India Real Estate:Realty check,Far from inflection point

Realty Index up c30% but sales momentum continues to decline. Absorption inthe top 8 cities declined 11% y-o-y YTD May 2016 and 14% y-o-y for May, whilelaunches declined 47% y-o-y YTD and 68% y-o-y for May. Total inventoryoutstanding at 1,119msf is c34 months based on the past three months of theabsorption rate. Most cities saw a decline in absorption m-o-m, and we believe anymeaningful recovery would need positive incremental m-o-m numbers given the lowbase currently. For key cities, demand declined 23% YTD in Mumbai (down 27% inMay) and 14% YTD in Gurgaon (down 23% in May). Southern markets continued toface pressure with Bengaluru witnessing a 12% YTD decline (down 6% in May) andChennai declining 33% YTD (down 25% in May). Hyderabad looks positive YTD withan absorption rate of +16%, though this is down 2% y-o-y for May.

    Other interesting trends. After the euphoria in the office space over the past coupleof years, PE funds are tapping into retail opportunities by investing in malls. Thesegment looks attractive in terms of valuations as cap rates exceed 11%, whileexisting office cap rates are as expensive as 8%. Fundamentally, with retail spendingexpected to pick up as the economy improves and e-commerce hype fades, mallsmight start witnessing good consumption followed by positive rental reversions.。

    Our view on the sector. We reiterate our bearish call on the sector. In our report,India Real Estate: The light at the end of tunnel is an oncoming train, 11 May 2016,we outlined that recent government measures will not be enough to bail out thesector for now. Also, expectations of price cuts and the reluctance of developers tolower prices will likely prolong the stand-off and worsen cash flow. Although webelieve a price correction is likely, buyers may stay on the side-lines as they wait forsteeper discounts, stalling any increase in demand.

    What to do with the stocks We expect weaker sales momentum for existingprojects and lower prices for new launches. We have Reduce ratings on PrestigeEstates (PEPL IN, INR177.0, TP INR150), Sobha Ltd. (SOBHA IN, INR320.0, TPINR240) and Godrej Properties (GPL IN, INR361.7, TP INR280) due to the weaknessin the Bengaluru and Mumbai markets. We have Hold ratings on DLF (DLFU IN,INR152.1, TP INR125) and Oberoi Realty (OBER IN, INR300.2, TP INR250).