Zimbabwe - Its $500 million currency note and real estate market! and the huge crisis!

WOW! A $500 million currency note after a $100 million currency note has been printed in Zimbabwe which is facing hyperinflation. Zimbabwe’s highest inflation was last estimated in July at 231 million percent but is now believed to be much higher. And did we say we were at 8% and still dreading the effects! Scary, isnt it.

$100 million in Zimbabwe = $14 USD. Unbelievably true!! The highest inflation India has ever faced is 53.8% way back in the famine year of 1943. Many other Asian countries have done far worse than India over the years. (The less said about hyperinflation-prone Latin America, the better.) Inflation in China reached 1,579% in 1947, when there was a civil war raging there. Japanese inflation peaked at 568% in 1945, the year of defeat and economic collapse. South Korea saw inflation shoot up to 210% in 1951, when it was at war with the communist North.

All this thought about the hyperinflation led me to wonder what the property market in Zimbabwe would be like. As it appears, the rentals are revised very rapidly without any major developments. Surprisingly, there is huge demand from South African and Russian buyers for Zimbabwean property despite the global meltdown and the countrys problems.

Further research provided more information about the problems. The president Mugabe who has been at the helm since the country got independence in 1980 from the Britishers in 1980, has started a new land redistribution project that takes property from white farmers and turns it over to blacks. He has said that Britain should be responsible for compensating farmers, because British settlers took the land in the first place. Land redistribution has led to widespread food shortages and stratospheric inflation.

The situation is expected to get worse in the country with widespread cholera epidemic that has killed thousands of people. The country is facing a currency crisis and a political infighting is not going to help Zimbabwe resolve its issues. Either the United Nations or the United States need to intervene to bring this country out of a crisis.

Is the fixed 9.5% rate for home loans justified?

My previous post talks about the new government regulation where home loans below Rs20 laks will be available at lower than market rates at 9.5% (Read here). On second thoughts I was wondering whether it is fair on the PSU banks to provide loans at such a cheap rate. The gainers will be home builders who have till now made millions by charging exhorbitant rates for their properties. The losers will be banks whose profitability will be eroded or the government will bear the losses through subsidies. Hence, in this case private realtors will bag the profits and government will bear the losses! Should'nt the real estate builders be asked to reduce prices of their flats/ houses/ villas that they have been selling at exhorbitant prices.

Secondly, why is the government supporting only the real estate sector. There are equally hit rate sensitive sectors like automobiles, construction etc. Why arent these being protected with impending bankruptcies in US of the 3 auto majors - GM, Ford and Chrysler. Is it because real estate contributes over 10% to GDP with its forward and backward linkages with steel, auto, construction sectors etc. Then sectors like textile need equal attention as they generate employment. What about banking? A banking sector collapse can send ripples across the economy.

Lets see what measures are further taken by the government to prop up the economy or more specifically the stronger lobbying sectors!

Sale of "The Courtyard"

A brief background of the deal

“The Courtyard” is a 5 star hotel developed by Unitech. Below you will find some of the other useful details

Location: Sushanklok, Gurgaon. Approximately 25kms from the New delhi airport and 10 kms from Gurgaon CBD ( Cyber greens).

Rooms: 198 rooms
Charges per room: INR 7000- 9000per day

The Hindujas have offered INR 198crore, approximately 1cr per room.

Approach of analysis

Calculate the revenue from hotel using varying occupancy level and room rates.

1. Calculate the revenue multiple of the transaction at various levels of revenues and compare it to other industry with similar growth pattern as that of real estate ex. IT services.
2. Calculate the cost of construction of a 5 star hotel (plug and play).
3. Calculate returns to the developer.
4. Other trading comparables in the hotel industry

Analysis

1. Revenue sensitivity

The table shows the revenues achievable at various room rate and occupancy assumptions

2. Revenue multiple

Formulae applied = Transaction value (198cr) / revenue (from the table in point 1)
The mean revenue multiple that I have picked up here is 4.9x. The range is 3.6x – 7.1x. Compare this to the revenue multiples in other high growth industry such as IT services. The mean revenue trading multiple for IT services is 3.0x for indian companies. EBITBA multiple would be around 12 - 15x.

3. Construction cost

Hotel “The courtyard” has 198 rooms. I have assumed that average room size is 400 – 800SFT and the cost of construction ranges from INR 5700 – INR 6300 per sft. Covered area has been assumed to be 60%.
With these assumptions the table above shows the sensitivity of costs with the changes in average room size and construction cost. I have taken average room size as 600SFT and construction cost has INR 6000 per SFT. The construction cost for this base case comes to INR 118.8 crore.

4. Calculation of returns
Assuming a construction period of two years and for the given transaction value of 198crores. The returns to Unitech is expected to be around 30% per year for the base case.
The table below shows the sensitivity to returns upon the change of construction cost.

5. Trading comparable
If I were to compare the revenue multiples derived above with the comparables chart below, I see that the revenue multiple of 4.9x touches the higher end of the valuation multiples. However one can argue that the valuation multiple of 4.9x doesn’t factor in the revenues that “The Courtyard” could have got through other sources such as F&B

Conclusion

From the analysis above I believe that the hotel industry still attracts high valuation multiples and this is probably the reason behinds Unitech’s planned investment of INR 2500crore into the hotel business.

Government plans to fix home loan rates for PSU Banks at 9.5% will be ineffective...Heres why?

Public sector banks are set to offer home loans of up to Rs20 - 25 lakh at a concessional rate of 9.5% for a period of five years as part of the government’s fiscal stimulus package to spur spending and bolster sagging economic growth. Read more

This would mean the cost of funds is greater than the return that these PSBs would be getting. As it is the profitability and efficiency of the Indian PSBs are dangling. Banks and housing finance firms are now charging between 12% and 14% for fixed-rate home loans and offering floating-rate mortgages at between 9.5% and 11.75%.

It seems the Indian bankers have not learnt the lessons of subprime crisis and option ARM pricing. Rates will stay at 9.5% until the loan resets to the market rate.This will greatly harm the bankers as it has done in the subprime crisis.

PSU Banks account for only 20% of the total housing market, hence limiting the scope of the stimulus package.

The obvious outcome of this policy will be that the homebuilders will price the houses at 20 - 25 laks in white and the remaining in black to increase sales. Moreover, they will build jodi flats, which will individually cost 25 laks and the affluent buyers can make use of this scheme to benefit.

One concern is what will happen once the interest rates fall below 9.5%, which seems to be happening in the next 2 years. Nothing has been mentioned and this makes the deal unattractive!

A peep into the 1996 real estate bust in India

Magnitude of the problem
Real estate directly accounts for 7.3% of India's GDP. Other background linkages in terms of sectors usage of iron, steel, cement etc., and forward linkages (travel) to other sectors impacts an estimated 14% of GDP. Thus the total impact to India's GDP on account of the real estate sector is 21%.

Understanding the movement of macro economic factors

The Indian property market witnessed a prolonged trough following a bust in 1996. Residential real estate prices which had seen an increase of an average 70% cumulatively in the three years preceding the 1996 bust, fell 40% in the three years after 1996.
The property market bust was accompanied by a period of relatively lower economic growth. GDP growth which had averaged 6.8% in the four year prior to the bust fell to 5.4% on average in the four years after it. The chart above shows GDP, private consumptions and investment in the given period. Can we see a similar pattern in the current scenario?

Looking into the movement of real (inflation stripped) realty prices

From the chart alongside we see that property prices in real terms in Mumbai and Chennai have not surpassed their 1996 levels.