Budget Impact - Realty Sector

Real Estate:

SATELLITE TOWNSHIPS AND CITIES TO GET A BOOST DUE TO HIGHER ALLOCATION TO RAIL, ROAD AND PORTS

*Interest rate subvention of 1 per cent for property loans extended

*Higher allocation for housing and urban poverty alleviation

*Increase in allocation for Rajiv Awas Yojana (RAY) for slum dwellers and urban poor

*Pending projects given another year for claiming deduction on profits under Section 80IB (10).

The continuation of one per cent interest rate subvention will help improve volumes in the affordable housing segment. The higher fund allocation for Rajiv Awas Yojana and Indira Awas Yojana should benefit residential segments in both urban and rural centres. The increase in allocation for slum redevelopment to Rs 1,270 Cr should give a boost to companies involved in the rehabilitation business. The permission to use external commercial borrowing money for cold storages will give a boost to industrial and logistics parks. The higher allocation to rail, road and port infrastructure and impetus to special economic zones (SEZs) will have a cascading impact on real estates it will lead to the development of satellite townships and cities.

Impact: Should benefit HDIL, Indiabulls Real Estate, Unitech, DLF, Orbit Corporation and DB Realty.

The Union Budget 2010-11 is Negative for the real estate industry. Not only have key industry expectations such as (i)increase in income tax deduction under Sec 24(B) for housing loans from Rs0.15m to ~Rs0.25m, (ii) industry status for the real estate sector, and (iii) reforms for introduction of REITs in India not been met, but the scope of service tax has also been expanded, which will lead to a ~3% impact. However, measures aimed at increasing disposable income in the hands of consumers and continuation of interest cost subvention benefits for affordable housing for FY11, are positive.

Explanation of service tax on developers: The government has issued an explanation on the service tax payable by developers. The tax has now been broad-based to include all new buildings intended for sale, wholly or partly by the builder at any stage of the building or after the construction. Industry is still awaiting clarification on whether this service tax is applicable on construction cost or on sale value. Currently, the consensus view is that this tax is applicable on the construction cost and not on the sale value of a building. If the tax is on construction, it would imply a service tax burden of 6-7% for the builder (labor attracts 10% tax and work contract attracts 4% of tax), which would imply a burden of 2-3% on the sale value(assuming 40-50% profit margin and deducting land cost). While clarity on this is still awaited, our view is that this tax is likely to be inflationary.
Higher disposable incomes to boost affordability: The real estate sector is likely to be a key beneficiary from the tax slab rationalization, aimed at increasing disposable income of consumers. The rationalization of tax brackets would lead to lower tax incidence for 60% of the tax payers and would increase affordability for potential homebuyers.

Continuation of interest subvention of 1% for loans up to Rs1m for property priced up to Rs2m: This is positive for companies with focus on affordable housing such as Unitech, Purvankara, HDIL, Sobha, etc.

Allocation for urban development increased by 75% from Rs30.6b to Rs54b: Allocation for Housing and Urban Poverty Alleviation has been raised from Rs8.5b to Rs10b: This is positive for real estate, as it would facilitate urbanization of key metros, boosting demand for real estate. Increase in allocation for the Rajiv Awas Yojna to Rs12.7b from Rs1.5b: This is positive for real estate, as it would aid urbanization by encouraging states to provide property rights to slum dwellers.

Increase in allocation for the Indira Awas Yojna to Rs100b: This is positive for real estate, as it would augment the pace of rural housing.

One-time interim relief to the real estate sector: The government has allowed completion of pending projects within a period of five years v/s four years for claiming deduction on companies' profits. Norms would be relaxed for built-up area of shops and other commercial establishments in housing projects to enable basic facilities for their residents. This is positive for real estate companies as it allows them to claim deductions for an additional year.

Sector view:

The Union Budget 2010-11 is Negative for the real estate industry. The sector continues to be firmly set for recovery, following the successful balance sheet recapitalization by key companies and the pick-up in activity. Recent underperformance of large cap real estate companies coupled with the recent price correction provides investors an opportunity to accumulate real estate stocks at ~25% discount to NAV. We believe that the two key catalysts that would drive stock performance in the medium-term are: (1) recovery in the commercial and retail verticals, and (2) visible acceleration in execution. Our top large cap picks are DLF and Unitech (recently upgraded to Buy). Within mid-caps, we like Anant Raj, Mahindra Lifespaces and Phoenix Mills.