The Karnataka government today awarded the 9,187-acre Bidadi Knowledge City, which will be positioned as New Bangalore, to the country’s largest realty firm DLF Ltd, reports the Business Standard. This project is three times the size of DLF City, the realty firm’s flagship integrated township in Gurgaon.

The project will entail an investment of over Rs 60,000 crore and will be developed in a 50:50 joint venture with the Dubai-headquartered Limitless Holdings, a sister company of Nakheel and a part of the diversified Dubai World group.

DLF and Nakheel already have a 50:50 joint venture for developing two townships of 20,000 acres each at Gurgaon and south Maharashtra at an initial investment of Rs 40,000 crore. DLF will be sponsoring a -1.5 billion fund to finance the three townships it is developing with Nakheel. The company will sell a part of its equity in the townships to the fund.

The township will be based on the ‘walk-to-work’ ideology. It will comprise high-quality office space, residential developments, shopping malls, multiplexes, hotels and service apartments. Of the entire area of 9,178 acres, 6,000 acres can be developed by the realty firm.

The Knowledge City is located around 30 km from Bangalore and 15 km from Mysore, between NH-209 and Bangalore-Mysore Expressway, and will look to supplement the existing urban infrastructure of Bangalore. The project is conveniently located on the Bangalore-Mysore railway line and has an additional advantage of being on the Southern Freight Corridor.

In addition to that, New Bangalore is approximately 30 km from the existing international airport and 60 km from the upcoming Bangalore International Airport, to which to which it will be connected by an expressway.

The city will also have a dedicated Metro Rail connectivity to Bangalore. DLF, however, is also planning to develop airports and metro stations within the township. The project was awarded to DLF, following a global tender issued by the Bangalore Metropolitan Regional Development Authority (BMRDA). In all, 32 consortiums, formed by over 100 companies, had filed for the request for qualification (RFQ). DLF, however, had emerged as the sole bidder.

Private equity funds have continued to flow aggressively into Bangalore-based real estate developers, committing at least half a billion US dollars to four realty players.

Companies like Brigade Group, Shriram Properties, Confident Group and Skyline Builders are in the final stages of completing the paper work of tying up these investments. While Brigade is raising Rs 500 crore, Shriram is raising Rs 350 crore, and Confident and Skyline will be raising at least Rs 300 crore each. In addition to this, Umiya Holdings and Featherlite are also understood to be in active discussion with various PE funds for investments.

“Most of these investments are project-specific and are not at the enterprise level. Extensive due diligence was carried out on these commercial and residential properties before these funds were committed,” an industry analyst said.

According to industry sources, funds like JP Morgan Asset Management, Sun Apollo, Blackstone and Morgan Stanley are active in the real estate market.

Venture Intelligence data indicates that of the $3 billion India-specific PE funds raised during the first six months of 2007, around $2.5 billion were for realty deals.

“Sun Apollo, the joint venture between US-based Apollo and Khemka-controlled Sun Group, is the most aggressive of the lot as it has raised around $630 million for India-focused realty deals,” said a spokesperson for Venture Intelligence. JP Morgan, on the other hand, has raised $360 million.

Industry sources further indicate that Goldman Sachs is also stepping on the gas and understood to be closing at least two deals with Century and Confident Group.

“There are also some indications that there might be a second round of investment in the Mantri Group, which last year raised around Rs 350 crore from Morgan Stanley,” the analyst said adding that Morgan might once again look at investing in this round.

UBS Investment Research has recommended buy rating on DLF with a 12-month target price of Rs 750.

Initiate coverage with a Buy rating

We initiate coverage of DLF with a Buy rating and a 12-month price target of Rs750. DLF is India’s largest listed real estate company and we think it is well positioned to maintain its position in the near term because of the rapid roll-out of its large portfolio of IT/ITES special economic zones, and mid-range and luxury residential projects across India, aided by execution ramp-up.


Key share price drivers

We believe DLF’s key drivers over the next few years will be: 1) volume growth and lower cap rates in office space—recent events suggest IT SEZs can be capped below 8-8.5%; 2) volume growth in middle-income residential—73% of the 40,000 apartment launches over FY08-10E in the middle-income range; 3) execution and delivery—DLF has 49.2 msf under development, rising to 103.6 msf in FY10E.

Earnings depend on sale vs rental model

We forecast a FY08-10 EPS CAGR of 91%, with growth dependent on the timing of asset sales to DLF Assets (DAL) and other investors. We estimate DAL will buy 50-60% of assets sold over 2008-10, funded by IPO proceeds and borrowings. We project 155.9 msf in launches and 84.8 msf in sales in 2008-10.

Valuation: activity generation key to valuation

We value DLF at a 10% premium to its forward NAV. Of our NAV estimate, office comprises 56%, residential 30% and retail 14%. We believe the premium to NAV is justified as: 1) our valuation excludes hotels and SEZs; 2) comparable Asian stocks trade at a premium to NAV; 3) there is visible generation of activity to generate cash flow, and 4) NAV could increase. Key sensitivities are: 1) caprates; 2) property prices; and 3) discount rates.

The trouble for property stocks, arising out of the crisis in the US subprime market which was unearthed earlier this year, seems to be far from over.

The latest quarterly global property & REIT report from Standard & Poor’s (S&P) indicated that the seven-year bull run in the global property and REIT (real estate investment trusts) stocks finally stalled in the second quarter of calendar 2007. This was partly due to the fallout from the US subprime mortgage market.

After recording a steady rise for seven consecutive years, the global property and REIT stocks started slipping. The S&P report stated that the losses have been the highest in Europe. The US was a close second, propelled by the fall-out from the subprime mortgage market.

REITs took a bigger hit as the S&P-Citigroup Global REIT index dipped 6.6%. The global property index dipped 4.5% in the second quarter of 2007, while the S&P-Citigroup BMI Global Index rose 7.4% during the same period.
According to S&Ps analysis, a prolonged seven-year stretch of continuous gains, leading to excessive valuations, low yields and legitimate desire for profit-taking, caused a sell-off for this sector.

The emerging market property stocks, however, were the exception as the S&P-Citigroup emerging market property index gained 19.4% during the period. Property stocks from Chile, China, Egypt, Indonesia, Malaysia and Thailand had large double-digit gains to sustain the growth of emerging market property companies, even though REITs from South Africa and Turkey followed the general global REIT trend and showed negative returns.

In India, however, property stocks still form a minuscule part of listed stocks. REITs are still at a conceptual stage with the government yet to frame the norms for the product. High leverage, which provided much of the impetus for the large property company deals in the last few years, has lost its sheen, given the cracks in the subprime mortgage market and its attendant securitisation market.

Tougher loan standards and the retreat by large investment banks from the subprime market have put a brake on the hyper-aggressive deals. There is no immediate link between the commercial mortgage-backed securities (CMBS) market and the property market. However, the problems faced by the CMBS market, coupled with the ratings agencies’ tougher ratings standards on bonds backed by commercial mortgages, have put a brake on the liberal financing.

The total size of property deals in the US dropped dramatically in the second quarter to $6 billion, from over $29 billion in the first quarter.

The contagion spread globally with property markets taking hits in Europe and Asia. While 12-month returns still remain double-digit across all global regions, year-to-date returns for several regions have gone into negative territory with this quarter’s sell-off.

Realty major DLF Ltd recently launched 5,000 square foot apartments in Greater Kailash II in New Delhi -- not one of the city's tony addresses -- priced at an astonishing Rs 8 crore (Rs 80 million) and more, which comes to over Rs 15,000 a sq ft. Of these 60 still-to-be-constructed flats, DLF has sold around 12 to buyers through its "strictly by invitation" policy for luxury homes.

Then, in DLF's The Magnolias, a 410-apartment complex on an 18-hole golf course, is causing quite a stir. A 5,900 sq ft flat in New Delhi costs Rs 4.5 crore (Rs 45 million) -- a little over Rs 7,500 a sq ft. But the price has already shot up to Rs 9,000 a sq ft, and DLF has sold nearly 20 apartments at this price -- around Rs 5.25 crore (Rs 52.5 million). The 10,000 sq ft penthouses, 32 in the complex, are also a hit and DLF is selling them for Rs 10 crore (Rs 100 million). The company has only five to six of these left.

In Noida, Unitech has launched Grande, a project featuring highrise apartments and penthouses on a signature Greg Norman nine-hole golf course. Prices here start at Rs 1.5 crore (Rs 15 million) and go up to Rs 4.5 crore (Rs 45 million). The project was launched only a month ago, and industry experts expect prices to head north.

Last year, the number of millionaires in India grew by 20.5 per cent -- the second fastest in the world after Singapore. Realizing the market for super-luxury homes, more and more developers are coming up with million dollar homes (costing over Rs 4.1 crore or Rs 41 million), in formats ranging from condominiums and suburban town houses to golf villas.

According to Sandalwood High Street Residential, a division of Jones Lang LaSalle Meghraj, some of the best residences on the market in Mumbai today are more expensive than those in Dubai. Going by prices per sq ft, London is the most expensive at $7,000, followed by New York at $3,000, Hong Kong at $2,000, Mumbai at $1,000 and Dubai, just a little less than that.

In Mumbai, Shapoorji Palonji is collaborating with a local builder to shortly launch two 60-floor towers at Tardeo, where each apartment, sized 2,550-10,105 sq ft, will be designed specifically for the buyer. Apartments will begin only on the twelfth floor, with the first 11 reserved for parking and common utilities like a fitness centre. Brokers say the smallest flat here will cost Rs 6 crore (Rs 60 million).

Buyers are also eagerly awaiting Ispat Industries' launch of 14 duplex apartments at Peddar Road, each of which is expected to cost at least Rs 4 crore (Rs 40 million). On Napean Sea Road in Mumbai, Lodha Builders is selling a 7,200 sq ft apartment for Rs 4.32 crore (Rs 43.2 million), which comes to Rs 60,000 a sq ft.

Prices in Mumbai's suburbs have also hit the million dollar mark. The Hiranandani Group is selling a premium 72-apartment building in Hiranandani Gardens at Powai, with flats ranging between 4,880 sq ft and 4,925 sq ft, at prices starting at about Rs 5 crore (Rs 50 million).

Such prices are not limited to Mumbai and Delhi -- the two most expensive real estate markets in the country. In Hyderabad, Emaar Properties is developing villas and apartments along an 18-hole golf course in Boulder Hills.

Brokers say the project is so exclusive that just a visit to see a sample villa is nearly impossible to get. Each villa is expected to be sold for Rs 7-8 crore (Rs 70-80 million). Nitesh Estates is selling 4,500 sq ft duplex penthouses for around Rs 4 crore (Rs 40 million) at Bangalore's Langford Town.

At Chennai's Poes Garden, Vishranthi Homes is selling 4,000-4,386 sq ft apartments for Rs 5 crore (Rs 50 million) and above. In Pune's upmarket Kalyani Nagar, Kumar Builders is selling its last 5,322 sq ft bungalow for Rs 4.25 crore (Rs 42.5 million). It had sold the others a few years ago for less than Rs 3 crore (Rs 30 million).

All’s well that ends well. The cliche holds true for what is now India’s biggest real estate company DLF, which listed on the bourses last week. Soon after listing, the company became the eighth most valuable in the country and its promoters,K P Singh and family are now the fourth wealthiest Indians behind the Ambani brothers and Sunil Mittal. But people who followed the issue carefully know it was one of the most tumultuous IPOs in recent times. All’s well that ends well. The cliche holds true for what is now India’s biggest real estate company DLF, which listed on the bourses last week. Soon after listing, the company became the eighth most valuable in the country and its promoters,K P Singh and family are now the fourth wealthiest Indians behind the Ambani brothers and Sunil Mittal. But people who followed the issue carefully know it was one of the most tumultuous IPOs in recent times.

Right from the time the issue was conceived in the first quarter of 2006, it was plagued by controversy. There was intense speculation that a company with significant interests in real estate did not want DLF to get big money from the stock markets.

An executive from the rival’s camp reportedly told close associates, “The DLF issue in its current form will happen over my dead body.’’ Call it coincidence if you will. But soon after DLF filed its draft red herring prospectus (DRHP), reports that the company had short changed its shareholders on an earlier rights issue of debentures in November 2005 surfaced.

A public interest litigation was filed and the company received over 500 complaints from shareholders. The company eventually allotted 1.9 million shares with retrospective effect. Around the same time, real estate stocks started to crash on the markets. Of course, valuations of companies like Unitech and Ansal Housing had run up rather quickly.

But this crash shaved off nearly a third of their stock prices. Suddenly, DLF started to look expensive and its merchant bankers began to get to feel jittery. They advised against going to the market with an IPO. Even as all of this was happening, Sebi issued a new directive.

It said that real estate companies could get land banks valued, only if a clear title deed existed. The move, on Sebi’s part, was a well thought and fair plan to rein in errant real estate companies milking the primary markets. For DLF though, the order took the wind out of its sails. Sources said this directive shaved off Rs 100-150 from the proposed issue price. The reason being that when DLF’s public issue was first mooted, analysts rated the company highly for the land bank it held.

This land bank though, was held using smaller companies under different names as a front. This was because DLF reckoned that smaller companies could negotiate a better price for land than what DLF could. They had realised that often sellers quoted higher than market prices if DLF was the buyer.

Even as this drama was unfolding, a cabinet minister intervened on DLF’s part and warned the rival camp that some of the permissions it was seeking from his ministry would be delayed inordinately if they didn’t back off. They did and the issue went through. But like the rival had sworn, not in the form it was originally planned in. Though company sources would never confirm, DLF had plans to issue shares in the region of Rs 900-1,100,when it first filed DRHP. It eventually issued stock at Rs 525 and reduced the shares on offer

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Domestic and foreign demand for property in India has surged alongside rapid economic growth. There are now concerns that the market may be overheating.

Following a decade of stagnation in property prices, the real estate sector has been experiencing an unprecedented boom since 2004-05, with prices rising by over 50% on a compounded annual basis in some cities.

Price appreciation has occurred across the board, in major cities such as Bangalore, Delhi and Mumbai (so-called "Tier I" cities); "Tier II" cities such as Chennai, Hyderabad and Pune, which have established themselves as alternative outsourcing centers and business locations; and satellite cities and towns--"Tier III" cities--that have experienced price appreciation as economic activities have diversified and infrastructure has improved.

The Indian real estate market has been particularly buoyant; this can be attributed to unprecedented rises in disposable incomes, sharp increases in global liquidity, selective capital account liberalization, looser credit policies, a greater availability of leverage due to financial liberalization and a consequent increase in mortgage lending and price increases that have themselves fueled a speculative boom.

There are concerns that the property market has risen too much and too fast in relation to economic fundamentals, which remain robust. Several structural factors should ensure that property prices continue to grow robustly, assuming that the economy maintains a trend growth rate of 7% to 9%.

These factors include rising incomes and a growing middle class, a favorable demographic structure, the nuclearization of families and subsequent drop in family size, increased urbanization (currently 30%), high population concentration (one in every six people in the world lives in India) and greater financial and capital market development, which will boost the under-developed mortgage market.

Nevertheless, there are concerns that the market may be on the verge of a sharp downturn.

In the near-term, the key challenge for the Reserve Bank of India is reining in inflation and cooling the market through monetary and credit tightening without creating a hard landing that could have significant political and economic consequences. The RBI has taken steps to curb liquidity by tightening monetary policy. It has increased interest rates several times over the past few months, to 7.75%, and the resulting squeeze appears to be cooling the property market.

The RBI is also closely monitoring the exposure of banks and financial institutions to real estate, urging them to exercise due diligence in assessing credit risks, and tightening loan regulations. However, the banking sector is strong and diversified enough to withstand a property price correction, provided it is localized.

Over the longer term, improving transparency would strengthen the property sector (particularly in Tier II and III cities).

The sector remains fragmented, and transactions costs are high. The regulatory framework also needs to be improved substantially to ensure that the rights of both home sellers and buyers are taken care of. Fostering financial and capital market development--including the promotion of asset securitization--will also be critical in ensuring the availability of a strong retail market for housing finance, while ensuring that banks are not overexposed.

Property prices have soared on the back of rising purchasing power, relatively easy financing and significant optimism about growth prospects. While there is a risk that the market may be overheating, the RBI has moved to minimize the impact of any correction on the financial system and the rest of the economy. Beyond the current cycle, growth in the sector is likely to remain strong on the back of rising demand for houses, malls and office space.

Source: Oxford Analytica's

The finale: Issues arising from the latest Red Herring Prospectus

Our note dated 10 May 2007 (DLF Limited - The third coming - Big issue, bigger concerns)compared the differences between DLF's first draft Red Herring Prospectus (DRHP) filed on 11 May 2006 and the one filed on 29 March 2007. DLF recently released its final RHP on 25 May 2007. We note the changes in the final RHP and the last draft.


Land bank

• Payments due for the land are slightly lower at INR 54.5bn as of 30 April 2007 compared to INR 62.6bn as of 31 December 2006
• Land yet to be acquired is substantial with at least 4,691 acres still to be acquired
• Ambiguity in residential area sold as earlier DRHP mentions 0.6m sq.ft of residential area sold between 1 December 2006 and 26 March 2007 whereas our calculation shows that only 0.5m sq. ft of residential space was sold between 1 December 2006 and 30 April 2007

Financials

• Final RHP lists FY07 figures; There is a big jump in net worth compared to 9mFY07 figures as subsidiaries issue non-convertible, non-cumulative, redeemable shares worth INR 9.5bn carrying a surprisingly low coupon of 0.01% for Q4FY07
• As of 30 March 2007, DLF Assets Limited had not paid INR 23.5bn it owed for the sale of commercial properties to it by DLF Limited. Final RHP reports that as of 25 May 2007, DAL had paid INR 15bn. During the analyst meeting on 29 May 2007, the management says that DAL had paid the entire amount
• Adjusted for above two transactions, the debt-equity ratio is fairly high at 5.9 compared to the revealed figure of 2.5

IPO proceeds usage and IPO size

• IPO of 175m shares at a price band of INR 500-550 will raise between INR 87.5-96.25bn
• INR 35bn to be used in land acquisitions, another INR 35bn to be used for construction and development costs, remaining INR 17.5-26.25bn to be utilised for repaying debt

Valuations

• The annualised FY07E EPS, based on the adjusted financials, would be INR 4.4 (number of shares at 1,704m). At the upper end of the price band, the FY07E P/E is 125, and, at the lower end, it is 113.6
• Our tentative NAV estimate is INR 323 per share

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Let us put things in perspective. The presentation made by Housing and Development Finance Corporation has time and again, maintained the fact that shortage of dwelling units in India is in the vicinity of around 19 m (there has been a marginal fall in the same, but not a very meaningful one). So, the demand side has never been an issue. Ultimately, every individual dreams of owning a house at some point in his life.

In our view, it is important to focus on the 'affordability factor', which is determined by broadly three parameters i.e. the property cost, income levels and interest rates. Prior to 2005, it is a known fact that the fall in interest rates on housing loans and income tax sops to individuals on housing loan repayments, boosted demand for housing in the country.

The graph below (Source: HDFC presentation) highlights the trend in property prices in South Mumbai, the income growth and the affordability (affordability here is derived by dividing the cost of the property by average annual income). As is evident, the rise in income accompanied by a decline in property prices, till 2000, resulted in property being 'affordable' for individuals. After remaining stable till 2002, property prices starting accelerating at a faster pace led by robust demand, with supply still lagging.

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But if one were to extrapolate HDFC's figures post 2004 (these are our assumptions), property prices in Mumbai have more than doubled (depending upon the location). Assuming a 9 per cent growth in annual income of households in general, it is clear that property is not that affordable as it is made out to be. This is because prices have skyrocketed and the supply side is still lagging (in terms of good quality construction).

Add to this the fact that interest rates have started moving up in the last one year. With further rate hikes on the anvil, we expect affordability to worsen even further. While we are not trying to predict property prices, basic economics tells us that demand tends to slow down when prices start accelerating beyond affordability.

Real estate fundamentals

Demand drivers for real estate
Demand supply-gap for quality residential housing, favourable demographics, rising income levels, availability of financing options as well as fiscal benefits available on availing of home loan are the key drivers supporting the demand for residential construction. In addition to this, demand for office space from the IT/BPO (business process outsourcing) segment is expected to continue due to emergence of India as a preferred outsourcing destination. Also, buoyancy in organised retail is expected to result in huge demand for real estate construction.

Key parameters for selecting a real estate stock
For an average investor, size of the 'land bank' remains the sole criterion for investing in real estate companies. More often than not, their decisions are based on these land banks with little or no importance attached to the execution time and the margins of the projects. While land banks definitely give an indication of visibility in growth of the company's revenues, there are a few other factors that investors need to consider before investing in stocks from the sector. These include:

Management: Though management is an important criterion for investment across the sectors, we believe that the same assumes greater significance in the real estate industry considering the poor disclosure standards followed by the companies.

Key ratios: Not giving much importance to the land bank, investors should focus on working capital to sales (considering high gestation period of projects), debt to equity, operating margins and return on capital employed ratios. Also, considering the huge amount of funding required for timely execution of projects, investors should also keep a check on the possible dilution in equity, going forward.

Valuations: We believe that 'price to earnings ratio', is an appropriate metric for valuing construction companies. Besides, investors can also use 'price to sales ratio' for valuation purpose. As we have explained earlier that 'land bank' should not be 'the' key criteria for looking at real estate stocks.

Also, while valuing such companies, one has to practice caution. When valuing a real estate company, taking the 'best' price per square foot skews the investment decision in favour of risks. It is therefore, pertinent to value real estate companies based on a 'normalised' square foot price. It is also important to focus not just on the 'price per square foot' but also the 'profit per square foot'. This is because real estate developers increase prices also because of higher input costs (including legislative policy changes).

Some pitfalls

With respect to real estate stocks, a new theme has emerged in the Indian equity markets - 'land banks'. In order to meet the rising demand for homes and commercial spaces in a fast developing economy, construction activity has reached feverish levels in the country.

Not only real estate companies but companies from other sectors having free land for development are also witnessing significant appreciation to their market values on the back of expectations that the free land would eventually be developed and monetised.

While there is nothing wrong with this approach, the fact remained that even loss-making companies with poor fundamentals are witnessing a sharp run up in their market capitalisation and this kind of euphoria is really uncalled for.

As far as the real estate companies are concerned (companies with real estate development as their core business), these companies are entirely being valued based on their land banks i.e. the total land they own and no thought is being given to important considerations such as track record of the management, execution capabilities and balance sheet strength.

Further, even the lands are being valued using a high per square feet rate, presumably on the back of the assumption that they will keep on increasing indefinitely!

The risks with respect to investing in real estate stocks only get amplified considering that projects have high gestation periods and are highly capital intensive. Add to this the fact that there are no clear valuation methods available for valuing land accurately; not to forget, the highly varied costs of land in different parts of the country.

Source: rediff.com

At least for now, banks will not hike rates. Over a period of time, banks have hiked interest rates, following a hike in the cash reserve ratio (CRR) by the Reserve Bank of India (RBI).

The realty sector is interest rate sensitive.

Unitech (up 9.20% to Rs 435.55), Indiabulls Real Estate (up 6% to Rs 322), Ansal Housing (up 9.48% to Rs 282.45), Mahindra Gesco Developers (up 7.85% to Rs 658), Parsvnath developers (up 7.16% to Rs 318.20), Akruti Nirman (up 4.66% to Rs 397.50), and Sobha Developers (up 4.86% to Rs 855.35) had surged.

Indiabulls Real Estate saw high volumes of 63.36 lakh shares, while Unitech clocked 33.66 lakh shares.

At a monetary policy meeting today, RBI kept its key borrowing rate, known as the reverse repo, steady at 6% and held the bank rate, used to price long-term lending, steady at 6%.

There was no change to the cash reserve ratio (CRR) beyond a previously announced increase to 6.5%, due on 28 April 2007.

The central bank reduced interest rate ceilings on non-resident deposits. It proposed allowing corporates to repay more external commercial borrowings (ECBs) ahead of schedule, proposed increasing the aggregate ceiling for overseas investment by mutual funds to $4 billion from $3 billion, and increased the foreign portfolio investment limit for listed firms.

The steps could ease some of the upward pressure on the rupee, which has risen to nine-year highs against the dollar. The RBI has intervened heavily in the currency market in recent months, to offset upward pressure on the rupee from tighter monetary policy and inflows of capital from abroad.

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