I am sharing an edited note, we published to subscribers recently. A few points to keep in mind as you read this note.
- I have a terrible track record in forecasting business cycles.
- I got the real estate cycle wrong the last time when we added to the sector in early 2017.
That said, I am stubbornly persistent. Even if I got it wrong the first time, it does not mean I will not try again.
I wanted to start the update for this quarter with some broad comments for the sector and how it is influencing our decisions for this basket. I am looking at the real estate basket versus individual companies, in the same manner as financial services/banks.
The real estate sector is a longer duration cyclical sector like infra in comparison to the financial sector. The real estate cycle is around 8-10 years from peak to peak versus 2-3 years for financials. Again, this is not an empirically proved number, just an observation.
The Indian real estate sector went through a longer down cycle this time due to some additional events namely Demonetization in 2016, Credit down cycle in 2018 and then covid in 2020. At the same time, demand for real estate is usually steady over the long term. There are sub cycles of extra demand from investors, but over the long run demand is tied to household formation, migration, and replacement of old stock.
We had an overinvestment phase from 2003-2010 which peaked around 2011. Since then, we have had a bear market for 11 years during which the excess inventory was absorbed. I had originally estimated that the cycle would turn in 2017 but got the timing wrong (by only 6 years!)
We are seeing an upcycle now. Keep in mind that this cycle will not be a linear one. We could have intermediate downcycles within this secular uptrend. This trend is now visible across the sector as follows.
- All real estate companies are now reporting high double digit pre-sales. This will translate to higher reported sales in the next 2-3 years.
- There is a trend towards higher priced housing. Increasing pre-capita income level is driving this trend.
- Regulatory and other changes mean that the organized sector is capturing incremental demand. This means industry consolidation, better pricing, and higher ROC in the long run.
My gut feel (Which can be wrong) is that we are in the initial phase of this cycle, and it can continue for 3 years or more. At the same time, there will be periodic corrections as we go along.
Our investment in this sector is based on the above thesis. We are spreading our bets so that we can benefit from the tailwinds without being 100% right at the company level. We may swap positions based on the relative performance of the companies in the sector
