played a significant role in driving real estate demand. The funding boom and the stock market rally attracted many startups to take advantage of the readily available liquidity by opting for public offerings or buyback of stock options. This in turn offered an opportunity for ESOP holders, particularly the startup founders and CXOs to sell their shares at soaring valuations and reinvest the proceeds in residential properties.

Moreover, the easy money policy in 2021 and 2022 led to record-high hiring and pay hikes across industries. With higher discretionary income, individuals were inclined to consider investing in residential real estate. This is especially true for luxury housing (apartments priced above Rs 1.5 crore) demand. Luxury housing now accounts for 22% of overall sales of real estate players. In Q4FY23, luxury housing saw a remarkable growth of 47%.

Meanwhile, the favorable dollar-rupee exchange rate and geopolitical uncertainty in the US and Europe caught the attention of NRIs, further fueling the interest in the premium real estate market. According to Zapkey’s Billion Homes Club study, over 150 luxury properties worth around Rs 7,500 crore were sold in 2022 to high profile individuals including business tycoons, Bollywood celebrities, and startup entrepreneurs.

Prominent names like Shekhar Bajaj of Bajaj Electricals, Siddharth Jain of Inox, N Chandrasekaran (and his family) from Tata Sons, were among those who invested in luxury properties in 2022.

Notably, few of these ultra rich profiles did not limit their investments to just one property, but rather bought multiple properties. For instance, the family members of Rahul Bajaj have reportedly bought 5 luxury apartments in Mumbai. Even renowned stock market investor and founder of Dmart Radhakrishna Damani who bought the most expensive house (exceeding Rs 1,000 crore) in 2021. He also bought another luxury property of around Rs 250 crore in 2022.

Capitalizing on the growing demand for luxury housing, leading developers accelerated investment in this segment. Overall, during Q4FY23, 27% of new launches were in the premium segment, with Delhi NCR and Mumbai leading in sales of apartments priced above Rs 1.50 crore.

For instance, for Bengaluru-based developer Sobha’s, the contribution of homes in the above Rs 3 crore segment to the total sales rose to 25% in FY23 from 7% just a year ago.

Then there is DLF’s property The Arbour, DLF. It sold all of its 1,137 apartments, priced at Rs 7 crore and above within 3 days of its launch. “This growing demand from consumers wanting to upgrade their homes and splurge more is a key reason why DLF will continue to focus on the luxury housing space”, said CEO, Ashok Kumar Tyagi.

Similarly, Macrotech Developers (Lodha Group), which earns over 60% of its revenue from the affordable and mid-income segment, highlighted the growing momentum in the luxury space during its Q4FY23 earnings call. As per the management, the company’s biggest success came from the luxury segment with Lodha Malabar crossing Rs 1,000 crore mark. Mr. Prashant Binda,CSO Lodha Group, also mentioned about the shift in the affordable and aspirational segments towards larger units, such as 1 BHK/2 BHK to 3BHK.

However, defining the luxury segment can be somewhat difficult due to different standards. Anarock, a real estate consultant, considers houses priced above Rs 1.5 crore as luxury. While Knight Frank India, another real estate consultancy, categorizes properties costing over Rs 10 crore as luxury housing. Different developers also have their own definitions, which may further vary based on the market. For instance, for Lodha in Mumbai, the average costs for luxury units range from Rs 35 crore at Lodha Ciel to Rs 125 crore at Lodha Malabar.

Regardless of the deal definition, it is evident that the demand for residential real estate is heavily influenced by the higher ticket size segment. A notable example is the Maharashtra government's record-high revenue collection of Rs 1,102 crore from property registrations in Mumbai for the month of Feb 2023. Although the number of registered properties declined 8% YoY, the revenue collection was 80% higher, due to the rising value of average deal size.

Some attribute the recent surge in luxury home sales to a last-minute rush to take advantage of tax deductions before the start of the new financial year on April 1, FY24. Until FY23, there was no limit on long term capital gain reinvestment arising from sales of investments. This led several unicorn promoters and management members holding ESOPs to sell their units and reinvest in luxury housing, taking advantage of the unlimited capital gain exemption.

However, in Union Budget FY24, Centre imposed a ceiling of Rs 10 crore for deduction on long-term capital gains on reinvestment in residential properties. As a result, many HNIs in top cities, including Mumbai and Bangalore, rushed to finalize luxury housing deals before the end of the financial year, leading to higher than the normal property registration in Q4FY23. However, now the rising focus of developers towards high-margin luxury segment can cause a supply glut.

Affordable Housing Losing Steam Amid Rising Costs

The uneven economic recovery, referred to as K-shaped recovery, hurt the low-income groups more. As a result, the affordable housing segment has been slowly losing its mojo. Builders are also finding it difficult to launch budget homes amid rising inflation of basic inputs. Data from real estate advisory Colliers shows that the cost of materials, which forms two-thirds of the overall construction cost, has jumped 32% since the end of 2019.

Rising interest rates is another discouraging factor. With the rise in repo rate by 250 basis points since May 2022, EMIs on fresh loans have increased by nearly 20-30% YoY. This has hurt demand. A report from Ambit Capital says that the value of disbursements in the 3rd quarter of FY23 remained stagnant compared to the previous year, while loan volumes declined by 4% in the same period. Moreover, the demand for loans to buy affordable homes has come down more significantly.

An SBI report says that during the months of Jan-Feb 2023, home loans of up to Rs 30 lakh accounted for approximately 45% of the total home loans disbursed, in contrast to 60% during the period from Apr-June 2022.

Despite considerable increase in home acquisition costs, the government's definition for affordable housing remains unchanged (houses under Rs 45 lakh and measuring not more than 60 sq. m). This presents buyers a challenging dilemma as they need to choose between enjoying government subsidies or acquiring a house that meets their space requirements.

Demand for commercial real estate shifting towards smaller spaces

After a good rebound in FY22, there seems to be some softness in demand for office space in Q4FY23. The net office leasing is down by 34% YoY and 4.5% QoQ across India’s 7 major cities. While Delhi NCR, Bengaulu, and Pune saw net leasing rise, Chennai, Hyderabad, and Mumbai saw a steep fall.

The challenging global environment has made companies more cautious about their technology spends, directly impacting India's IT services companies, which have historically been the largest tenants in office leasing. Real estate costs make up a substantial portion (15-20%) of the total expenses for IT giants. Amidst the slowdown in demand, IT companies are now focusing on downsizing their office spaces to sustain their margins. For instance, IT software firm Cognizant is planning to give up 80,000 seats or 11 million sq feet of office space, aiming to rationalize workspace and reduce the operational cost.

Apart from the cautious spends on office leasing, an emerging trend is the shift in the real estate portfolios of occupiers. With global uncertainty prevailing, more companies now prefer flexible rental spaces such as flex spaces and co-working spaces, which offer flexible lease terms and greater affordability compared to Grade A offices.

Though the recent pause in rate hikes by the RBI suggests that the interest rate has peaked out, a rate cut is unlikely in the near future due to surplus liquidity in the system. Moreover, concerns remain regarding the transition of previous hikes, as not all of the 250-bps hike has been passed on by the lenders.

Nevertheless, the luxury housing market appears to be more resilient compared to affordable housing, which relies heavily on policy interventions. Also, the weak income growth in the lower income bracket poses a significant challenge to the recovery in affordable housing. Going forward, the margin performance of developers will depend on the right product mix.

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