Land banks come under Sebi scanner

In the surreal world of property valuations, this one perhaps takes the cake. A real estate company wanting to buy a piece of property roped in a reputed international consultant to do the valuation.

The consultant, eager to oblige, submitted a document valuing the property at Rs 4 crore. The company trumpeted the number to an investor, who promptly wrote a cheque buying a piece of the company. The company went to the owner, bought the property not for the value estimated by the consultant but for a much smaller amount—Rs 50 lakh.

K Raheja Corp recently valued a four-acre property in Bangalore’s Whitefields area at Rs 44 crore per acre. The actual going rate: Rs 7-8 crore per acre. Yet another company, just ahead of an IPO, valued its properties in Bangalore on what is called the macroanalysis method. They calculated the value based on the average of the highest transactions in the city in recent times.

Any responsible valuer would have done the valuation by visiting the properties, finding out the actual rates based on location, approach etc.

These are some instances of the fancy footwork employed by domestic real estate companies to jack up valuations and create hype. Consultants eager to make a quick buck and not wanting to miss out on a hot growth sector are willing to oblige. And gullible investors, who buy shares of these companies only to watch them sink, are often left in the lurch. But a backlash is brewing. As India’s superheated real estate market begins to cool, the methods used by real estate companies to dress up valuations are being questioned, criticised and condemned.

On Friday, Sebi chairman M Damodaran said there is lack of clarity in the disclosures of real estate companies, especially regarding their land banks.

“We sought clarity from those that have brought issues to us on matters like what does your land bank comprise, what are the valuation aspects that you have indicated,” Mr Damodaran said.

Real estate industry experts say there are two major issues here. One is the method of analysis, which is often cursory and lacks the detail and depth that a proper valuation commands. Many draft prospectuses contain reports from prominent consulting firms such as Cushman & Wakefield, Jones Lang LaSalle, Knight Frank etc. These are not valuation reports, only `opinion of value’, which is completely different.

A valuation is a proper, thorough exercise conducted by a government-approved valuer who spends time at the location, examines title deeds, land records and estimates the value of the land based on comparable rates.

What many of these firms do is to rely on data provided by real estate companies to estimate the value of the property. They don’t do a comprehensive analysis either of the title deeds or visit the property in question to determine whether it can command such a price.

Take, for instance, Cushman & Wakefield’s report for Sobha Developers, which did an IPO last year and is now a listed stock. “This report has been prepared on the basis of market information available from secondary sources only. We have not conducted a legal review of the documents for the subject property...This report is not based on a comprehensive market research for all possible market situations,” the firm said in its caveats and limitations.

“We are not giving any valuations to developers. What we are doing is evaluating the data of land provided by the developers. It is just a comparison of the location of land and the prevailing prices in that location,” says Knight Frank India chairman Pranay Vakil.

An analyst with Cushman & Wakefield said the consultants are not necessarily aware whether the land has been bought, paid for, or whether it has been paid only partially. The consultants are also not told about the exact location of the property or its immediate neighbourhood. So the vagaries inherent in property valuation in India are not taken into account fully.

DLF, which is in the spotlight after reports estimating its value at over Rs 1 lakh crore, has removed its valuation report in the draft prospectus filed with the market regulator in December. The earlier document filed in May 2006 contained a valuation report from Cushman & Wakefield and Jones Lang Lasalle.

A building may fetch completely different rates depending upon the view, access roads and location alone. In Mumbai, a building in the eastern part of the city fetches a different value compared with one located in the western part, which is closer to the sea.

Doing a macroanalysis in such a situation to determine value of a specific property would be madness, say experts. No two houses in one building sell for the same price—there is always a difference based on a corner house or the floor. This is applicable to the theory of land banks as well.

“With such fine elements determining price, how do you value a real estate company and its stock? Land is an illiquid asset in the market and one of the least transparent, with very high transaction costs,” said an analyst with a domestic brokerage.

The other problem is that examination of land and title deeds is not done in the reports. This is crucial as companies seldom own land completely at the time of a public issue or the land is owned by the promoters of the companies in their personal capacity.

The problems with land bank valuations could have serious implications in other areas as well. Real estate mutual funds, when they are allowed, could face problems in calculating the net asset value if there are wide disparities or disputes in valuation.

A leading Mumbai-based developer said, “There is no doubt that land banks are a deciding factor as far as the valuations of real estate companies are concerned. However, it all depends upon where the land is located, what kind of development is scheduled and how long the new construction takes to generate revenue. If I am saying that I have 200 acres of land in Pune and it has a value of Rs 100 crore, this does not make any sense. However, in case the land has an IT park that has started generating revenue, I can say the land has contributed to the valuations of my company.”

While valuing a real estate company, the investor needs to see not only the quantity but also the quality of land banks along with their location. Many of these are said to be around special economic zones, but the future of SEZ-led development is still not clear in India. The gestation time associated with the development of an SEZ may be very long.

Non-SEZ well-located land parcels too will take time to develop. This raises two questions. One, when will this land bank lead to cashflows? Second, at what price will the sale happen? The questions that crop up now are: with the rising cost of construction (both in inputs and labour), will companies be able to maintain margins in future, how much of the current demand is effective demand, and how much is supply-side push?