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Is the Real Estate Bubble Bursting?

Comments Off on Is the Real Estate Bubble Bursting?   |   February 19, 2007    01:54pm   |Contributed by nakul

WHEN BIG trees fall, they fall with a thud. The market is still reeling from the complete collapse in realty stocks over the last fortnight. And now everyone wants to know whether this was just a bubble and a passing fad.

As often happens with new things, markets in their love of novelty overestimate prospects and thus overprice assets. It happened with eyeballs in the Internet dotcom craze and it has happened here with land bank values for real estate stocks. Back in September when the real estate frenzy was unfolding we heard DLF will do an IPO with an ascribed market cap of over Rs. 100,000 crore, as it had a strong land bank.

The market started calculating the land bank value of all realty stocks and giving it a “multiple” of that as market value! The implicit assumption: every square inch of this land bank will be developed with zero execution risk, that today’s prices can be extrapolated infinitely and wonder of all wonders that every square foot of property will obviously find buyers at these prices. Everyone played along but now it seems ridiculous that the market actually looked at these stocks with such green eyeshades. Hindsight is always 20:20.

All bubbles need to be pricked. This one has been pricked by rising interest rates. In the light of this new reality how should you approach property stocks? First, get back to basics. Like any other sector, cash-flows, revenues and earnings should be the yardsticks for valuation. Good old discounted cash flows and PE multiples should work for real estate stocks as well. Assume that not all the built-up capacity will be sold easily.

Remember the old maxim: everything is good at a price. And the Indian real estate story is very far from over. The froth has to be skimmed. Most stocks have corrected between 30 and 50% already. Very soon some good quality companies will be available cheap. But you may need to be patient.

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