By M H Ahssan
Drive through any of India's major cities and it will be impossible to go a mile without running into brightly colored cranes, construction rubble and men in yellow helmets scurrying up and down skyscrapers. Commercial high rises, residential townships, industrial parks and shopping malls are exploding into existence, encouraged by both long-term and speculative investors. Oversized private equity commitments by a growing number of foreign investors and home-grown financial institutions are helping to feed the frenzy.
But several astute industry watchers have begun poking big holes in that picture. For one, they say that many foreign investors have actually brought in only a small portion of their promised investments. Second, soaring land prices and price resistance from buyers are narrowing investors' margins significantly. Finally, they note that concerns continue to run high about the regulatory opaqueness for real estate ventures, bureaucratic red tape and the absence of title insurance, in addition to a host of other issues. India Knowledge@Wharton spoke with prominent private investors, property developers and brokerage firms to understand how these factors are tempering investors' appetites for Indian real estate.
With yields between 30% and 40% during the past two years, India's real estate industry has been the toast of global investment funds. But expectations for future returns have been sharply reduced to between 12% and 20% over the next few years. For many foreign investors, this means having to weigh Indian real estate opportunities against deals that offer comparable returns in other emerging markets like Eastern Europe or Latin America.
Fears of a real estate bubble and an overheated economy have led India's central bank to require a lender cutback on real estate loans. That move has pushed up interest rates, lowering consumers' appetites for home financing and simultaneously raising rents for apartments and offices. Most Indian real estate companies are privately held and their financial information is not readily available. The absence of comprehensive market data across product types like office, retail, industrial and residential properties further hurts the ability of investors to read the right signals, and the occasional rumor of a large deal going bust or a property developer resorting to a distress sale can damage investment sentiments far more than warranted.
More Hype than Actual Investments
Clearly, local investors understand the terrain far better than foreign investors. Much of the foreign capital committed to Indian real estate ventures has yet to be invested, says Aashish Kalra, co-founder and managing director of Trikona Capital, a private equity firm with offices in New York City, London and Mumbai. "Last year, less than $1 billion [was actually invested in] Indian real estate. That's less than the value of half a building in Times Square," he says. That compares with market estimates of between $15 billion and $20 billion in foreign capital headed for Indian real estate.
Kalra cited these figures during a panel discussion on real estate investing at a recent New York City event organized by The Indus Entrepreneurs (TiE), a network of entrepreneurs founded 15 years ago in Silicon Valley. "A negligible amount of foreign capital will get invested in Indian real estate in the next 24 months," he told the panel.
Sameer Nayar, managing director and head of real estate finance-Asia Pacific at Credit Suisse, offers a similar assessment. "There is a lot of hype about capital going into Indian real estate ... [but] not a lot of money is actually going in," he says. Extracting good returns from those investments calls for significant local market expertise in dealing with regulatory and other obstacles. "You make money because you can deal with the problems, and that's why your returns could be 50%," he adds. "If it were an easy market to work in, you would make only 15%."
Short-term Disenchantment
In April 2006, Trikona Capital group firm Trinity Capital raised 250 million pounds ($500 million) for Indian real estate investment in a public offering through London's Alternative Investment Market (AIM). Kalra says his company has deployed about $400 million in Indian real estate projects over the past year.
Including Trinity, about a dozen real estate funds targeting India have raised a combined $2 billion in the past year through listings on the AIM. Most of them are currently trading at levels significantly below their offer prices, revealing investor disenchantment. Trinity's share made its debut in April 2006 at one pound; it now trades at about 86 pence. Hirco, an Isle of Man-domiciled company promoted by the Mumbai-based Hiranandani Constructions group, raised about 382 million pounds ($755 million) from its IPO last December; since then, its shares have lost considerable sheen, down from 5 pounds to about 390 pence in the second week of May. Exceptions include Unitech Corporate Parks, which listed on the AIM last December at 93 pence and now trades at 96.25 pence.
"We see the opportunity [in Indian real estate], but we also see the risks and challenges involved," says Chanakya Chakravarti, managing director of real estate at Actis, a London-based private equity fund that manages assets of about $3.4 billion. Actis plans to set up a $300 million India real estate fund. It already has two other existing funds with an estimated equity of $475 million that have invested in Indian real estate, auto ancillaries and other industries. "Each fund has a unique risk-return profile, and we work with these. For us, India is a long-term story," he adds.
Chakravarti lists three main risks or challenges that real estate investors in India will be up against in the short term. The first, he says, is an oversupply of office space in the major and second-tier cities. A hazy regulatory framework fostering indecision and delayed investments is another concern. Finally, he notes, opaque deal-making processes that narrow the exit routes will deter serious investors.
"The property market today is rife with uncertainties. Prices as well as interest rates have been rising," says Anuj Puri, managing director of real estate services firm Trammell Crow Meghraj, the Indian joint venture of Dallas, Tex.-based real estate services firm Trammell Crow and the Meghraj Group, a financial services firm in London. "It is not advisable to expect any short-term gains; but of course, for long-term investors, India's strong fundamentals are still intact. A long-term investor can expect average returns of 15% to 20% per year."
Vikas Oberoi, managing director of Oberoi Constructions in Mumbai, says the risk-return profile for real estate investments is far brighter for those who have accumulated land inventory at prices much lower than prevailing levels. "The average net margin in today's market is 20% to 25%; we can easily do 15% better than the market," he says. Oberoi claims his company can achieve those higher returns because, among other reasons, "most of the land has been bought earlier."
Oberoi Constructions has an inventory of 15 million square feet of mostly prime land in Mumbai. At today's prices, Oberoi expects it to generate gross revenues of $2.2 billion. The company is focused mostly on for-sale residential apartments, although it dabbles in shopping malls, hotels and other commercial property lines. Oberoi expects his company to post $200 million in revenue this year, rising to $300 million in 2008.
This past January, Morgan Stanley's Special Situations Fund invested $152 million for a 10.75% stake in Oberoi Constructions, effectively valuing the company at about $1.4 billion. Oberoi says the untapped upside in his company's land bank was a major attraction for the institutional suitors it attracted. For instance, five years ago it bought a land lot with 8 million square feet in Mumbai's northwestern suburb of Goregaon for Rs. 100 crore ($24 million). Oberoi says the property would be worth 20 times more today.
"Where is the supply? There is only demand," says Oberoi. "In fact, I want the market to stabilize or [prices to] come down because then we would get land at cheaper prices. It is absolutely a seller's market."
Second-tier Migration
The most visible changes in the Indian real estate sector include the emergence of well defined product categories, the division of the market into tiered cities and a widening of financing options.
In the past, real estate was sold either as residential or as commercial property. With the maturing of the market and globalization of the investor base, the categories have been sharpened and new ones established. "Investors in the residential market are very different from the office and retail space investor," says Sanjeev Dasgupta, CFO and head of investments at Kshitij Investment Advisory Services, part of the Future Group, a large Mumbai-based owner of shopping malls across the country. In the residential sector, investors are in for high returns and are willing to take high risks, he says. This also allows for easy exit, although the risk of a mismatch between potential and real returns is high, he adds.
According to Poonam Mahtani, a national director of retail services firm Colliers International in India, "The investment risk is lower in the metros, but prices there are much higher than those in tier II cities." Several equity funds have consciously focused on tier II cities, because they believe that this offers the most potential. "Land prices are skyrocketing. Buying to sell is a very risky strategy. Land prices are way beyond levels that will generate a decent return. It doesn't make sense to invest any more unless you go to second- or third-tier markets."
Kalra, too, sees the markets outside of India's major cities as the most attractive, simply because they are not the low-hanging fruit sought by the early crop of investors with relatively lower risk appetites. "There are lots of opportunities outside the main metros. India has 30 cities with a population of a million people each," he says. Adds Dasgupta, "The returns are huge in tier II cities, where there is a large untapped potential." He believes that this sector will see a rental yield of 12% to 14% in the next few years.
In office space, experts see a migration towards second-tier cities. A recent report by Deutsche Bank on real estate trends notes, "As the demand for modern space has continually increased, new office locations have had to be developed in the south and east of the urban area (Mumbai and Delhi)." In Mumbai, secondary business districts have emerged in recent years, including the Bandra-Kurla complex in the central suburbs, 25 miles from the old commercial hubs in the southern end of the city.
Much-needed Transparency
For foreign investors, one troubling fact is a pan-India phenomenon: inadequate transparency in land valuations they use to price their investments. In an interview last month, M. Damodaran, chairman of the Securities and Exchange Board of India, discussed the lack of clarity in real estate companies' disclosures, especially with respect to their land banks. "We sought clarity ... on matters like, 'What does your land bank comprise, [and] what are the valuation aspects you have indicated?'" he told the India news wire service. "Where there is only an agreement to develop land, there must be complete disclosure. All such agreements are to be made available for inspection," he said, adding that he preferred land valuations to be made at current prices and not on the basis of future projections.
Trammell Crow Meghraj's Puri agrees. "There is a marked lack of transparency, corporate governance and accountability among India's real estate developers. There also continues to be a serious lack of quality infrastructure. In addition, India scores low in terms of congenial political environment in terms of the real estate sector. This means that there is a lack of clarity in pertinent policies."
But Puri also believes those issues will soon fade away as India's real estate markets mature. "Although real estate is a regional and highly location-specific industry, India will replicate the events that occurred in emerging markets like Mexico and Central Eastern Europe [including Russia, Bulgaria and Poland]," he says. "In these countries, too, foreign investments were the primary drivers for transparency, accountability and higher capital appreciation in the real estate sector."
Thursday, February 12, 2009
Real Estate - Reeling under debt
By M H Ahssan
Unitech, the second biggest real estate player is overburdened with short term loans and is struggling to keep its head above water. The company's difficulties are further compounded since they are unable to raise fresh loans to service existing ones.
Overburdened with short-term loans and facing serious cash-flow problems, India's second biggest real estate player Unitech Ltd is struggling to keep its head above water. It is facing difficulties in raising fresh loans to service the existing ones, with bankers and financial institutions wary of lending to the real estate sector when stock markets are in the dumps. Meanwhile, credit ratings agencies have downgraded the company's various loan instruments on concern that it might default on repayment. The company has failed to mobilize required Rs. 5,000 crore fund as per schedule. And given the widespread perception that the real estate sector is due for further price correction, Unitech's fund mobilization plan seems unlikely to be going anywhere.
Unitech has a total debt of about Rs 8,000 crore, of which Rs 2,500 crore was due for repayment in the period up to March 31, and another Rs. 2,500 crore later in 2009. But taking advantage of the government's stimulus package, Unitech has got loans worth Rs 1,000 crore rescheduled. It is negotiating with banks for roll-over of another Rs 500 crore loan. As part of the second stimulus package, the Reserve Bank of India has relaxed non-performing asset (NPA) classification norms for commercial real estate advances, which are restructured till June 2009.
Meanwhile, the Industrial Finance Corporation (IFCI) sold 1.75 crore shares pledged with it by Unitech promoters at the National Stock Exchange (NSE) in a bulk deal. The IFCI resorted to this move after the promoters defaulted on repayment of loans raised against the mortgaged shares. That indicates that Unitech is having problems raising money.
The IFCI's move that came just ahead of the extraordinary general meeting (EGM) called by the company on January 19 to seek investors' approval for raising Rs 5,000 crore to meet its loan repayment obligations, put downward pressure on Unitech's share prices. Analysts expect a further drop in the coming trading days.
Hardnews finds out, Unitech promoters have been periodically pledging shares since March 2008 to raise money. The promoters borrowed Rs. 200 crore from Indiabulls Financial Services, which was repaid in November 2008. Analysts believe about eight per cent of the promoter shares are pledged with lenders. One of the non-banking finance companies (NBFCs), DBS Chola Finance, had on December 24, 2008 sold 1.28 crore shares of Unitech's shares.
Meanwhile, international credit ratings agency Fitch has downgraded Unitech's various loan instruments on concern that the company might fail to raise funds to meet repayment obligations on its short-term debts. Fitch has said that the downgrade reflects the company's continued delay in raising the required funds as earlier projected and increasing uncertainty regarding its ability to service its interest cost and fulfill its immediate debt and land payment obligations.
Fitch has also noted that Unitech's immediate ability to service or refinance its debt obligations is largely dependent on asset sales and the cash inflow from Telenor ASA to repay an estimated Rs. 1100 crore of debt repayment due during January. While the company has made some progress on its asset sales and fundraising from other sources, the quantum and timing of these remain uncertain, increasing the risk of delays in servicing its debt obligations in a timely manner.
"The rating downgrades also reflect the rapidly deteriorating real estate sector and the likely impact on Unitech's operating performance. It anticipates that operating performance in 2009 will continue to be weak due to the significant slowdown in demand for properties. Fitch will continue to monitor the company's financial and operating prospects, as well as its liquidity position," as said in an official statement. Fitch has also put Unitech on the watchlist for further downgrading in case it fails to service the large payments falling due in January.
Meanwhile, Unitech's board has approved the management's proposal to raise Rs 5,000 crore through debt and equity issues in the company's EGM on January 19. Sanjay Chandra, Unitech managing director, was reported to have said that the proposal was just an enabling provision. "The company could raise these resources through private placement, public issues on overseas stock exchanges, non convertible bonds, foreign currency convertible bonds or a combination of these," quoted Chandra. He, however, declined to share specific details.
Ironically, Unitech's troubles also began when the RBI started tightening lending norms for the real estate sector towards the end of 2007. Significantly, the Indian realty was one of the top-performing sectors during the recent economic boom as property prices across all segments went skyrocketing on spurt in demand due to increased economic activities. The low interest rates, easy availability of loans and strong foreign investment inflows further helped to fuel the property market boom. Carried away by the bullish sentiment, Unitech Ltd went on a borrowing spree to support its growth plans.
Meanwhile, a bubble was building in the property market. The government woke up to it late in 2007. But by that time, the bubble had already taken on dangerous proportions. It was too late to secure a soft landing for the overheated property market. When the RBI put the brakes on lending to the realty sector, Unitech was caught unawares.
Later, rising interest rates on home loans forced buyers to postpone plans. Besides, the big retail chains, the segment whose requirement of commercial space was a key factor in fueling the property market boom, also started cutting back their ambitious expansion plans on emerging signs of slowdown in the wider economy. This has created a huge supply side glut.
The government had asked the RBI to relax NPA norms for the realty sector on the calculation that developers would use this breathing space to liquidate their piling up stocks for repaying loans. However, despite benefiting from the RBI's loan restructuring programmes for the realty sector, most of the developers are sitting on their excess stocks in the desperate hope of a turnaround in the market, though some new projects are on hold due to fund shortages. And that is the reason why the market is betting on the opposite possibility of market correction.
Industry analysts say that the current slowdown in the domestic real estate market, stratospheric property prices and high interest rates have adversely impacted the liquidity profiles of real estate companies. And banks' continued risk-aversion has further compounded financial woes of the real estate players.
Over the past one year, demand for real estate has declined significantly in almost all the major markets in the country, with the economy slowing down and interest rates on home loans ruling high. Since this came after a boom period of four years which saw home prices chart a steep rise in all markets, the pain is acute. Currently, while property developers are still holding on to these elevated prices, potential home buyers are deferring plans in anticipation of a price correction.
As for commercial space, demand for the same has also been affected by the current slowdown in the economy and the global meltdown in the stock markets. Until recently, the demand for commercial space was being driven largely by IT, IT-enabled services and the financial services sectors. But in view of the economic slump, a slowdown in the growth of outsourcing services is anticipated, which in turn would impact the expansion plans of the IT/ITES sector.
Faced with a tight liquidity situation and a dip in profits, financial sector companies too have pruned their growth plans. But on the other hand, there is a surplus on the supply side. The liquidity problem for commercial properties is especially grave because developers are required to incur construction expenditure upfront, while payments from tenants and buyers they receive are mostly staggered, unlike in the case of residential projects where construction is partly funded out of customer advances.
Unitech, the second biggest real estate player is overburdened with short term loans and is struggling to keep its head above water. The company's difficulties are further compounded since they are unable to raise fresh loans to service existing ones.
Overburdened with short-term loans and facing serious cash-flow problems, India's second biggest real estate player Unitech Ltd is struggling to keep its head above water. It is facing difficulties in raising fresh loans to service the existing ones, with bankers and financial institutions wary of lending to the real estate sector when stock markets are in the dumps. Meanwhile, credit ratings agencies have downgraded the company's various loan instruments on concern that it might default on repayment. The company has failed to mobilize required Rs. 5,000 crore fund as per schedule. And given the widespread perception that the real estate sector is due for further price correction, Unitech's fund mobilization plan seems unlikely to be going anywhere.
Unitech has a total debt of about Rs 8,000 crore, of which Rs 2,500 crore was due for repayment in the period up to March 31, and another Rs. 2,500 crore later in 2009. But taking advantage of the government's stimulus package, Unitech has got loans worth Rs 1,000 crore rescheduled. It is negotiating with banks for roll-over of another Rs 500 crore loan. As part of the second stimulus package, the Reserve Bank of India has relaxed non-performing asset (NPA) classification norms for commercial real estate advances, which are restructured till June 2009.
Meanwhile, the Industrial Finance Corporation (IFCI) sold 1.75 crore shares pledged with it by Unitech promoters at the National Stock Exchange (NSE) in a bulk deal. The IFCI resorted to this move after the promoters defaulted on repayment of loans raised against the mortgaged shares. That indicates that Unitech is having problems raising money.
The IFCI's move that came just ahead of the extraordinary general meeting (EGM) called by the company on January 19 to seek investors' approval for raising Rs 5,000 crore to meet its loan repayment obligations, put downward pressure on Unitech's share prices. Analysts expect a further drop in the coming trading days.
Hardnews finds out, Unitech promoters have been periodically pledging shares since March 2008 to raise money. The promoters borrowed Rs. 200 crore from Indiabulls Financial Services, which was repaid in November 2008. Analysts believe about eight per cent of the promoter shares are pledged with lenders. One of the non-banking finance companies (NBFCs), DBS Chola Finance, had on December 24, 2008 sold 1.28 crore shares of Unitech's shares.
Meanwhile, international credit ratings agency Fitch has downgraded Unitech's various loan instruments on concern that the company might fail to raise funds to meet repayment obligations on its short-term debts. Fitch has said that the downgrade reflects the company's continued delay in raising the required funds as earlier projected and increasing uncertainty regarding its ability to service its interest cost and fulfill its immediate debt and land payment obligations.
Fitch has also noted that Unitech's immediate ability to service or refinance its debt obligations is largely dependent on asset sales and the cash inflow from Telenor ASA to repay an estimated Rs. 1100 crore of debt repayment due during January. While the company has made some progress on its asset sales and fundraising from other sources, the quantum and timing of these remain uncertain, increasing the risk of delays in servicing its debt obligations in a timely manner.
"The rating downgrades also reflect the rapidly deteriorating real estate sector and the likely impact on Unitech's operating performance. It anticipates that operating performance in 2009 will continue to be weak due to the significant slowdown in demand for properties. Fitch will continue to monitor the company's financial and operating prospects, as well as its liquidity position," as said in an official statement. Fitch has also put Unitech on the watchlist for further downgrading in case it fails to service the large payments falling due in January.
Meanwhile, Unitech's board has approved the management's proposal to raise Rs 5,000 crore through debt and equity issues in the company's EGM on January 19. Sanjay Chandra, Unitech managing director, was reported to have said that the proposal was just an enabling provision. "The company could raise these resources through private placement, public issues on overseas stock exchanges, non convertible bonds, foreign currency convertible bonds or a combination of these," quoted Chandra. He, however, declined to share specific details.
Ironically, Unitech's troubles also began when the RBI started tightening lending norms for the real estate sector towards the end of 2007. Significantly, the Indian realty was one of the top-performing sectors during the recent economic boom as property prices across all segments went skyrocketing on spurt in demand due to increased economic activities. The low interest rates, easy availability of loans and strong foreign investment inflows further helped to fuel the property market boom. Carried away by the bullish sentiment, Unitech Ltd went on a borrowing spree to support its growth plans.
Meanwhile, a bubble was building in the property market. The government woke up to it late in 2007. But by that time, the bubble had already taken on dangerous proportions. It was too late to secure a soft landing for the overheated property market. When the RBI put the brakes on lending to the realty sector, Unitech was caught unawares.
Later, rising interest rates on home loans forced buyers to postpone plans. Besides, the big retail chains, the segment whose requirement of commercial space was a key factor in fueling the property market boom, also started cutting back their ambitious expansion plans on emerging signs of slowdown in the wider economy. This has created a huge supply side glut.
The government had asked the RBI to relax NPA norms for the realty sector on the calculation that developers would use this breathing space to liquidate their piling up stocks for repaying loans. However, despite benefiting from the RBI's loan restructuring programmes for the realty sector, most of the developers are sitting on their excess stocks in the desperate hope of a turnaround in the market, though some new projects are on hold due to fund shortages. And that is the reason why the market is betting on the opposite possibility of market correction.
Industry analysts say that the current slowdown in the domestic real estate market, stratospheric property prices and high interest rates have adversely impacted the liquidity profiles of real estate companies. And banks' continued risk-aversion has further compounded financial woes of the real estate players.
Over the past one year, demand for real estate has declined significantly in almost all the major markets in the country, with the economy slowing down and interest rates on home loans ruling high. Since this came after a boom period of four years which saw home prices chart a steep rise in all markets, the pain is acute. Currently, while property developers are still holding on to these elevated prices, potential home buyers are deferring plans in anticipation of a price correction.
As for commercial space, demand for the same has also been affected by the current slowdown in the economy and the global meltdown in the stock markets. Until recently, the demand for commercial space was being driven largely by IT, IT-enabled services and the financial services sectors. But in view of the economic slump, a slowdown in the growth of outsourcing services is anticipated, which in turn would impact the expansion plans of the IT/ITES sector.
Faced with a tight liquidity situation and a dip in profits, financial sector companies too have pruned their growth plans. But on the other hand, there is a surplus on the supply side. The liquidity problem for commercial properties is especially grave because developers are required to incur construction expenditure upfront, while payments from tenants and buyers they receive are mostly staggered, unlike in the case of residential projects where construction is partly funded out of customer advances.
Tuesday, February 3, 2009
Trickle of customers has builders bending backwards
By M H Ahssan
It was after a lull of six months that a city builder witnessed a rare sight— a potential customer. Not having sold a single property in the last few months, the builder says he was in no mood to take any chances. So, he brushed aside his marketing manager, flashed his best smile, fished out the brochure and gave his best performance. And, as luck would have it, he got a chance to repeat the same act two days later. Two sales in a week, he now beams, are a “positive sign’’ and hopes that these are signs of things to come.
City builders agree. They say after State Bank of India cut its floating home loan rate, which was soon followed by several other banks, they have finally seen a trickle of buyers who had turned elusive over the last few months. Builders, who would routinely send their marketing teams to meet clients and net deals, are now doing the needful themselves.
Anand Reddy, executive director, PBEL, says that while earlier customers had to approach the builders, now “we are going to them’’. “We are making ourselves available 24X7 and trying to establish a comfort level with them, sharing details on home loans and the banks they could approach,’’ Reddy says.
Besides, tapping new customers is the mantra for most builders now as they are now approaching individual entrepreneurs and those in businesses other than IT.
But the excitement of receiving customer calls is evident. “Just today (Tuesday) I met a client who is on the verge of buying property and is looking for the right bank to take a loan from,” says Anwar Pasha, general manager, Sillicon Property Dealers, his excitement palpable over the phone. He shares that he is making personal visits now as against talking to potential customers over the phone. “I now have a one-on-one interaction with them,’’ he says.
Most builders are giving out each and every detail of the property they are developing in the fond hope that at least one detail would woo the customer. C Shekhar Reddy, president of Builders’ Forum, says that builders in the city over the last two weeks have suddenly seen some increased activity after a period of gloom and predictably, wouldn’t want such consumers to look any other way and grab their full attention.
Several real estate firms in the city had started downsizing over the last few months with much of their activity coming to a standstill. Construction activity of many upcoming projects had stopped and their phones had stopped ringing. Some builders had started placing advertisements explaining the downward economy and how it was the right time to buy property.
But consumers were clearly not convinced and what could eventually stir them was the drop in home loan interest rates.
Prem Kumar head of Doyen Constructions says that after a lull in the real-estate market the reduction of interest rates have brought some much needed cheer to the sector. “People want to take advantage of the situation and a number of buyers who had temporarily put their plans of purchasing property on hold, are now approaching real estate agents,” he says.
Shekhar Reddy notes how the high interest rates in the last few months had led to buyers thinking twice before availing of loans. “We were expecting a cut in home loan rates by March or April but fortunately the banks decided to reduce their rates earlier than expected,” says Reddy, adding that with builders lowering their property prices and interest rates declining conditions have become more balanced and conducive for buying.
However, some like Ashwin Rao, director of Manbhum Constructions is not too hopeful, with many private banks that control a large chunk of the home loan sector not slashing interest rates yet. “The rate cuts are uneven and even SBI’s move to increase demand is not adequate to encourage customers. And even though property prices have fallen they haven’t decreased at the rate that customers were expecting, so it is not going to bring a great change in the market,’’ he predicts.
It was after a lull of six months that a city builder witnessed a rare sight— a potential customer. Not having sold a single property in the last few months, the builder says he was in no mood to take any chances. So, he brushed aside his marketing manager, flashed his best smile, fished out the brochure and gave his best performance. And, as luck would have it, he got a chance to repeat the same act two days later. Two sales in a week, he now beams, are a “positive sign’’ and hopes that these are signs of things to come.
City builders agree. They say after State Bank of India cut its floating home loan rate, which was soon followed by several other banks, they have finally seen a trickle of buyers who had turned elusive over the last few months. Builders, who would routinely send their marketing teams to meet clients and net deals, are now doing the needful themselves.
Anand Reddy, executive director, PBEL, says that while earlier customers had to approach the builders, now “we are going to them’’. “We are making ourselves available 24X7 and trying to establish a comfort level with them, sharing details on home loans and the banks they could approach,’’ Reddy says.
Besides, tapping new customers is the mantra for most builders now as they are now approaching individual entrepreneurs and those in businesses other than IT.
But the excitement of receiving customer calls is evident. “Just today (Tuesday) I met a client who is on the verge of buying property and is looking for the right bank to take a loan from,” says Anwar Pasha, general manager, Sillicon Property Dealers, his excitement palpable over the phone. He shares that he is making personal visits now as against talking to potential customers over the phone. “I now have a one-on-one interaction with them,’’ he says.
Most builders are giving out each and every detail of the property they are developing in the fond hope that at least one detail would woo the customer. C Shekhar Reddy, president of Builders’ Forum, says that builders in the city over the last two weeks have suddenly seen some increased activity after a period of gloom and predictably, wouldn’t want such consumers to look any other way and grab their full attention.
Several real estate firms in the city had started downsizing over the last few months with much of their activity coming to a standstill. Construction activity of many upcoming projects had stopped and their phones had stopped ringing. Some builders had started placing advertisements explaining the downward economy and how it was the right time to buy property.
But consumers were clearly not convinced and what could eventually stir them was the drop in home loan interest rates.
Prem Kumar head of Doyen Constructions says that after a lull in the real-estate market the reduction of interest rates have brought some much needed cheer to the sector. “People want to take advantage of the situation and a number of buyers who had temporarily put their plans of purchasing property on hold, are now approaching real estate agents,” he says.
Shekhar Reddy notes how the high interest rates in the last few months had led to buyers thinking twice before availing of loans. “We were expecting a cut in home loan rates by March or April but fortunately the banks decided to reduce their rates earlier than expected,” says Reddy, adding that with builders lowering their property prices and interest rates declining conditions have become more balanced and conducive for buying.
However, some like Ashwin Rao, director of Manbhum Constructions is not too hopeful, with many private banks that control a large chunk of the home loan sector not slashing interest rates yet. “The rate cuts are uneven and even SBI’s move to increase demand is not adequate to encourage customers. And even though property prices have fallen they haven’t decreased at the rate that customers were expecting, so it is not going to bring a great change in the market,’’ he predicts.
Friday, January 23, 2009
India's Construction Boom: Boon or Bust?
By M H Ahssan
Almost every Indian company -- big or small -- that has some expertise in construction finds itself flooded with orders that are nearly three to four times its annual sales. The size and pace of orders could threaten the development of the country's already creaking and short-supplied infrastructure. "Execution is the biggest issue in India today, especially on time and within budget," says Pratyush Kumar, president and chief executive officer of GE Infrastructure, India.
Although construction companies are prepared to spend money to raise their production capacities, experts say that a shortage of skilled talent and the limited ability of capital equipment suppliers to meet demand mean that skillful project management and innovative solutions will be necessary to prevent bottlenecks.
India's planned infrastructure outlay over the next five years has been revised upward by various government authorities, from $150 billion to almost $475 billion. The country currently spends around $21 billion a year on infrastructure, compared to China's $150 billion. Corporate capital spending tracked by research firms like the Centre for Monitoring Indian Economy (CMIE) is at a multi-year high in India. The effect of all of this demand can be seen in the order books of infrastructure builders, which have also reached a multi-year high.
Consider just a few examples: Punj Lloyd, one of the country's largest engineering, procurement and construction (EPC) companies, earned 72% more income for the quarter ended June 2007, at Rs 1,4179.5 million ($359.43 million). Yet, its order backlog rose to Rs 152,250 million ($3,859.32 million). Larsen & Toubro, one of Asia's largest vertically integrated engineering and construction companies, announced that gross sales rose 47% in the quarter ended September 2007 to Rs 55.74 billion ($1.41 billion), and yet its order backlog rose to a record Rs 400 billion ($10.14 billion). At Wartsila India, which had an order book of one times sales in 2003, the backlogs have risen to almost three times that amount. And Patel Engineering, which expects to close the current year with sales of Rs 16,000 million ($405.58 million) has an order book of Rs 54,000 million ($1.37 billion).
Rupen Patel, managing director of Patel Engineering, says that alone, the planned roll-out of highways by the National Highways Authority of India (NHAI) over the course of the next 10 years exceeds the total turnover of all construction companies in India today. "Construction companies have never seen such a boom in India. Even if [they all] did only road projects and left all work on building airports and power plants aside, NHAI still has more work to offer than firms can take," he says.
"The turnover of all construction companies in India last year was around $15 billion. This year it may rise to $20 billion. But a total of $50 billion is [slated] to be spent on construction every year in India, which requires a capability of 2.5 times the sector's size," says a senior executive at IVRCL Infrastructures who did not wish to be named. India will need several billion-dollar, pure-play construction companies to be able to execute such projects, but it has only a couple of such companies, calling into question the ability of the private sector to build out infrastructure in a public-private partnership mode.
Foreign firms might view the huge gap between the sector's existing capabilities and those required as an opportunity to make their mark in India. Indeed, the infrastructure spending boom in India has benefited a bevy of overseas companies, such as Dongfang Electric Corporation in China and Doosan Heavy Industries and Construction Company in Korea, who are filling orders for turbines used to generate power. A number of leading global construction companies, such as Australia's Leighton Holdings and Italian-Thai Development Public Company, have also entered India.
Skilled-labor Shortage
It's difficult to fathom the words "talent shortage" in a country of a billion people that's getting younger over time. But speak to any infrastructure builder, and you hear anecdotes about shortages of trained fitters, welders, masons and plumbers. "Whether we will get the people necessary to support the growth is the real challenge. Both engineering and blue-collared skilled workers are in short supply. Fitters and welders are not available in the numbers you want. The industry also needs mechanical engineers who have worked in capital goods industries and would like to pursue a career [in that sector] rather than switch into software," says Allen Antao, vice president, process equipment, at Godrej & Boyce Manufacturing Company.
"Once, India had such a supply of labor that we never thought we'd run out, but today things are certainly moving towards that," says Satish Magar, chairman and managing director of Magarpatta Township Development & Construction Company, which has developed a 250-acre plot near the city of Pune in western India.
According to Magar, semi-skilled labor was once brought in from the neighboring south Indian states of Andhra Pradesh and Karnataka, but now projects in the west Indian state of Maharashtra are pulling in laborers from far flung Eastern states of Orissa and West Bengal where surplus laborers are still available. Importing lower-skilled workers from overseas would be too problematic, "given the significant wage differentials and the effect such inflated costs would have on a project's viability," says Patel.
The construction industry remains one of India's largest employers. Realizing the need for skilled vocational staff, the industry has begun collaborating with academic institutions to either train staff for plumbing and masonry type work, or to set up in-house training programs. "We are tying up with industrial training institutes for education and vocational development as well as organizing local training at our school," says Godrej's Antao.
Training is important, because by mechanizing their operations, companies have needed to substitute low-end, semi-skilled artisans with comparatively high-end machine operators who are in short supply. As a result, wages for crane operators and others with higher levels of expertise have risen faster than the average for other industrial workers. For instance, Sanjay Verma, head of ship power for Wartsila India, estimates that welders have seen their wages rise by 30% to 40%, while those for traditionally well-compensated naval architects and marine engineers have risen by 50% over a 3-4 year period.
Antao says that the appreciation of the rupee and the rise in wages are happening so quickly that their effect on costs cannot be countered with a rise in productivity. "If margins drop as a result, companies may not be able to commit large sums for capital investments with the same freedom as we would otherwise."
One area of shortage which hurts all infrastructure builders is the availability of skilled project managers. In the case of many developers, "there may not be that level of experience available to execute the size of the projects [that are] planned," says Aniruddha Joshi, executive vice president of the Hiranandani family-controlled Hirco Group, which has large realty projects underway in India. India hasn't seen many large projects until very recently, and the country has traditionally not produced enough skilled project managers to coordinate multiple vendors and optimal allocation of resources.
For prospective engineering students, civil engineering had lost its charm and was seen as a low-growth area, where progress would be limited and the hours long and hard. In comparison, many males who completed computer engineering programs found jobs as code writers in India's burgeoning software services industry. These jobs, which came with a possibility of overseas placements, also made the men good prospects in the traditional Indian marriage market. But with the construction boom, "salaries for civil engineers from reputed colleges, which averaged around Rs 7,000 ($190) a month three years ago, have risen to around Rs 25,000 ($600) a month now, which makes them comparable to what software engineers get. As a result, we are seeing engineering colleges report a higher percentage of students opting for civil engineering courses after several years of relative drought," says Patel.
Many companies have turned to acquisitions to cover their short-term labor needs. Punj Lloyd has acquired Singapore's Sembawang E&C to help provide expertise in EPC projects, while Patel Engineering has bought U.S.-based Westcon Microtunneling to build on its construction expertise. Many firms are also hiring expatriate project managers to take charge of projects and train juniors to assume such positions over time.
Verma feels that the high wages for such positions in India may help in attracting talent from other areas like Eastern Europe and Japan. Patel says skilled project managers and planning engineers could be hired from outside India as well. Reliance Industries, for instance, has an expatriate as its chief of drilling services, who helps train its drillers and rig operators to meet target dates for commercial production of gas.
Joshi sees a silver lining in the shortage of human resources as well. He cites the example of Japan, where construction companies adopted a "top-down" method that helped attract talent to the industry -- one that Japanese society considered a "tough, dangerous and dirty" profession. "It's good to have constraints; it forces you to come up with new solutions," says Joshi.
Wanted: Equipment (and Capital)
At the lower end of the skills chain, companies are responding to labor shortages by automating parts of the production process, which makes them less susceptible to shortages of vocational staff. As a result of this, and partly in response to customer demand for faster build-outs, construction companies that once relied on an army of cheap labor now employ a variety of equipment, from low-end concrete mixers to goods elevators and tipper trucks for transporting materials, tower cranes, tunnel-boring machines, robotic drills and hydraulic excavators.
Patel, for instance, has spent Rs 600 million to Rs 800 million ($ 20.28 million) so far to build an equipment bank, while IVRCL estimates it has invested between Rs 2,500 million to Rs 2,750 million ($69.71 million) in equipment so far. "We even think about having a second set of fall-back equipment ready for certain contracts. We now need national equipment yards, as high-end equipment required for finishing jobs in time is not available for hire," says one official from IVRCL.
"A lot of this equipment could be rented at some point, but these days many companies, including ours, have been purchasing used equipment. Often, the required machinery is not available at the right price and within the desired time frames," says Patel. The boom in building activity in Asia and the Middle East has not only increased demand for such building equipment but also resulted in a rise in lease rentals and forced many companies to own equipment. This has made the operations of such companies far more capital intensive.
As companies take on larger size projects, the capital intensity of their operations increases, forcing many companies to rely on private equity or the public markets. So far, the Indian capital markets have been supportive of this, with DLF Ltd. -- one of India's largest real estate developers -- raising capital in a record-breaking IPO earlier this year. Many realty companies also managed to raise funds on London's Alternative Investment Market for investing in projects in India.
Lately, as real estate stocks have come under increasing pressure, many companies have begun to reassess the premiums they can hope to receive when they go public. Infrastructure builders, however, have discovered that the stock market is still receptive, with Mundra Port & Special Economic Zone becoming the first SEZ developer to go public in October this year.
While funds can be raised, companies have also been rethinking their work methods and the building materials they use. Many companies now employ ready-mix concrete rather than prepare a cement and sand mixture on site. This helps speed up production since ready-made cement can be poured faster and in a uniform consistency to lay out foundations and pillars. Companies have also started employing prefabricated materials -- like brick wall sections or Siporex blocks for ceilings -- to help speed things up while using less manual labor. "India may soon move to [another] stage of mechanization, where developers use completely knock-down assembly components to build projects," says Magar.
One of the reasons for using alternative materials is the reduced availability of materials like clay bricks and sand which traditionally came from the outskirts of a city. With cities expanding, the typical 50 kilometres distance of such brick kilns from a city centre work site no longer holds true. "Thanks to India's huge foreign exchange reserves, import of goods has been liberalised so supply side constraints in the domestic market can be compensated with global sourcing," says Joshi. This has not come a moment too soon: Companies want their projects built in much shorter times than what it historically took in India.
Challenges on the Supply Side
At this point in time, many of India's capital equipment and shipbuilding firms face a Hobson's choice: There is great demand for their products and services and a global shortage of available capacity, but forecasting future demand is difficult. "Putting up a manufacturing facility for turbines, for instance, requires a couple of years, and by the time the project starts commercial production, we expect China to have surplus production capacity seeking global markets," says GE's Kumar.
Dhananjay Nalwade, president and CEO of GE Equipment & Services, India, also raises the issue of how fast firms can digest new technology required to set up advanced manufacturing facilities that can meet market demand. "You need a local supply chain which supports this technology transfer into India. This process takes time and a huge investment on the part of the suppliers to implement modern manufacturing techniques, such as Six Sigma."
"In the case of our investment in Titagarh Wagons, for instance, we will hire people well before the factory is built, train them in our U.S. factories to build the products that will be manufactured in India and then bring them back to India to train other staff in turn," says Kumar. However, GE says some of its partners are reluctant to transfer designs to Indian companies as there is no patent protection available here.
Despite these limitations, firms have been expanding capacity. But several capital equipment and shipbuilding firms find that their component suppliers who have gone from one shift to three and de-bottlenecked their facilities can no longer expand capacity without fresh investments. "With demand showing continued growth, delivery lead times have lengthened. For instance, a ship engine which could be delivered in as little as four to six months from the date of the order could now take as long as 24 to 30 months to arrive," says Verma. According to Antao, "Steel suppliers can't match demand for the exotic grades of steel firms such as ours use. As a result, project timelines have almost doubled. But expanding capacity at the supplier's end requires high capital expenditure, and these firms are afraid that [the demand] bubble may burst and they may not recover their investments."
In the meanwhile, equipment manufacturers are coping with lengthened delivery times by becoming far more choosy about what orders they take. "One prioritizes customers whom one has a long history of working with, and new markets where one may seek to establish oneself," says Wartsila's Verma. "We are going slow on taking fresh orders until our new capacity is ready. Our order book has already doubled in the last year," says Prakash Chandra Kapur, managing director of Bharati Shipyard.
"Contractors these days want to work with companies who will be a source of repeat business and will be regular in paying dues. In the past, it was difficult for these firms to be choosy about their clientele, but today, when they have people knocking on their door, they would prefer to work with people who will be around in the long term too," says Joshi.
Almost every Indian company -- big or small -- that has some expertise in construction finds itself flooded with orders that are nearly three to four times its annual sales. The size and pace of orders could threaten the development of the country's already creaking and short-supplied infrastructure. "Execution is the biggest issue in India today, especially on time and within budget," says Pratyush Kumar, president and chief executive officer of GE Infrastructure, India.
Although construction companies are prepared to spend money to raise their production capacities, experts say that a shortage of skilled talent and the limited ability of capital equipment suppliers to meet demand mean that skillful project management and innovative solutions will be necessary to prevent bottlenecks.
India's planned infrastructure outlay over the next five years has been revised upward by various government authorities, from $150 billion to almost $475 billion. The country currently spends around $21 billion a year on infrastructure, compared to China's $150 billion. Corporate capital spending tracked by research firms like the Centre for Monitoring Indian Economy (CMIE) is at a multi-year high in India. The effect of all of this demand can be seen in the order books of infrastructure builders, which have also reached a multi-year high.
Consider just a few examples: Punj Lloyd, one of the country's largest engineering, procurement and construction (EPC) companies, earned 72% more income for the quarter ended June 2007, at Rs 1,4179.5 million ($359.43 million). Yet, its order backlog rose to Rs 152,250 million ($3,859.32 million). Larsen & Toubro, one of Asia's largest vertically integrated engineering and construction companies, announced that gross sales rose 47% in the quarter ended September 2007 to Rs 55.74 billion ($1.41 billion), and yet its order backlog rose to a record Rs 400 billion ($10.14 billion). At Wartsila India, which had an order book of one times sales in 2003, the backlogs have risen to almost three times that amount. And Patel Engineering, which expects to close the current year with sales of Rs 16,000 million ($405.58 million) has an order book of Rs 54,000 million ($1.37 billion).
Rupen Patel, managing director of Patel Engineering, says that alone, the planned roll-out of highways by the National Highways Authority of India (NHAI) over the course of the next 10 years exceeds the total turnover of all construction companies in India today. "Construction companies have never seen such a boom in India. Even if [they all] did only road projects and left all work on building airports and power plants aside, NHAI still has more work to offer than firms can take," he says.
"The turnover of all construction companies in India last year was around $15 billion. This year it may rise to $20 billion. But a total of $50 billion is [slated] to be spent on construction every year in India, which requires a capability of 2.5 times the sector's size," says a senior executive at IVRCL Infrastructures who did not wish to be named. India will need several billion-dollar, pure-play construction companies to be able to execute such projects, but it has only a couple of such companies, calling into question the ability of the private sector to build out infrastructure in a public-private partnership mode.
Foreign firms might view the huge gap between the sector's existing capabilities and those required as an opportunity to make their mark in India. Indeed, the infrastructure spending boom in India has benefited a bevy of overseas companies, such as Dongfang Electric Corporation in China and Doosan Heavy Industries and Construction Company in Korea, who are filling orders for turbines used to generate power. A number of leading global construction companies, such as Australia's Leighton Holdings and Italian-Thai Development Public Company, have also entered India.
Skilled-labor Shortage
It's difficult to fathom the words "talent shortage" in a country of a billion people that's getting younger over time. But speak to any infrastructure builder, and you hear anecdotes about shortages of trained fitters, welders, masons and plumbers. "Whether we will get the people necessary to support the growth is the real challenge. Both engineering and blue-collared skilled workers are in short supply. Fitters and welders are not available in the numbers you want. The industry also needs mechanical engineers who have worked in capital goods industries and would like to pursue a career [in that sector] rather than switch into software," says Allen Antao, vice president, process equipment, at Godrej & Boyce Manufacturing Company.
"Once, India had such a supply of labor that we never thought we'd run out, but today things are certainly moving towards that," says Satish Magar, chairman and managing director of Magarpatta Township Development & Construction Company, which has developed a 250-acre plot near the city of Pune in western India.
According to Magar, semi-skilled labor was once brought in from the neighboring south Indian states of Andhra Pradesh and Karnataka, but now projects in the west Indian state of Maharashtra are pulling in laborers from far flung Eastern states of Orissa and West Bengal where surplus laborers are still available. Importing lower-skilled workers from overseas would be too problematic, "given the significant wage differentials and the effect such inflated costs would have on a project's viability," says Patel.
The construction industry remains one of India's largest employers. Realizing the need for skilled vocational staff, the industry has begun collaborating with academic institutions to either train staff for plumbing and masonry type work, or to set up in-house training programs. "We are tying up with industrial training institutes for education and vocational development as well as organizing local training at our school," says Godrej's Antao.
Training is important, because by mechanizing their operations, companies have needed to substitute low-end, semi-skilled artisans with comparatively high-end machine operators who are in short supply. As a result, wages for crane operators and others with higher levels of expertise have risen faster than the average for other industrial workers. For instance, Sanjay Verma, head of ship power for Wartsila India, estimates that welders have seen their wages rise by 30% to 40%, while those for traditionally well-compensated naval architects and marine engineers have risen by 50% over a 3-4 year period.
Antao says that the appreciation of the rupee and the rise in wages are happening so quickly that their effect on costs cannot be countered with a rise in productivity. "If margins drop as a result, companies may not be able to commit large sums for capital investments with the same freedom as we would otherwise."
One area of shortage which hurts all infrastructure builders is the availability of skilled project managers. In the case of many developers, "there may not be that level of experience available to execute the size of the projects [that are] planned," says Aniruddha Joshi, executive vice president of the Hiranandani family-controlled Hirco Group, which has large realty projects underway in India. India hasn't seen many large projects until very recently, and the country has traditionally not produced enough skilled project managers to coordinate multiple vendors and optimal allocation of resources.
For prospective engineering students, civil engineering had lost its charm and was seen as a low-growth area, where progress would be limited and the hours long and hard. In comparison, many males who completed computer engineering programs found jobs as code writers in India's burgeoning software services industry. These jobs, which came with a possibility of overseas placements, also made the men good prospects in the traditional Indian marriage market. But with the construction boom, "salaries for civil engineers from reputed colleges, which averaged around Rs 7,000 ($190) a month three years ago, have risen to around Rs 25,000 ($600) a month now, which makes them comparable to what software engineers get. As a result, we are seeing engineering colleges report a higher percentage of students opting for civil engineering courses after several years of relative drought," says Patel.
Many companies have turned to acquisitions to cover their short-term labor needs. Punj Lloyd has acquired Singapore's Sembawang E&C to help provide expertise in EPC projects, while Patel Engineering has bought U.S.-based Westcon Microtunneling to build on its construction expertise. Many firms are also hiring expatriate project managers to take charge of projects and train juniors to assume such positions over time.
Verma feels that the high wages for such positions in India may help in attracting talent from other areas like Eastern Europe and Japan. Patel says skilled project managers and planning engineers could be hired from outside India as well. Reliance Industries, for instance, has an expatriate as its chief of drilling services, who helps train its drillers and rig operators to meet target dates for commercial production of gas.
Joshi sees a silver lining in the shortage of human resources as well. He cites the example of Japan, where construction companies adopted a "top-down" method that helped attract talent to the industry -- one that Japanese society considered a "tough, dangerous and dirty" profession. "It's good to have constraints; it forces you to come up with new solutions," says Joshi.
Wanted: Equipment (and Capital)
At the lower end of the skills chain, companies are responding to labor shortages by automating parts of the production process, which makes them less susceptible to shortages of vocational staff. As a result of this, and partly in response to customer demand for faster build-outs, construction companies that once relied on an army of cheap labor now employ a variety of equipment, from low-end concrete mixers to goods elevators and tipper trucks for transporting materials, tower cranes, tunnel-boring machines, robotic drills and hydraulic excavators.
Patel, for instance, has spent Rs 600 million to Rs 800 million ($ 20.28 million) so far to build an equipment bank, while IVRCL estimates it has invested between Rs 2,500 million to Rs 2,750 million ($69.71 million) in equipment so far. "We even think about having a second set of fall-back equipment ready for certain contracts. We now need national equipment yards, as high-end equipment required for finishing jobs in time is not available for hire," says one official from IVRCL.
"A lot of this equipment could be rented at some point, but these days many companies, including ours, have been purchasing used equipment. Often, the required machinery is not available at the right price and within the desired time frames," says Patel. The boom in building activity in Asia and the Middle East has not only increased demand for such building equipment but also resulted in a rise in lease rentals and forced many companies to own equipment. This has made the operations of such companies far more capital intensive.
As companies take on larger size projects, the capital intensity of their operations increases, forcing many companies to rely on private equity or the public markets. So far, the Indian capital markets have been supportive of this, with DLF Ltd. -- one of India's largest real estate developers -- raising capital in a record-breaking IPO earlier this year. Many realty companies also managed to raise funds on London's Alternative Investment Market for investing in projects in India.
Lately, as real estate stocks have come under increasing pressure, many companies have begun to reassess the premiums they can hope to receive when they go public. Infrastructure builders, however, have discovered that the stock market is still receptive, with Mundra Port & Special Economic Zone becoming the first SEZ developer to go public in October this year.
While funds can be raised, companies have also been rethinking their work methods and the building materials they use. Many companies now employ ready-mix concrete rather than prepare a cement and sand mixture on site. This helps speed up production since ready-made cement can be poured faster and in a uniform consistency to lay out foundations and pillars. Companies have also started employing prefabricated materials -- like brick wall sections or Siporex blocks for ceilings -- to help speed things up while using less manual labor. "India may soon move to [another] stage of mechanization, where developers use completely knock-down assembly components to build projects," says Magar.
One of the reasons for using alternative materials is the reduced availability of materials like clay bricks and sand which traditionally came from the outskirts of a city. With cities expanding, the typical 50 kilometres distance of such brick kilns from a city centre work site no longer holds true. "Thanks to India's huge foreign exchange reserves, import of goods has been liberalised so supply side constraints in the domestic market can be compensated with global sourcing," says Joshi. This has not come a moment too soon: Companies want their projects built in much shorter times than what it historically took in India.
Challenges on the Supply Side
At this point in time, many of India's capital equipment and shipbuilding firms face a Hobson's choice: There is great demand for their products and services and a global shortage of available capacity, but forecasting future demand is difficult. "Putting up a manufacturing facility for turbines, for instance, requires a couple of years, and by the time the project starts commercial production, we expect China to have surplus production capacity seeking global markets," says GE's Kumar.
Dhananjay Nalwade, president and CEO of GE Equipment & Services, India, also raises the issue of how fast firms can digest new technology required to set up advanced manufacturing facilities that can meet market demand. "You need a local supply chain which supports this technology transfer into India. This process takes time and a huge investment on the part of the suppliers to implement modern manufacturing techniques, such as Six Sigma."
"In the case of our investment in Titagarh Wagons, for instance, we will hire people well before the factory is built, train them in our U.S. factories to build the products that will be manufactured in India and then bring them back to India to train other staff in turn," says Kumar. However, GE says some of its partners are reluctant to transfer designs to Indian companies as there is no patent protection available here.
Despite these limitations, firms have been expanding capacity. But several capital equipment and shipbuilding firms find that their component suppliers who have gone from one shift to three and de-bottlenecked their facilities can no longer expand capacity without fresh investments. "With demand showing continued growth, delivery lead times have lengthened. For instance, a ship engine which could be delivered in as little as four to six months from the date of the order could now take as long as 24 to 30 months to arrive," says Verma. According to Antao, "Steel suppliers can't match demand for the exotic grades of steel firms such as ours use. As a result, project timelines have almost doubled. But expanding capacity at the supplier's end requires high capital expenditure, and these firms are afraid that [the demand] bubble may burst and they may not recover their investments."
In the meanwhile, equipment manufacturers are coping with lengthened delivery times by becoming far more choosy about what orders they take. "One prioritizes customers whom one has a long history of working with, and new markets where one may seek to establish oneself," says Wartsila's Verma. "We are going slow on taking fresh orders until our new capacity is ready. Our order book has already doubled in the last year," says Prakash Chandra Kapur, managing director of Bharati Shipyard.
"Contractors these days want to work with companies who will be a source of repeat business and will be regular in paying dues. In the past, it was difficult for these firms to be choosy about their clientele, but today, when they have people knocking on their door, they would prefer to work with people who will be around in the long term too," says Joshi.
Bumps in the Road: India's Industrial Growth Seeks Solid Ground
By M H Ahssan
For a small car, the Nano has traveled quite a bit. Just in October it has moved from Singur, in West Bengal -- where Tata Motors abandoned a production facility two years in the making and gearing for start-up -- to Sanand, in Gujarat. En route, Tata surveyed other sites for the production of its Rs100,000 ($2,000) automobile.
It hasn't been an easy ride. In Andhra Pradesh, the villagers of Seetarampuram, one of the sites offered by the state government, staged a protest, blockading the Bangalore-Mumbai highway for several hours. Like the farmers of Singur whose tactics eventually forced out the Nano, they resisted the industrial project. In Maharashtra, a senior politician publicly declared that the Nano was not wanted because the state was facing an electricity crisis.
The going has been smoother at Sanand, although bumps in the road still exist. The state government thought it was playing safe by allotting the Tatas 1,100 acres belonging to the Anand Agricultural University. But farmers have already petitioned the Gujarat High Court to stop the deal. They say that the British government acquired the land from them in 1902 on a 90-year lease, and that it should have been returned in 1992, but was not. Now that the land's value has risen sharply, they are demanding compensation. Land prices in neighboring areas have gone up from around Rs400,000 (US$8,000) per bigha (an Indian land unit equivalent to about 25,000 square feet) to Rs1.2 million (US$24,000) per bigha.
The Congress opposition in Gujarat, a state ruled by the rightist Bharatiya Janata Party, has hinted at a Singur-style agitation. But the agitation's purpose would not be to drive out the Tatas. It would aim to secure compensation for farmers deprived of their land a century ago.
The farmers, meanwhile, are organizing themselves under banners such as the Rashtriya Kisan Dal. Maharana JaiShiv Sinh Vaghela, the scion of the royal family of Sanand, an erstwhile princely state, has led a delegation of farmers to the state chief minister, Narendra Modi, to demand their share. Meanwhile, Anand Agricultural University has asked for equivalent land in other districts of Gujarat as compensation for the 1,100 acres it has surrendered for the Nano.
"The real debate is about the correct compensation price," says Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB). "Once land is acquired, the value of the entire area goes up several times and the people who benefit the most are those who own land just outside the area of the acquired lands." Those initially dispossessed -- no matter how handsomely they may have been compensated -- are invariably left feeling they have been given a raw deal.
Soaring Land Prices
According to estimates by the business magazine Business Today, land prices in Singur rose from US$24,000 per acre to US$120,000 per acre. (They have dropped sharply since the Tata pullout.) Land prices associated with other projects and special economic zones (SEZs) have shown similar increases. Among them: the Reliance Haryana SEZ (from US$45,000 to US$200,000 per acre); the Reliance Mumbai SEZ (US$20,000 to US$100,000); the Reliance Maha Mumbai SEZ (US$10,000 to US$100,000); Tata Steel's Kalinganagar project in Orissa (US$6,500 to US$10,000); and the Renault Nissan plant at Oragadam in Tamil Nadu (US$40,000 to US$160,000).
"We follow an 1890s act for land acquisition," Chakrabarti explains. The huge projects that change neighboring lands' value by such huge multiples didn't exist back then. "So there is definitely need to change the laws in such a way that the people who are being evicted get compensated in a fair manner," Chakrabarti says.
The Nano's woes may have grabbed headlines, but land acquisition problems spread across sectors and the entire nation. The government of Uttar Pradesh, led by Bahujan Samaj Party president Kumari Mayawati, recently canceled a deal allotting 190 acres for a railway coach factory in Sonia Gandhi's parliamentary constituency Rai Bareli. Gandhi is the powerful chairwoman of the ruling United Progressive Alliance in Delhi. Mayawati gave in after Gandhi threatened to stage a protest and court arrest. But land has clearly become the currency of political vendetta, too.
Here's a rundown of some other projects running into acquisition problems, for a variety of reasons:
Sterlite Industries, the Indian arm of the London-based metals and natural resources conglomerate Vedanta, has the go-ahead from the Supreme Court to mine bauxite in the Niyamgiri hills in the Kalahandi district of Orissa. But the indigenous tribal community treats the area as a shrine. Kumuti Majhi, a tribal leader, has visited London to explain to Vedanta shareholders that digging up Niyamgiri would be equivalent to demolishing St. Paul's Cathedral.
Navi Mumbai airport, the much-needed lifeline for India's business capital, has stayed on the drawing board for years. The latest objection is from a government department. The Union environment ministry has refused to clear the project because mangrove forests occupy part of the area. The public-sector agency overseeing the project has offered to replant the mangroves -- which occupy just 7.3% of the total area -- elsewhere. But the Delhi bureaucrats are unmoved.
Close to the proposed Navi Mumbai airport, at the Raigad SEZ, villagers and farmers have voted in a symbolic referendum. Activists claim that the referendum has produced a 95% vote against the project being set up by India's richest industrialist, Reliance Industries chief Mukesh Ambani. The farmers in Raigad, in Maharashtra, simply want a better deal. The project is being delayed while its promoters consider their next steps. Reliance, meanwhile, had appealed to the Bombay High Court opposing the Maharashtra government's decision to hold the referendum. While that judgment is pending, the Maharashtra government has announced that the Raigad referendum was unique and will not be repeated elsewhere in the state.
In Jharkhand, the world's largest steel company, ArcelorMittal, is facing tribal opposition against a proposed 12-million-ton steel plant. The project needs 11,000 acres, including 2,400 acres for a township. The protests have been building since mid-October, when ArcelorMittal met villagers to hard-sell the plan. (The 700MW Koel-Karo hydroelectric project, which was proposed some 35 years ago in the same areas, battled opposition from villagers for decades before it was abandoned.)
In West Bengal, the locals of the Chakchaka area in Cooch Behar district have launched an agitation against expansion of the local airport. The airport is critical because Chakchaka (part of a designated backward district) is being projected as a growth center by the West Bengal Industrial Infrastructure Development Corp. The Trinamool Congress, which spearheaded the Singur agitation, has been active here too, accusing the government of forcible land acquisition. (Meanwhile, things are moving smoothly at the Madurai airport in Tamil Nadu, where 614 acres are required for expansion.)
Large-scale Controversy
All projects can pose problems. But the SEZ arena is likely to witness the most controversy because the zones need large amounts of land. The Raigad SEZ, for instance, proposes to cover 25,000 acres; the Nano production facility needs just 1,100. Before the passage of the SEZ Act of 2005, just 19 SEZs functioned in the country. Many of them were barely limping along. Since the act's passage, some 260 new SEZs have been established. Prior to the act, state and central governments and private companies had invested some Rs7,745 crore (US$1.56 billion) in SEZs. From February 2006 to June 2008, an additional Rs73,348 crore (US$14.74 billion) was pumped in, according to Union Ministry of Commerce and Industry data. Some 100,000 jobs have been created. But land issues still bog down many of the zones.
This is proving expensive. According to a recent estimate by the Centre for Monitoring Indian Economy (CMIE), a Mumbai-based data agglomerator and think tank, projects worth a whopping Rs250,000 crore (US$50.23 billion) are encountering hurdles in acquiring land.
"We should not expect the government to allot us land," says Irfan Razack, chairman and managing director of the Bangalore-based Prestige Group, which has interests in real estate and infrastructure. "That's where the controversy comes in. Either the government must auction the land at market prices or the developer must have the capacity to buy the land and then go to the government for approvals. The heartburn comes when the government buys land at a subsidized price and allots it to the developer who then goes on to make big money."
Razack is talking principally about SEZs. But what he says applies to large industrial projects as well. An additional catch is that the government may well subsidize the land it gives to a project like the Nano because such projects are expected to act as catalysts for further investment in the region or state. Tata Motors was supposed to pay US$200,000 a year for the first five years for the Singur land. This was to rise to US$2 million a year in the next 10 years, and $4 million a year after that. The government, meanwhile, paid US$24 million to the farmers as compensation. In the short term, the Tatas were required to pay peanuts. This lends itself to accusations of corporate houses profiteering.
Industry appears to be able to pay more. CMIE data show that in the five years ended March 2008, large-market-cap companies spent US$3.33 billion in land acquisition costs. These companies' total fixed capital expenditures were $113.97 billion. Land is just 2.9% of that total, leaving room for growth in what the companies can pay for land. Industrialists privately confess that they are prepared to pay more for land acquisition. But it has the danger of becoming a never-ending spiral.
No model has proved problem-free. Where the state has acquired land, farmers have cried foul over the rates. Where the private sector has tried to go it alone, accusations of intimidation have arisen. Landowners have realized the advantages of holding out. It often boils down to who blinks first. Says Chakrabarti of ISB: "There is the issue of sorting out 'hold-up' lands," where the landowner has asked for an exorbitant price because he knows that the project cannot proceed without his land.
Chakrabarti has a suggestion. "The government should definitely not do the entire acquisition on its own because, as soon as the government gets into the act, a lot of political forces come into play. On the other hand, the private sector cannot do it completely on its own because of the hold-up problem. One model is that the private partner acquires around 70%-80% of the total land required by paying a fair compensation. The remaining [including the hold-ups] can be acquired by the government by paying the same rate as what the private party has paid.
"There are other ways. Let us say the SEZ needs 1,000 acres. But the consortium [of private players and the government] can acquire 1,500 acres and then ration out the extra 500 on a pro-rata basis to those from whom the land has been acquired. That will mean that instead of giving just cash compensation, everyone will have some real estate holding in the developed area, which will enable them to get the appreciation benefits of that land. This, of course, requires multiparty negotiations, and I don't think it is in practice in India." And Chakrabarti points out a catch. "Being agriculturists, the landowners are not trained for anything else," he says. "They need to be provided with training so that their future is protected."
Comprehensive Ground Rules
What is needed is a comprehensive set of ground rules. They may be in the works, albeit belatedly. The government has been working on a replacement for the Land Acquisition Act of 1894 for a couple of years now. The prime minister's office has written to the Ministry of Parliamentary Affairs asking that the processing of bills related to land acquisition be expedited. Three bills are involved: the Rehabilitation and Resettlement Bill, 2007; the Compensatory Afforestation Fund Bill, 2008; and the Land Acquisition (Amendment) Bill, 2007.
The Land Acquisition Bill has just been vetted by the parliamentary standing committee concerned. The prime minister's office wants all this speeded up to get these bills on the statute books before it demits office next year. Sonia Gandhi told a farmers' rally at the end of September that the bills would be piloted through parliament soon.
The standing committee on the Land Acquisition Bill, which submitted its report on October 21, recommended that:
- States should be allowed to acquire 100% of the land required.
- The definition of "public purpose," which allows the state to take over land, should be expanded.
- States should be given more power to decide on use of agricultural land.
- The compensation benchmark should be the highest price paid in the last three years plus 50%.
The report's submission doesn't necessarily mean that the Land Acquisition Act is on the fast track. "We have to examine the report," Raghuvansh Prasad Singh, the Union minister for rural development, told the Delhi-headquartered business daily Business Standard. "But it is not necessary that all the recommendations of the standing committee have to be accepted."
Political analysts in Delhi say the bills may not be passed this parliamentary session. Compensation is a contentious issue. The definition of "public purpose" is another. In Singapore, "public purpose" can mean residential buildings. Not so in India. The Nanos of the future may have some distance to travel to find a home.
For a small car, the Nano has traveled quite a bit. Just in October it has moved from Singur, in West Bengal -- where Tata Motors abandoned a production facility two years in the making and gearing for start-up -- to Sanand, in Gujarat. En route, Tata surveyed other sites for the production of its Rs100,000 ($2,000) automobile.
It hasn't been an easy ride. In Andhra Pradesh, the villagers of Seetarampuram, one of the sites offered by the state government, staged a protest, blockading the Bangalore-Mumbai highway for several hours. Like the farmers of Singur whose tactics eventually forced out the Nano, they resisted the industrial project. In Maharashtra, a senior politician publicly declared that the Nano was not wanted because the state was facing an electricity crisis.
The going has been smoother at Sanand, although bumps in the road still exist. The state government thought it was playing safe by allotting the Tatas 1,100 acres belonging to the Anand Agricultural University. But farmers have already petitioned the Gujarat High Court to stop the deal. They say that the British government acquired the land from them in 1902 on a 90-year lease, and that it should have been returned in 1992, but was not. Now that the land's value has risen sharply, they are demanding compensation. Land prices in neighboring areas have gone up from around Rs400,000 (US$8,000) per bigha (an Indian land unit equivalent to about 25,000 square feet) to Rs1.2 million (US$24,000) per bigha.
The Congress opposition in Gujarat, a state ruled by the rightist Bharatiya Janata Party, has hinted at a Singur-style agitation. But the agitation's purpose would not be to drive out the Tatas. It would aim to secure compensation for farmers deprived of their land a century ago.
The farmers, meanwhile, are organizing themselves under banners such as the Rashtriya Kisan Dal. Maharana JaiShiv Sinh Vaghela, the scion of the royal family of Sanand, an erstwhile princely state, has led a delegation of farmers to the state chief minister, Narendra Modi, to demand their share. Meanwhile, Anand Agricultural University has asked for equivalent land in other districts of Gujarat as compensation for the 1,100 acres it has surrendered for the Nano.
"The real debate is about the correct compensation price," says Rajesh Chakrabarti, assistant professor of finance at the Hyderabad-based Indian School of Business (ISB). "Once land is acquired, the value of the entire area goes up several times and the people who benefit the most are those who own land just outside the area of the acquired lands." Those initially dispossessed -- no matter how handsomely they may have been compensated -- are invariably left feeling they have been given a raw deal.
Soaring Land Prices
According to estimates by the business magazine Business Today, land prices in Singur rose from US$24,000 per acre to US$120,000 per acre. (They have dropped sharply since the Tata pullout.) Land prices associated with other projects and special economic zones (SEZs) have shown similar increases. Among them: the Reliance Haryana SEZ (from US$45,000 to US$200,000 per acre); the Reliance Mumbai SEZ (US$20,000 to US$100,000); the Reliance Maha Mumbai SEZ (US$10,000 to US$100,000); Tata Steel's Kalinganagar project in Orissa (US$6,500 to US$10,000); and the Renault Nissan plant at Oragadam in Tamil Nadu (US$40,000 to US$160,000).
"We follow an 1890s act for land acquisition," Chakrabarti explains. The huge projects that change neighboring lands' value by such huge multiples didn't exist back then. "So there is definitely need to change the laws in such a way that the people who are being evicted get compensated in a fair manner," Chakrabarti says.
The Nano's woes may have grabbed headlines, but land acquisition problems spread across sectors and the entire nation. The government of Uttar Pradesh, led by Bahujan Samaj Party president Kumari Mayawati, recently canceled a deal allotting 190 acres for a railway coach factory in Sonia Gandhi's parliamentary constituency Rai Bareli. Gandhi is the powerful chairwoman of the ruling United Progressive Alliance in Delhi. Mayawati gave in after Gandhi threatened to stage a protest and court arrest. But land has clearly become the currency of political vendetta, too.
Here's a rundown of some other projects running into acquisition problems, for a variety of reasons:
Sterlite Industries, the Indian arm of the London-based metals and natural resources conglomerate Vedanta, has the go-ahead from the Supreme Court to mine bauxite in the Niyamgiri hills in the Kalahandi district of Orissa. But the indigenous tribal community treats the area as a shrine. Kumuti Majhi, a tribal leader, has visited London to explain to Vedanta shareholders that digging up Niyamgiri would be equivalent to demolishing St. Paul's Cathedral.
Navi Mumbai airport, the much-needed lifeline for India's business capital, has stayed on the drawing board for years. The latest objection is from a government department. The Union environment ministry has refused to clear the project because mangrove forests occupy part of the area. The public-sector agency overseeing the project has offered to replant the mangroves -- which occupy just 7.3% of the total area -- elsewhere. But the Delhi bureaucrats are unmoved.
Close to the proposed Navi Mumbai airport, at the Raigad SEZ, villagers and farmers have voted in a symbolic referendum. Activists claim that the referendum has produced a 95% vote against the project being set up by India's richest industrialist, Reliance Industries chief Mukesh Ambani. The farmers in Raigad, in Maharashtra, simply want a better deal. The project is being delayed while its promoters consider their next steps. Reliance, meanwhile, had appealed to the Bombay High Court opposing the Maharashtra government's decision to hold the referendum. While that judgment is pending, the Maharashtra government has announced that the Raigad referendum was unique and will not be repeated elsewhere in the state.
In Jharkhand, the world's largest steel company, ArcelorMittal, is facing tribal opposition against a proposed 12-million-ton steel plant. The project needs 11,000 acres, including 2,400 acres for a township. The protests have been building since mid-October, when ArcelorMittal met villagers to hard-sell the plan. (The 700MW Koel-Karo hydroelectric project, which was proposed some 35 years ago in the same areas, battled opposition from villagers for decades before it was abandoned.)
In West Bengal, the locals of the Chakchaka area in Cooch Behar district have launched an agitation against expansion of the local airport. The airport is critical because Chakchaka (part of a designated backward district) is being projected as a growth center by the West Bengal Industrial Infrastructure Development Corp. The Trinamool Congress, which spearheaded the Singur agitation, has been active here too, accusing the government of forcible land acquisition. (Meanwhile, things are moving smoothly at the Madurai airport in Tamil Nadu, where 614 acres are required for expansion.)
Large-scale Controversy
All projects can pose problems. But the SEZ arena is likely to witness the most controversy because the zones need large amounts of land. The Raigad SEZ, for instance, proposes to cover 25,000 acres; the Nano production facility needs just 1,100. Before the passage of the SEZ Act of 2005, just 19 SEZs functioned in the country. Many of them were barely limping along. Since the act's passage, some 260 new SEZs have been established. Prior to the act, state and central governments and private companies had invested some Rs7,745 crore (US$1.56 billion) in SEZs. From February 2006 to June 2008, an additional Rs73,348 crore (US$14.74 billion) was pumped in, according to Union Ministry of Commerce and Industry data. Some 100,000 jobs have been created. But land issues still bog down many of the zones.
This is proving expensive. According to a recent estimate by the Centre for Monitoring Indian Economy (CMIE), a Mumbai-based data agglomerator and think tank, projects worth a whopping Rs250,000 crore (US$50.23 billion) are encountering hurdles in acquiring land.
"We should not expect the government to allot us land," says Irfan Razack, chairman and managing director of the Bangalore-based Prestige Group, which has interests in real estate and infrastructure. "That's where the controversy comes in. Either the government must auction the land at market prices or the developer must have the capacity to buy the land and then go to the government for approvals. The heartburn comes when the government buys land at a subsidized price and allots it to the developer who then goes on to make big money."
Razack is talking principally about SEZs. But what he says applies to large industrial projects as well. An additional catch is that the government may well subsidize the land it gives to a project like the Nano because such projects are expected to act as catalysts for further investment in the region or state. Tata Motors was supposed to pay US$200,000 a year for the first five years for the Singur land. This was to rise to US$2 million a year in the next 10 years, and $4 million a year after that. The government, meanwhile, paid US$24 million to the farmers as compensation. In the short term, the Tatas were required to pay peanuts. This lends itself to accusations of corporate houses profiteering.
Industry appears to be able to pay more. CMIE data show that in the five years ended March 2008, large-market-cap companies spent US$3.33 billion in land acquisition costs. These companies' total fixed capital expenditures were $113.97 billion. Land is just 2.9% of that total, leaving room for growth in what the companies can pay for land. Industrialists privately confess that they are prepared to pay more for land acquisition. But it has the danger of becoming a never-ending spiral.
No model has proved problem-free. Where the state has acquired land, farmers have cried foul over the rates. Where the private sector has tried to go it alone, accusations of intimidation have arisen. Landowners have realized the advantages of holding out. It often boils down to who blinks first. Says Chakrabarti of ISB: "There is the issue of sorting out 'hold-up' lands," where the landowner has asked for an exorbitant price because he knows that the project cannot proceed without his land.
Chakrabarti has a suggestion. "The government should definitely not do the entire acquisition on its own because, as soon as the government gets into the act, a lot of political forces come into play. On the other hand, the private sector cannot do it completely on its own because of the hold-up problem. One model is that the private partner acquires around 70%-80% of the total land required by paying a fair compensation. The remaining [including the hold-ups] can be acquired by the government by paying the same rate as what the private party has paid.
"There are other ways. Let us say the SEZ needs 1,000 acres. But the consortium [of private players and the government] can acquire 1,500 acres and then ration out the extra 500 on a pro-rata basis to those from whom the land has been acquired. That will mean that instead of giving just cash compensation, everyone will have some real estate holding in the developed area, which will enable them to get the appreciation benefits of that land. This, of course, requires multiparty negotiations, and I don't think it is in practice in India." And Chakrabarti points out a catch. "Being agriculturists, the landowners are not trained for anything else," he says. "They need to be provided with training so that their future is protected."
Comprehensive Ground Rules
What is needed is a comprehensive set of ground rules. They may be in the works, albeit belatedly. The government has been working on a replacement for the Land Acquisition Act of 1894 for a couple of years now. The prime minister's office has written to the Ministry of Parliamentary Affairs asking that the processing of bills related to land acquisition be expedited. Three bills are involved: the Rehabilitation and Resettlement Bill, 2007; the Compensatory Afforestation Fund Bill, 2008; and the Land Acquisition (Amendment) Bill, 2007.
The Land Acquisition Bill has just been vetted by the parliamentary standing committee concerned. The prime minister's office wants all this speeded up to get these bills on the statute books before it demits office next year. Sonia Gandhi told a farmers' rally at the end of September that the bills would be piloted through parliament soon.
The standing committee on the Land Acquisition Bill, which submitted its report on October 21, recommended that:
- States should be allowed to acquire 100% of the land required.
- The definition of "public purpose," which allows the state to take over land, should be expanded.
- States should be given more power to decide on use of agricultural land.
- The compensation benchmark should be the highest price paid in the last three years plus 50%.
The report's submission doesn't necessarily mean that the Land Acquisition Act is on the fast track. "We have to examine the report," Raghuvansh Prasad Singh, the Union minister for rural development, told the Delhi-headquartered business daily Business Standard. "But it is not necessary that all the recommendations of the standing committee have to be accepted."
Political analysts in Delhi say the bills may not be passed this parliamentary session. Compensation is a contentious issue. The definition of "public purpose" is another. In Singapore, "public purpose" can mean residential buildings. Not so in India. The Nanos of the future may have some distance to travel to find a home.
Real Estate Developers Can Expect Relocation, not Dislocation, from the Internet
By M H Ahssan
Some real estate developers see the Internet revolution the same way an aristocrat during the French revolution might have viewed the guillotine. The reasons for their dread are easy to fathom. As more and more CEOs recognize that the Internet is here to stay, they wonder how e-commerce will affect demand for real estate. E-commerce, after all, is about moving business from physical to virtual space and replacing brick-and-mortar storefronts with digital ones. As mainstream Corporate America embraces e-commerce, shouldn't those whose revenues and profits are derived from brick-and-mortar construction fear for their lives?
Not really. Real estate developers and brokers must recognize that the coming of the Internet does not eliminate demand for real estate; it simply changes it, according to academics and industry professionals who met at Wharton recently for the fall members' meeting of the Samuel Zell and Robert Lurie Real Estate Center. Speaker after speaker at the conference — which featured the first Max M. Farash Roundtable on E-Commerce and Real Estate — pointed out that the Internet offers more opportunities than threats to property developers and brokers. As such, real estate professionals would be better off embracing e-commerce rather than ignoring or fearing it.
How does e-commerce change demand for real estate? By way of an example, consider Amazon, the Seattle-based granddaddy of online merchants. The company, which did not exist five years ago and now claims to offer the biggest selection of products on earth, does not occupy a single square foot of space in any mall or shopping center. And yet, as its operations have grown, the company has had to build large stocks of inventory and find warehouses to house them. "Amazon wants to build a fleet of warehouses," says Christopher Peacock, president of Jones Lang LaSalle, a global real estate services firm. In New Jersey alone, Amazon last year was in the market for one million square feet of warehouse space.
That is just one way e-commerce changes demand for real estate. It also changes the skills requirements within real estate companies, which must now increasingly build expertise in technology. "We must help our clients make the right infrastructure decisions," Peacock says. "Our challenge is not just to hire brokers but experts in telecommunications, energy, corporate finance and logistics." Building such skills is crucial as real estate firms seek to redefine their roles for the digital economy. "Success does not begin and end with designing a web page for your company," Peacock adds. "We should use e-commerce to serve our clients."
Jones Lang Lasalle has begun to explore ways of doing that. The company's property management business buys services worth $6 billion from more than 35,000 vendors. In the past, sales orders were typically placed and processed by fax. Recognizing the potential of the Internet to transform the purchasing process, the company decided to move these operations online. Result: Jones Lang Lasalle was able to slash costs by 10% — or $600 million. "That's just one project, so consider the potential," says Peacock. "The future will be even more exciting. I can see a day when the ability to trade in intellectual property relating to real estate will be as valuable as the real estate itself."
Other speakers emphasized that the Internet makes it essential for companies to act fast. One reason is that the web itself has grown — and continues to grow — at an incredible pace. In a presentation on "Forces Shaping the Digital Economy," Gerald Lohse, research director of the Wharton Forum on Electronic Commerce, pointed out that while radio took 38 years and television 13 years to reach 50 million users, the Internet reached that milestone in just five. E-commerce, too, has been exploding. Forrester Research, a consulting firm, estimates that global e-commerce transactions by 2003 will exceed $3.2 trillion. (To put that number in context, Lohse explains, the U.S. economy today is $20 trillion.)
In a panel on e-commerce and retail, Wharton real estate professor Todd Sinai offered another perspective. Discussing whether e-commerce would cannibalize or augment bricks-and-mortar retail, he pointed out that the latter would certainly happen in some markets. "There are places where no one would set up a shopping center, and the Internet can pick up those sales around the edges," he says. In other instances, though, e-commerce sales may not cannibalize traditional retail as much as catalog sales. Time-starved consumers who once browsed through catalogs and ordered products by phone or by mail may now do so over the web. "The Internet is a direct marketing channel," he says.
The Internet also transforms where and how property is built, which means that real estate companies must re-think old assumptions. The maxim that the three most important things in real estate are location, location and location assumes a new meaning in a global, web-based economy. When business is transacted over the web, producers of intellectual products need no longer be physically close to their customers or even their suppliers. Carrie Byles, an architect with the firm Skidmore, Owings & Merrill, says that if one country's regulations are too onerous, Internet-based companies could easily move overseas or to tax havens. Technology, in many ways, makes location less relevant than it used to be. "For companies like Yahoo, the most important consideration is being close to bandwidth," she says.
Technology also makes it possible for architects to design better environments in which people can work. "We can create offices with casual collision spaces, where new ideas spawn," she says. "Our goal is to create environments that support learning, casual interaction, flexibility and speed in a setting where technology is invisible and the buildings and landscape sustain the human soul."
James Young, president of the Jameson Group, points out that the coming of the Internet is not a short-term change, like the typical 10-year real estate cycle. "This is a major socio-economic shift," he says, comparable in world historic terms to the agricultural revolution and the industrial revolution. The implications for real estate companies, Young says, are clear. "If you sold barns at the end of the agricultural age, you might consider something called a factory."
Some real estate developers see the Internet revolution the same way an aristocrat during the French revolution might have viewed the guillotine. The reasons for their dread are easy to fathom. As more and more CEOs recognize that the Internet is here to stay, they wonder how e-commerce will affect demand for real estate. E-commerce, after all, is about moving business from physical to virtual space and replacing brick-and-mortar storefronts with digital ones. As mainstream Corporate America embraces e-commerce, shouldn't those whose revenues and profits are derived from brick-and-mortar construction fear for their lives?
Not really. Real estate developers and brokers must recognize that the coming of the Internet does not eliminate demand for real estate; it simply changes it, according to academics and industry professionals who met at Wharton recently for the fall members' meeting of the Samuel Zell and Robert Lurie Real Estate Center. Speaker after speaker at the conference — which featured the first Max M. Farash Roundtable on E-Commerce and Real Estate — pointed out that the Internet offers more opportunities than threats to property developers and brokers. As such, real estate professionals would be better off embracing e-commerce rather than ignoring or fearing it.
How does e-commerce change demand for real estate? By way of an example, consider Amazon, the Seattle-based granddaddy of online merchants. The company, which did not exist five years ago and now claims to offer the biggest selection of products on earth, does not occupy a single square foot of space in any mall or shopping center. And yet, as its operations have grown, the company has had to build large stocks of inventory and find warehouses to house them. "Amazon wants to build a fleet of warehouses," says Christopher Peacock, president of Jones Lang LaSalle, a global real estate services firm. In New Jersey alone, Amazon last year was in the market for one million square feet of warehouse space.
That is just one way e-commerce changes demand for real estate. It also changes the skills requirements within real estate companies, which must now increasingly build expertise in technology. "We must help our clients make the right infrastructure decisions," Peacock says. "Our challenge is not just to hire brokers but experts in telecommunications, energy, corporate finance and logistics." Building such skills is crucial as real estate firms seek to redefine their roles for the digital economy. "Success does not begin and end with designing a web page for your company," Peacock adds. "We should use e-commerce to serve our clients."
Jones Lang Lasalle has begun to explore ways of doing that. The company's property management business buys services worth $6 billion from more than 35,000 vendors. In the past, sales orders were typically placed and processed by fax. Recognizing the potential of the Internet to transform the purchasing process, the company decided to move these operations online. Result: Jones Lang Lasalle was able to slash costs by 10% — or $600 million. "That's just one project, so consider the potential," says Peacock. "The future will be even more exciting. I can see a day when the ability to trade in intellectual property relating to real estate will be as valuable as the real estate itself."
Other speakers emphasized that the Internet makes it essential for companies to act fast. One reason is that the web itself has grown — and continues to grow — at an incredible pace. In a presentation on "Forces Shaping the Digital Economy," Gerald Lohse, research director of the Wharton Forum on Electronic Commerce, pointed out that while radio took 38 years and television 13 years to reach 50 million users, the Internet reached that milestone in just five. E-commerce, too, has been exploding. Forrester Research, a consulting firm, estimates that global e-commerce transactions by 2003 will exceed $3.2 trillion. (To put that number in context, Lohse explains, the U.S. economy today is $20 trillion.)
In a panel on e-commerce and retail, Wharton real estate professor Todd Sinai offered another perspective. Discussing whether e-commerce would cannibalize or augment bricks-and-mortar retail, he pointed out that the latter would certainly happen in some markets. "There are places where no one would set up a shopping center, and the Internet can pick up those sales around the edges," he says. In other instances, though, e-commerce sales may not cannibalize traditional retail as much as catalog sales. Time-starved consumers who once browsed through catalogs and ordered products by phone or by mail may now do so over the web. "The Internet is a direct marketing channel," he says.
The Internet also transforms where and how property is built, which means that real estate companies must re-think old assumptions. The maxim that the three most important things in real estate are location, location and location assumes a new meaning in a global, web-based economy. When business is transacted over the web, producers of intellectual products need no longer be physically close to their customers or even their suppliers. Carrie Byles, an architect with the firm Skidmore, Owings & Merrill, says that if one country's regulations are too onerous, Internet-based companies could easily move overseas or to tax havens. Technology, in many ways, makes location less relevant than it used to be. "For companies like Yahoo, the most important consideration is being close to bandwidth," she says.
Technology also makes it possible for architects to design better environments in which people can work. "We can create offices with casual collision spaces, where new ideas spawn," she says. "Our goal is to create environments that support learning, casual interaction, flexibility and speed in a setting where technology is invisible and the buildings and landscape sustain the human soul."
James Young, president of the Jameson Group, points out that the coming of the Internet is not a short-term change, like the typical 10-year real estate cycle. "This is a major socio-economic shift," he says, comparable in world historic terms to the agricultural revolution and the industrial revolution. The implications for real estate companies, Young says, are clear. "If you sold barns at the end of the agricultural age, you might consider something called a factory."
Is Commercial Property Still a Good Investment?
By M H Ahssan
These are blissful times for commercial real estate investors. Having fallen into a deep slump with the ending of the Internet boom, the market has come surging back. In 2004 alone, prices rose 26% for apartment complexes, 21% for industrial properties, 14% for retail properties and 6% for office buildings, according to Real Capital Analytics, a New York real estate research firm.
And the market gives no sign of slackening. "We're not seeing any slowdown at all," says Steven Dunn, chief economist for CB Richard Ellis, a big commercial real estate services company based in Los Angeles. "The numbers are great, not just for sales but for leasing, too."
But not everyone is so confident. Over the past few months, a number of major institutional and private investors have been selling off large chunks of their portfolios of prime commercial real estate. These investors, which include Calpers, the $186 billion pension fund, have been taking advantage of what they see as a frothy market. They are putting the sale proceeds into less expensive real estate or into other assets entirely.
The Rubenstein Company, a Philadelphia-based real estate firm, is one investor that has pulled its money out of real estate with the expectation that prices will come back down. Last year, the company sold nearly all of its office buildings for about $1 billion. "We thought the markets weren't going to get much better and had a chance to get considerably worse," says CEO David Rubenstein.
To be sure, for every seller there is a buyer, and other investors have rushed forward to buy these properties, often at record prices. But as the consensus builds that the housing market has become seriously overvalued, some are asking whether the same might be true of commercial property. The answer matters not just to the individual and institutional investors who are committing ever-greater sums to real estate, but also to the growing number of companies who are using their valuable property to obtain cheap financing.
A Flood of Capital
Several forces are driving commercial real estate's revival. Most obviously, the economy is improving and businesses are growing once more. As they expand their operations and hire new employees they need additional space. But real estate pricing has recovered faster than the economy itself. Indeed, while prices have rebounded nicely, rents have been sluggish: The average rent today is $15.42 a foot, down from $28.92 in 2000. A more important reason for real estate's rise has been a flood of new investment capital. Some of this comes from individuals seeking better returns than they can achieve in the debt or equity markets. These investors have channeled great sums to investment vehicles such as REITs and TICs (tenants-in-common).
The big money has come from institutions. Spooked by their losses after the dotcom bust and drawn to the reliable cash flows offered by property, these investors are now paying closer attention to commercial real estate. One is TIAA-CREF, a national financial services company with over $340 billion in assets under management. "We see this asset class as a great addition to our portfolio," says Tom Garbutt, the company's managing director and head of real estate. "It's a nice diversifier, has a current income stream and a potential for appreciation." The company now owns $14 billion of real estate properties.
The resulting upswing in prices for the best properties has been a boon for the owners. In fact, a growing number of corporations are taking the opportunity to use their real estate as a financing tool. Through sale-leasebacks, companies can sell their property to an investor who will agree to lease it back to the company for a specified period. Many find this as attractive as issuing debt, since property values are high but rents remain affordable. Some of these deals have been gargantuan. Last year, Bank of America did a $770 million leaseback for most of its bank branches. McDonald's (which has historically been an owner of property) also did one, valued at $340 million. Companies are using the money for different purposes, ranging from balance sheet improvement to acquisitions.
Few Signs of Trouble
How sustainable are today's high prices? Not very, argue some. "We feel that properties are overvalued," says David Harris, a research analyst who covers REITs for Lehman Brothers. Harris notes that the "euphoria" of bidding on certain commercial properties should give investors pause, especially since rising interest rates may soon make real estate a less attractive investment.
Another potential concern is that yields on property ownership are falling. Also known as capitalization rates ("cap rates" for short), yields have dropped over the past three years to near-historic lows. While this is the natural outcome of higher prices -- cap rates are the ratio of a property's yearly income to purchase price -- it can also indicate that operating income hasn't kept pace with the higher prices. This can make real estate less attractive to investors primarily interested in the cash stream.
But there are good reasons to believe that the market is actually quite strong. One is that the fundamentals are improving. Metropolitan office vacancies, for example, have fallen from 16.8% during the first quarter of 2004 to 15.4% today. Dunn points to San Francisco as an example of an area where the improvement has been substantial: In eight quarters, vacancies in that market have fallen from 23% to just 15%.
And improving occupancy levels mean higher income. "People often forget that income goes up faster than occupancy," says Peter Linneman, a professor of real estate at Wharton. "That's because as occupancy picks up you can boost your rents a little and you pick up more ancillary income from things such as parking and health clubs. I think this year will be good in terms of income for commercial properties, and next year will be great."
Furthermore, the market does not suffer from excess construction. "There was huge overbuilding in the late 1980s which really hurt the market when we had a recession," says Joseph Gyourko, also a professor of real estate at Wharton. "But for the most part real estate did not get overbuilt before the last downturn." Nor do developers' plans seem excessive. One reason is that banks have become more conservative in their lending, requiring developers to show that their buildings will be fully leased. Another is that the soaring price for concrete and steel (a product of China's massive construction boom) has made new construction costly. The result, of course, is limited supply at a time of growing demand, which suggests that prices have further to rise.
Ultimately, say many experts, investors should be asking how commercial real estate compares with other investments. And next to stocks and bonds, it remains attractive. "If you do CAPM or other risk pricing models, you find that real estate remains 15 to 35% underpriced based on its cash stream and its risk profile relative to other alternatives," says Linneman. In other words, not only does real estate give investors a better current income than debt or equity, but it's safer.
The reason is simple: commercial real estate is a lease claim on the same companies that make up the S&P 500. If a company runs out of cash, it will always pay its rent before it pays a dividend and will usually pay rent before it makes debt payments. "Real estate has a risk profile closer to bonds, but it's trading as if it's equity," says Linneman.
Largely because of this comparatively attractive income stream, the institutional investors are unlikely to abandon the market. This may be true even if cap rates fall farther. Because institutional investors often pay with cash, they can accept lower cap rates: Without interest payments, their effective yields are higher that those of more leveraged buyers. Garbutt says that TIAA-CREF has no plans to reduce its exposure to real estate. "We don't play the short game. For us, the question is, 'What makes sense for our participants?' And the answer is to stay well diversified and active in all markets."
What about interest rates? While higher rates can dampen the real estate market by raising borrowing costs, rates remain at historic lows. The Federal Reserve has signaled its intention to increase rates gradually, about a quarter point per quarter, but this may not be enough to ward off buyers. "If we saw a 200 basis point uplift in the 10-year treasury over a year, that would have some effect on real estate pricing," comments Garbutt. "But remember that an abrupt jump in interest rates and the 10-year would affect other asset classes, too."
Buyer Beware
None of this is to say that some real estate isn't perilously overpriced. In particular, speculation appears to be driving the prices of many apartment buildings and condominiums to unsustainable levels. "There some people who are being wildly aggressive when it comes to pricing cash streams for apartment buildings," says Linneman. "They are looking at a building with 45% vacancy and saying 'I'm going to buy it as if it's 90% occupied.'" Similarly, condominiums -- which offer virtually no income stream since they are owned, not leased -- are looking shaky. Between 50% and 60% are now being presold to investors who don't plan to live in them. Once buyers stop showing up to the presales, the prices will tumble.
David Rubenstein also sees weakness in certain office markets, especially in the suburbs of Washington, D.C., and in southern California. In those markets leasing costs are rising, net operating income is falling (due to leases that tenants signed five years ago but are now up for renewal, at lower rents), and investors are taking on what he considers excessive leverage. That should produce lower prices for some properties.
And there's always the risk of some broader meltdown that would bring down the real estate market along with stocks and bonds. Linneman argues that in this case, an investor would be wise to be in the asset that's the least overvalued to begin with: commercial real estate.
Barring a calamity, investors should expect solid, if not spectacular, returns, says Gyourko. He predicts that while the real estate market will continue to do well, the days of double-digit appreciation are over. "Relative to historic pricing, real estate is pretty expensive, and that's something that should make everyone think hard," he says. "Does it mean that prices are going to fall? No it doesn't. But it almost certainly means that the returns will be lower going forward. The million dollar question is this: Will you be disappointed relative to other things you could have done with your money?"
These are blissful times for commercial real estate investors. Having fallen into a deep slump with the ending of the Internet boom, the market has come surging back. In 2004 alone, prices rose 26% for apartment complexes, 21% for industrial properties, 14% for retail properties and 6% for office buildings, according to Real Capital Analytics, a New York real estate research firm.
And the market gives no sign of slackening. "We're not seeing any slowdown at all," says Steven Dunn, chief economist for CB Richard Ellis, a big commercial real estate services company based in Los Angeles. "The numbers are great, not just for sales but for leasing, too."
But not everyone is so confident. Over the past few months, a number of major institutional and private investors have been selling off large chunks of their portfolios of prime commercial real estate. These investors, which include Calpers, the $186 billion pension fund, have been taking advantage of what they see as a frothy market. They are putting the sale proceeds into less expensive real estate or into other assets entirely.
The Rubenstein Company, a Philadelphia-based real estate firm, is one investor that has pulled its money out of real estate with the expectation that prices will come back down. Last year, the company sold nearly all of its office buildings for about $1 billion. "We thought the markets weren't going to get much better and had a chance to get considerably worse," says CEO David Rubenstein.
To be sure, for every seller there is a buyer, and other investors have rushed forward to buy these properties, often at record prices. But as the consensus builds that the housing market has become seriously overvalued, some are asking whether the same might be true of commercial property. The answer matters not just to the individual and institutional investors who are committing ever-greater sums to real estate, but also to the growing number of companies who are using their valuable property to obtain cheap financing.
A Flood of Capital
Several forces are driving commercial real estate's revival. Most obviously, the economy is improving and businesses are growing once more. As they expand their operations and hire new employees they need additional space. But real estate pricing has recovered faster than the economy itself. Indeed, while prices have rebounded nicely, rents have been sluggish: The average rent today is $15.42 a foot, down from $28.92 in 2000. A more important reason for real estate's rise has been a flood of new investment capital. Some of this comes from individuals seeking better returns than they can achieve in the debt or equity markets. These investors have channeled great sums to investment vehicles such as REITs and TICs (tenants-in-common).
The big money has come from institutions. Spooked by their losses after the dotcom bust and drawn to the reliable cash flows offered by property, these investors are now paying closer attention to commercial real estate. One is TIAA-CREF, a national financial services company with over $340 billion in assets under management. "We see this asset class as a great addition to our portfolio," says Tom Garbutt, the company's managing director and head of real estate. "It's a nice diversifier, has a current income stream and a potential for appreciation." The company now owns $14 billion of real estate properties.
The resulting upswing in prices for the best properties has been a boon for the owners. In fact, a growing number of corporations are taking the opportunity to use their real estate as a financing tool. Through sale-leasebacks, companies can sell their property to an investor who will agree to lease it back to the company for a specified period. Many find this as attractive as issuing debt, since property values are high but rents remain affordable. Some of these deals have been gargantuan. Last year, Bank of America did a $770 million leaseback for most of its bank branches. McDonald's (which has historically been an owner of property) also did one, valued at $340 million. Companies are using the money for different purposes, ranging from balance sheet improvement to acquisitions.
Few Signs of Trouble
How sustainable are today's high prices? Not very, argue some. "We feel that properties are overvalued," says David Harris, a research analyst who covers REITs for Lehman Brothers. Harris notes that the "euphoria" of bidding on certain commercial properties should give investors pause, especially since rising interest rates may soon make real estate a less attractive investment.
Another potential concern is that yields on property ownership are falling. Also known as capitalization rates ("cap rates" for short), yields have dropped over the past three years to near-historic lows. While this is the natural outcome of higher prices -- cap rates are the ratio of a property's yearly income to purchase price -- it can also indicate that operating income hasn't kept pace with the higher prices. This can make real estate less attractive to investors primarily interested in the cash stream.
But there are good reasons to believe that the market is actually quite strong. One is that the fundamentals are improving. Metropolitan office vacancies, for example, have fallen from 16.8% during the first quarter of 2004 to 15.4% today. Dunn points to San Francisco as an example of an area where the improvement has been substantial: In eight quarters, vacancies in that market have fallen from 23% to just 15%.
And improving occupancy levels mean higher income. "People often forget that income goes up faster than occupancy," says Peter Linneman, a professor of real estate at Wharton. "That's because as occupancy picks up you can boost your rents a little and you pick up more ancillary income from things such as parking and health clubs. I think this year will be good in terms of income for commercial properties, and next year will be great."
Furthermore, the market does not suffer from excess construction. "There was huge overbuilding in the late 1980s which really hurt the market when we had a recession," says Joseph Gyourko, also a professor of real estate at Wharton. "But for the most part real estate did not get overbuilt before the last downturn." Nor do developers' plans seem excessive. One reason is that banks have become more conservative in their lending, requiring developers to show that their buildings will be fully leased. Another is that the soaring price for concrete and steel (a product of China's massive construction boom) has made new construction costly. The result, of course, is limited supply at a time of growing demand, which suggests that prices have further to rise.
Ultimately, say many experts, investors should be asking how commercial real estate compares with other investments. And next to stocks and bonds, it remains attractive. "If you do CAPM or other risk pricing models, you find that real estate remains 15 to 35% underpriced based on its cash stream and its risk profile relative to other alternatives," says Linneman. In other words, not only does real estate give investors a better current income than debt or equity, but it's safer.
The reason is simple: commercial real estate is a lease claim on the same companies that make up the S&P 500. If a company runs out of cash, it will always pay its rent before it pays a dividend and will usually pay rent before it makes debt payments. "Real estate has a risk profile closer to bonds, but it's trading as if it's equity," says Linneman.
Largely because of this comparatively attractive income stream, the institutional investors are unlikely to abandon the market. This may be true even if cap rates fall farther. Because institutional investors often pay with cash, they can accept lower cap rates: Without interest payments, their effective yields are higher that those of more leveraged buyers. Garbutt says that TIAA-CREF has no plans to reduce its exposure to real estate. "We don't play the short game. For us, the question is, 'What makes sense for our participants?' And the answer is to stay well diversified and active in all markets."
What about interest rates? While higher rates can dampen the real estate market by raising borrowing costs, rates remain at historic lows. The Federal Reserve has signaled its intention to increase rates gradually, about a quarter point per quarter, but this may not be enough to ward off buyers. "If we saw a 200 basis point uplift in the 10-year treasury over a year, that would have some effect on real estate pricing," comments Garbutt. "But remember that an abrupt jump in interest rates and the 10-year would affect other asset classes, too."
Buyer Beware
None of this is to say that some real estate isn't perilously overpriced. In particular, speculation appears to be driving the prices of many apartment buildings and condominiums to unsustainable levels. "There some people who are being wildly aggressive when it comes to pricing cash streams for apartment buildings," says Linneman. "They are looking at a building with 45% vacancy and saying 'I'm going to buy it as if it's 90% occupied.'" Similarly, condominiums -- which offer virtually no income stream since they are owned, not leased -- are looking shaky. Between 50% and 60% are now being presold to investors who don't plan to live in them. Once buyers stop showing up to the presales, the prices will tumble.
David Rubenstein also sees weakness in certain office markets, especially in the suburbs of Washington, D.C., and in southern California. In those markets leasing costs are rising, net operating income is falling (due to leases that tenants signed five years ago but are now up for renewal, at lower rents), and investors are taking on what he considers excessive leverage. That should produce lower prices for some properties.
And there's always the risk of some broader meltdown that would bring down the real estate market along with stocks and bonds. Linneman argues that in this case, an investor would be wise to be in the asset that's the least overvalued to begin with: commercial real estate.
Barring a calamity, investors should expect solid, if not spectacular, returns, says Gyourko. He predicts that while the real estate market will continue to do well, the days of double-digit appreciation are over. "Relative to historic pricing, real estate is pretty expensive, and that's something that should make everyone think hard," he says. "Does it mean that prices are going to fall? No it doesn't. But it almost certainly means that the returns will be lower going forward. The million dollar question is this: Will you be disappointed relative to other things you could have done with your money?"
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