OVERVIEW

 

The real estate sector is highly fragmented & unorganised. This apart, the regional dynamics also play a significant role in the functioning of this sector. Further, there are many small players in this sector which leads to a low level of Investor trust. Despite the above, there are quite a few large corporate houses which have entered into this sector and the same is bringing some level of transparency. Pricing of properties, existence of informal market, quality of construction, level of adherence to committed specifications of both materials & designs, presence of actual users & investors – all have significant bearing in this sector requiring thorough evaluation of all the relevant parameters.

For the purpose of rating of any debt instrument and/or borrowing programme of a real estate entity, various parameters are looked into to facilitate appropriate credit risk assessment. While each parameter is important, on a standalone basis, different parameter has different level of criticalities. The parameters evaluated for the purpose are described below:

(A) PROMOTER(S)/PROMOTER GROUP

The stature & standing of promoter/promoter group are evaluated, in general, and in the real estate sector, in particular. As it is quite customary in the real estate business that the umbrella company forms a number of small companies (SPVs and JVs) for execution of various real estate projects, the project completion track record and the financial resourcefulness of the promoter group are looked into. If the parent entity of the group, irrespective of the sector it operates, is the main revenue earner for the group, then the financial soundness of such entity is examined. The major group companies are analysed with reference to performance & financials, business synergy, group support, mutual dependence, exposure to group companies, if any, and so on.

(B) QUALITY OF MANAGEMENT

All ratings necessarily capture an assessment of the quality of the issuer’s management, as well as the strengths/weaknesses arising from the issuer’s being a part of a group. Usually, a detailed discussion is held with the management of the issuer to understand its business objectives, plans & strategies and views on past performance. The management capability is evaluated from different perspectives like
experience of the top management in the real estate sector, overall experience, past accomplishments, track record in managing medium to large sized projects. The quality of technical personnel, including architects and engineers, is also examined.

(C) OPERATING RISK

The areas of business like whether the company is in all facets of real estate business like residential, commercial, retail or not need to be seen. The geography/geographies in which the entity is present are considered. The project completion track record of the entity being rated is seen. The projects in hand with particular reference to size, location – diversified or in same territory, project execution arrangement (like joint venture model or not), means of financing & extent of financial closure are factored in. Also the proposed projects, land bank, etc. are taken into consideration. The quality of technology being used, quality control framework being in place, procedures & systems being adhered to and project implementation process (encompassing land identification & acquisition, project execution, costing & pricing and project manning) are evaluated in detail

 

(D) INDUSTRY EVALUATION

As stated earlier, the real estate business is a regional game and hence, regional demand-supply dynamics is very important. While evaluation of this sector starts with pan-India situation, the demand-supply scenario of the territory(ies) where the entity is operating is also critically analysed. The effect of new Real Estate Bill and other government pronouncements are considered. The overall sector evaluation essentially covers all the major segments like residential, commercial and retail.

 

(E) FINANCIAL ANALYSIS

Similar to other infrastructure segments, the real estate is also characterised by fairly high level of capital intensity. Infomerics carries out an in-depth analysis of the projected operations to get a clear indication of the entity’s ability to service the debt after taking into account the past trend. For this purpose, the projected cash flow coverage assumes significance. The analysis would include critical examination of the underlying assumptions, location of possible stress points and the extent of flexibility to tide over difficulties. A key element of the analysis is an assessment of the sufficiency of revenue for meeting operating expenses and debt service obligations. 

The key sensitivity scenarios include delays in project implementation, cost overrun, fall in prices, etc. Pending redemption of debt obligations, surplus funds, if any, would have to be appropriately invested by the entity. The investment policies of the company for deployment of surplus funds are also examined to evaluate the safety of such investment and the liquidity thereof.

Each of the above factors and their linkages are examined to arrive at the overall assessment of credit quality. The reduction in credit risk due to any credit enhancements provided is carefully evaluated before assigning the rating.

OTHER FACTORS TAKEN INTO CONSIDERATION ARE AS FOLLOWS:

STRUCTURAL RISKS

Infomerics also reviews certain structural aspects of debt instrument/facility. Presence of strong escrow mechanism and ring fencing of cash flows to prevent any leakage of funds are some of the structural considerations. Availability of adequate funds in Debt Service Reserve Account (DSRA) so as to cover few months’ debt servicing obligations also provides structural support for ratings.

CREDIT ENHANCEMENT

The credit enhancement in a real estate project can be in the form of DSRA or guarantee of a strong entity of the group/external entity or letter of comfort or escrow mechanism with waterfall arrangement and so on. In case of guarantee/letter of comfort, examination of guarantee deed/letter of comfort, evaluation of the provider of guarantee/letter of comfort and soundness of the waterfall arrangement are carried out in detail.

CONCLUSION

The rating process ultimately determines the likelihood of the rated debt obligation to be repaid in full and on time. Infomerics analyses each of the above factors and their linkages to arrive at the overall assessment of credit quality of an issuer. The credit rating is an overall assessment of all aspects of the issuer factoring comprehensive operating, financial, promoter, management and sectoral analysis.