How to analyze Indian real estate stocks-some pointers

On my other blog focused on special situations, I'd given my views on why real estate stocks trade at historically low(intra sector and relative to broader market)[http://specialsituationsindia.blogspot.com/2011/12/why-do-indian-real-estate-companies.html]. But at the same time, one has debt free stocks like Oberoi Realty trading at P/BV of 2.9x, and DLF trading around 1.5x FY11 book value. So why this difference? After reading annual reports/concalls and investor relations of the S&P CNX Realty Index(whose 10 stocks accounted for 80% of the listed real estate stocks) stocks like DLF, Unitech, HDIL, Oberoi Realty, Phoenix Mills, Sobha Developers, Godrej Properties, Parsvnath Developer Ltd, Anant Raj and DB Realty, I gleaned some insights which I proceed to share in this blog post.

1. Location Location Location:-Like the 4Ps of the marketing, the 1L of realty is location, which drives the possible uses(commercial, residential) and also development restrictions(for example height restrictions in areas near airports). 
2. Extreme interest rate sensitivity:-Builders being highly levered, and most first time house buyers incurring debt to purchase house, both demand and costs are influenced by home loan interest rates and bank interest rates, which move in tandem. While commercial real estate demand is less sensitive to interest rates than residential, the effect is still there. Hence, sector is sensitive and suffered due to RBI's consecutive interest rate hikes.Also, bank lending margin requirements play a crucial role. In late 2010, RBI had lowered the Loan To Value (LTV) to 80% from 90%.  This led to a 100% increase in margin requirement from an individual homeowner
3. Understanding percentage completion accounting:-Investors may wonder whether project completion based on actual work completed on the ground or is it more based on advances, payments made to contractors? A lot of approval costs(development fee etc) and architectures cost  goes into the overall development cost, and so initially, the  work completion is  higher but later on it is ideally based purely on the milestone base or slab base. If the cost estimates change, then profit estimate gets affected. For example, DB Realty recognized a negative revenue of Rs 92.4 crores in FY11, in its project Orchid Ozone, on account of upward revision of originally envisaged Project cost, which increased from Rs. 6,250 Million to Rs. 8,170 Million.
4. Use of partnership firms to execute SPVs:-This is done to avoid the repeated double taxation of dividend via dividend distribution tax, and also to execute projects jointly/co-developing. Hence, the Companies Act does not apply to attaching the separate balance sheets of these companies, which may be an issue if not consolidated(stake below 50% etc). If too many partnerships are <50%, then it is matter of concern from governance perspective & investor risk.
5. Interest expense-capitalized AND expensed:-Before doing ratio analysis, remember that interest during project period is often capitalized, and hence the interest expense line item does not reflect the total interest expense. While notes to accounts in annual reports disclose that, it is not done in interim quarterly reports. So remember that during modelling TTM numbers. 
6. Land Bank equivalent of revenue visibility:-As Anant Raj mentions in its annual report, in realty business, land bank is equivalent of visibility. Visibility of revenues,visibility of profits and most importantly, visibility of cash flows. Caveat for shareholders though - the land bank has to be prime, bought at the right price, and should be ready for developments. If the prices rise too high, they do not make ROI sense, and if location poor/under litigation, development is delayed blocking capital and accruing interest. 
7. Land Records:-In India, property records do not provide a guarantee of title.  Property records in India have not been fully computerised and are generally maintained and updated manually through physical records of all land-related documents. The title to agricultural land is often fragmented and the land  may, in many cases, have multiple owners and claimants who may not have perfect title to it

Hence, plenty of groundwork is advisable before investing in real estate stocks.