Merril lynch report on Bangalore real estate

The following is Merril lynch’s latest report on Bangalore real estate

We expect Bangalore real estate sector growth to remain slow but steady over the next 12 months with flat residential volume for the second year in a row, while favorable office demand-supply fundamentals will likely lead to a further fall in vacancy levels. So, we prefer diversified developers, with limited investment in land banks, like Prestige & Brigade over pure residential players like Sobha and Puravankara.

We foresee residential sales volume to remain flat YoY in FY13 despite expected mortgage rate cuts of 100bp in 2HFY13, salary hikes of 8-10% in FY12/13 and project launches at affordable prices. We believe the above-mentioned positive factors shall get nullified by strong global economic headwinds, slowdown in IT sector & our FY13 estimate of 6-8% rise in prices (mainly to offset rise in costs).

We expect Bangalore office leasing (demand) to slow down from ~8mn sq ft in FY12 to ~6mn sq ft in FY13. However, we expect a sharper slowdown in supply, from ~6.5mn sqft in FY12 to ~4.25mn sq ft in FY13. Thus, we expect rents to rise by 5-6% (exception Electronic City) led by demand-supply mismatch and under-investment in office sector by developers since 2009.

We expect Bangalore real estate market’s growth to continue to remain slow for the next 12 months given global and domestic economic slowdown. We forecast another year of flattish sales volume in the residential segment. On the other hand (in the office segment), while leasing is expected to fall by 25% to 6mn sq ft, demand is still expected to exceed supply for second year running leading to a marginal increase in rentals.

Capital values in Bangalore have seen just 8% CAGR in the past 8-10 years and remain the most affordable among metro cities in India. This in turn has led to limited growth in land value. Thus, we believe large investment in land is unlikely to yield rich dividends (unlike Gurgaon/ Mumbai). Therefore, our preference for developers (Prestige and Brigade) with limited capital investment in land.

Bangalore city has provided the much-needed stability to the Indian real estate sector in FY12, with ~10mn sqft of commercial leasing and residential absorption of ~16,000 units (~25mn sq ft). We expect this trend to continue in FY13, albeit at a slower pace with the commercial sector expected to lease another ~6mn sq ft

The prime reason for lower commercial leasing in Bangalore is due to lack of vacant space to satiate demand in Bangalore and global economic headwinds. Vacancy levels in prime and growth locations are at their historical lows.Also, average prices in Bangalore residential markets continued to rise a notch above inflation, at 10-12%, in FY12. Historical data series show that Bangalore residential prices have witnessed CAGR of 8.6% over the past decade. We believe this has emerged as the prime reason for solid volumes in Bangalore given its affordability. We expect prices to remain flat across the city and rise marginally in select projects and/or locations through FY13.

Bangalore unlikely to see any price correction

We don’t expect any correction in Bangalore residential prices going forward and believe the worst in terms of volume is already behind us. Bangalore developers offered a maximum of 2-3% discount to buyers through FY12 even in a tough environment. We believe these discounts will dry up as we progress into FY13. Total number of units launched in FY12 was ~24,000 compared to ~25,000 units in FY11. Correspondingly, total number of units absorbed in FY12 was ~15,500 units compared to ~16,000 units in FY11, indicating stability in the market, despite rising interest rates during the said period and global economic uncertainties. We can attribute this trend to affordability in price, increase in investors’ interest from other cities and new launches by renowned developers.

Also, our affordability analysis suggests that the rate cuts alongside an 8-10% increase in salary should help drive affordability in Bangalore to levels that existed in mid-2009. India Inc. hands out salary hikes and annual bonuses in 1QCY every year. Anecdotal data suggests the average salary hikes this year (CY2012) have been nearly 8-10%, which we have incorporated in our affordability model. Salary hikes and annual bonuses have helped improve affordability further. Although various sources hint towards a slowdown in IT sector, though there is no evidence of cuts in headcount across the industry offering tremendous comfort.

Again, anecdotal data collated from brokers and developers shows that Bangalore has seen significant interest from non-resident Indians (NRIs) in FY12, primarily led by a sharp depreciation of rupee (20%) against US dollar and Singapore dollar. The rupee depreciation further increased affordability in an already affordable city in dollar terms.


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