(This story was originally published in the February 2020 issue of the magazine.)

The NBFC (non-banking financial company) crisis and the resultant liquidity crunch is not the biggest road-block for the resurrection of Indian real estate. Or so says Irfan Razack, chairman and managing director of Prestige Group, who points to a more pressing concern.“The biggest challenge, as I see it, is the mounting trust deficit,” says Razack, 66. The Bengaluru-based real estate leader is referring to the consumer’s flagging confidence in a builder’s ability—and sometimes in-tent—to complete projects, meet deadlines, and deliver on promises. (His own company, as it stands, has been cognisant of this need to fuel the faith, and finished projects covering 24.2 million sq. ft., including 19 million sq. ft. of residential space and 5.2 million sq. ft. of office space, in the last calendar year.)

Razack can afford to have a contrarian view. The Prestige Group had two consecutive quarters of profit in FY20, a silver lining in a beleaguered real estate industry. (Cumulative sales in the top eight metros reported a 1% year-on-year decline in July-December 2019.)

More significantly, its home market is also an anomaly: Bengaluru has seen a 10% surge in residential sales in 2019 over the preceding year, according to real estate consultancy Knight Frank India, the only market to report double-digit sales growth. Chennai is a distant second at 6%.

But hope floats amidst the doom and gloom, particularly for those developers who are able to go beyond the beleaguered residential segment and turn their attention to office space. “The net absorption of office space in 2019 was the highest ever,” points out Sanjay Dutt, MD and CEO, Tata Realty and Infrastructure Limited. Office leasing activity in 2019 touched a historic high of 60.6 million sq. ft. despite the ongoing slowdown in the economy, registering a 27% growth over 2018. This was primarily driven by the IT/ITeS industry, which accounted for over 40% of the total office space absorption.

This surge indicates a paradox of job creation despite increasing job losses in sectors such as automobile, auto components, and real estate. “There are jobs that are being created because of the office space take-up by the IT, BPO, and financial services sectors. Large international corporates are offshoring work and a lot of Indian companies are expanding,” says Anshuman Magazine, chairman and CEO, India, South East Asia, Middle East & Africa at CBRE.

For the realty industry, the office surge isn’t enough to offset the residential dilemma. “In sales terms, when compared to the housing market peak in 2010-11, the market is about one-third of what it was,” says Gulam Zia, executive director, valuation & advisory, retail &hospitality, at Knight Frank India. Roughly, 33 apartments are being picked up for every 100 apartments sold around a decade ago, he points out. “So you can imagine how bad things are.”

After all, spending on housing is low on the consumer's priority list. Food, education, and healthcare take precedence, says Zia. “Only if there is more money in people’s pockets will spends on real estate happen.”Even assuming the best—that the current economic environment turns around sooner rather than later—it will take two or three quarters for the residential sector to bounce back, he says. That is largely because not one but several factors combined to bring the giant residential real estate sector to its knees.

Bitten by reforms and more

As is Indian economic legend now, things took a turn in 2016—for all sectors including real estate which had already, at the time, been dealing with slow sales and an inventory overhang for around three years, after a period of heightened exuberance. There was a sense of optimism, however, due to government initiatives like smart cities, housing for all by 2022, and the Atal Mission for Rejuvenation and Urban Transformation. Buton November 8, 2016, the government’s demonetisation (withdrawal of high-denomination notes) initiative derailed the market. “Demonetisation sucked a lot of liquidity from the system by slowly depleting the parallel cash economy,” says Shishir Baijal, chairman and managing director, Knight Frank India.

Other reform measures, introduced around the same time, hampered the sector’s ability to bounce back. The Real Estate Regulatory Authority (RERA), launched in 2016, says Baijal, “created a crunch on the supply side for some time until all projects becameRERA-certified”. (RERA and its norms are meant to protect the interests of homebuyers from rampant malpractices that plagued the industry.) The Insolvency and Bankruptcy Code (IBC) saw the downing of shutters of developers with weak financials. The rollout of the goods and services tax, with multiple tax slabs on housing and on raw materials, added to the sector’s woes. “On the whole, the combined impact was massive,” adds Baijal.

To compound the teething issues of those reforms, the unravelling of NBFCs such as the IL&FS Group(which is now sitting on a debt of ₹94,000 crore)escalated the liquidity crisis. This led to some NBFCs halting the disbursal of earlier sanctioned loans to developers, while others wanted their money back. According to various research reports, the exposure ofNBFCs to the Indian real estate sector is to the tune of ₹4 lakh crore.

Not all of it is bad news, however. A recent research report by Anarock Capital, the investment, banking, and advisory vertical of the Anarock Group, optimistically contends that approximately $58 billion of loan advances to the Indian real estate sector by banks, NBFCs, and housing finance companies is “completely stress-free”. The report added that about $21 billion of loan advances to the real estate sector was “under some pressure”, but can potentially be resolved as the stress is largely on the recovery of interest and not on the principal amount.

Many experts are not convinced though. “We can expect a few more skeletons to tumble out of the cupboard... for every IL&FS that comes up... it pulls down the real sector by a couple of notches,” says Zia.

The Indian real estate sector, however, is not one-dimensional. It is a mix of commercial (office spaces, shopping centres, warehousing, industrial, and data centres), residential (affordable-, mid-, premier-, and luxury housing), and newer asset classes such as student housing, senior living, co-working, and co-living. The stress point is primarily caused by the mid- and the premier housing segments due to excessive supply in the National Capital Region (NCR) and Mumbai: Till date, close to 450,000 homes remain unsold across the country, with 60% of the inventory almost equally split between the two regions.

Since the residential market is intrinsically linked to domestic consumption, economic headwinds such as slower GDP growth, reduced industrial output, and poor consumer sentiment, amongst others, have a direct impact on sales. But developers are hopeful that2020 would see a revival in fortunes.

The PE play

“The real estate demand story is not necessarily negative as most in the market perceive it to be,” says Dutt of Tata Realty. “We have seen private equity (PE) funds allocating more capital for shopping centres, warehousing, industrial buildings, and data centres.”Additional data shared by Anarock Capital noted that the sector attracted nearly $14 billion in foreign PE in-vestments between 2015 and Q3 2019. Approximately63% of this was in commercial real estate assets. The top five foreign investors—Blackstone, Brookfield, GIC, Ascendas, and Xander—contributed 75% of the overall funds invested in the sector, notably going beyond the top seven metros into tier 2 cities like Indore, Ahmedabad, and Amritsar.

Meanwhile, the residential sector attracted just$1.5 billion of foreign PE in the same period, “trailing behind even the retail sector which saw cumulative inflows of $1.7 billion”, says Shobhit Agarwal, MD and CEO, Anarock Capital.

Steady demand for office space and rising rentals proved decisive for foreign PEs as did the overwhelming response to the launch of Embassy Office Parks’REIT. (REIT, or a real estate investment trust, owns and operates income-yielding commercial assets.) This saw the commercial segment emerge as the bigger draw for investors. In fact, several other large developers are also looking to list their commercial assets under REITs.

In stark contrast, of the nearly $2.4 billion domestic investor money pumped into the Indian real estate market since 2015, nearly 71% has gone into the housing sector. The top five domestic funds—Motilal Oswal, HDFC Venture, Kotak Realty, ASK Group, and Aditya Birla PE—accounted for about 54% of the funding.“Over the short-to-mid-term, the housing sector, which has the greatest need for liquidity infusions, will retain its ‘poor cousin’ status and garner much more gradual attention from wary investors,” adds Agarwal.

They might take a cue from one intrepid investor, Motilal Oswal, which closed its fourth real estate fund of ₹1,200 crore in December and is preparing to deploy the capital into the residential market. The firm already has assets under management of ₹3,500 crore. “Because of various factors, the residential real estate market is going through a phase of consolidation—a one-time re-set—which would require capital, and we would like to play a part in that,” says Sharad Mittal, CEO of Motilal Oswal Real Estate Fund.

Their confidence would be buoyed by government schemes such as the launch of the ₹25,000-crore real estate Alternate Investment Fund. “This will help provide last-mile funding to affordable housing projects. And the slashing of the repo rate by 135 basis points last year has helped home loan borrowers,” adds Dutt.J.C. Sharma, vice chairman and MD, Sobha Limited, also points to “the additional deduction of up to ₹1.5lakh for interest paid on loans borrowed up to March 31, 2020, for purchase of a home valued at ₹45 lakh” as an added boost to the affordable housing segment.

At the same time, going by the current market trends, the first half of 2020 may not see any significant activity in the residential space since these initiatives take time to bear fruit. Also, the liquidity crisis is likely to continue to hurt cash-starved developers, leading to mergers and consolidations or even shut shops.“Towards the second half of 2020, we may see better growth in residential real estate as the seeds of many of the measures announced will begin to bear fruit,” says Anuj Puri, chairman and founder, Anarock Group. That said, the sector’s hopes of a revival also depend on the actual on-ground implementation of some of the announced sops.

“In 2020, I expect to see greater optimism in Indian real estate,” says Razack, and, as a result, a restoration of trust.

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