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Sunday, June 24, 2007

Real Estate Stocks to decline ?


Once real estate prices correct, stock prices of sectors that have benefited from the boom will also decline.

The housing and construction boom of the past four years has created a lot of wealth and spread it around more than any phenomenon of the past five decades. Ever since banks started to target retail clients in 2003-04, millions of middle-class citizens have leveraged future earnings to buy property.

At the same time, growth in IT/ITES has driven commercial property. If you'd bought real estate in 2004, you would have probably doubled your investment by now. What's interesting is that returns from other beneficiaries are even higher than returns from real estate itself.

The real estate developers were the stock market success story of 2006-07 with half a dozen multi-baggers. The cement and construction industries and the finance industry have also been major beneficiaries of the boom.

If you'd bought the few listed real estate companies in 2004, your percentage returns would be four-digit. Cement and construction companies have delivered high triple-digit returns. The top rung banking and housing finance stocks have tripled since 2004.

There has been an asset bubble – that is inevitable when real estate doubles in value and more, in three-four years. It now appears that real estate itself is cooling. Lower interest rates and smoother paperwork enabled the boom – higher interest rates have caused cooling.

The recent sale of sticky home loans to asset reconstruction companies is a signal that NPAs are hurting. Real estate prices have softened little but we've got classic signals that suggest further softening in metro markets, at least.

Demand for new home loans has eased substantially – quite apart from defaults. In new real estate, while the price line is officially steady, cash-down buyers are getting 10-15 per cent discounts. Inevitably that will lead to lower prices.

The real estate market itself may clear, given price correction (15-20 per cent) that adjusts for rate hikes and eliminates speculators. Now, does the upside price-sensitivity translate into similar downside sensitivity?

If a 100 per cent rise in real estate prices set off 300 per cent increases in listed companies that benefited from the real estate boom, will a 10-15 per cent fall or a zero-growth scenario lead to a crash in those listed companies?

That's a scary though but it is something a trader should consider. Price declines in these industries can be exploited. Most of the big boys are available in F&O, which means that you can hold short futures positions for months on end. Fundamental shorts are a distinct possibility.

We've already seen 30 per cent corrections in the developer industry in February-March 2007 on the basis of lower 2007-08 projections. Cement also took a hammering especially after the lunatic dual excise rate.

Perhaps the corrections in these two industries have already factored in softer real estate prices. However, I would be tempted to short both sectors given another rate hike.

Banks are doing well in terms of stock prices. In fundamental terms, they shouldn't be. The interest rate hikes of the previous year have already hit both volumes and bottom lines. The highest growth in credit disbursal between 2003 and 2007 was from home loans. That segment is clearly impaired.

But in game-theory terms, banks are likely to continue delivering a decent performance. Every bank of respectable size must recapitalise to meet Basel II norms. ICICI's FPO has just got the ball rolling. This creates a "you scratch my back, I'll scratch yours" situation.

Every financial institution has a vested interest in ensuring all FPOs are successful. Extending the logic, the RBI has an interest in ensuring that bank FPOs go through. Whether it can persuade the political establishment to enable this process is a different matter. But banks won't get a hammering – until the FPOs have gone through.

This implies that unless interest rates start travelling downwards, the entire banking sector will be significantly over-valued by the time FPO action tapers off.

This has implications for banks – the sooner they get their FPOs in, the better. It has implications for FPO investors – you should book profits quickly in FPO allotments because the money will skip onto the next FPO.

It has long-term trading implications. Traders should ignore higher rates and be long on banks in apparent defiance of fundamentals until the FPO action ends. After that, "double-minus" – close long positions and go short unless rates have dropped. If the logic is broadly correct, banking will be a focal point for two years. First, prices will go up, then down.