Real Estate Sector – Lower GST to potentially revive the sector but at the cost of near term profitability hit By Motilal Oswal

In its 33rd meeting on 24th Feb’19, the GST Council announced a rate cut for under construction residential real estate projects. The GST rate for affordable housing has been reduced from 8% to 1%, and for other than affordable housing segment, the rate has been reduced from 12% to 5% – both without input tax credit (ITC). The new rate will be applicable from 1st Apr’19. Details of the scheme will be worked out by an officer committee and will be approved by the GST Council in a meeting specifically called for this purpose.

Implications in our view

Sales velocity in under construction projects to improve: As per industry sources, approximately 88% of inventory is under construction in MMR region and 83% in Bangalore and 87% in NCR. Due to higher GST rate of 12% on under construction projects, the demand here was subdued and was postponed post OC. With lower GST rate now, we expect fence sitters to show interest in buying under construction property and spur demand. Amongst the listed developers, Prestige estates has highest value of under-construction projects while DLF has lowest inventory under construction.

Customer advances to partially replace external financing:

Improved velocity will lead to improvement in customer advances and reduce dependence on external finance, leading to savings which shall gradually aid in reducing the impact on margins. This is also likely to partially address the ongoing liquity crisis.

Negative impact on margins:

Due to non-availability of ITC, the cost will increase for developers (as highlighted in table below). Under the current situation and state of real estate market we believe it will be difficult for developers to pass on the increased cost which shall be absorbed into the margins. We expect negative impact of approx. 3% to 5% reduction in margins. For a Mumbai based player where land component is high and especially for a player like Oberoi realty where margins are higher (EBITDA margins of ~50%) the impact is likely to be 3% reduction in margins whereas for a south based player (Prestige, Sobha and Brigade) the impact will be higher to the extent of approx. 5% reduction in margins as the land cost is low.