In this article, we will understand the revenue source of Real Estate Companies, what are the parameters to analyze this sector, and how can an investor analyze this sector. So, let’s get started!
General Business Model of the Real Estate Business:
Realty companies generally operate on 3 different models – Developers, Rentals, and Hybrid.
The properties can be segregated into 4 types in terms of usage – Commercial, Retail, Hospitality, and Residential. The major income stream from the first 3 types is Rental/Lease income and the 4th type is through the sale of inventory.
The major expenses in this business are Land Acquisition, Construction Costs [Labor & Material cost], and Interest Costs.
The profitability of the business is largely driven by the trend of realty rates in the region in which the company operates. Along with that having a good inventory management system in place and a controlled financing cost boosts growth and profitability.
Key Characteristics of Real Estate Sector Business:
Asset Heavy Business
Employees working on-site are the backbone
Cyclical business
Capital Intensive sector
Government policies directly affect the demand and supply of the sector
Liquidity risk, Hybrid work model risk for leasing businesses.
Important Parameters for Real Estate Sector:
1) Revenue per sq ft.:
It refers to the revenue earned per square foot by the company. Calculated as total revenue/total area sold.
It is considered to be higher the better it is. It will depend on the region where the company operates. For Eg. the MMR region will have the highest Revenue per sq. ft.
For Example, Oberoi Realty is having revenue per sq. ft. of around Rs. 14,957 Rs. Per square ft.
2) Occupancy Rate:
It is the rate that shows how much area is occupied of the available area
Higher the better as the higher the occupancy higher the revenue. The company needs to target maximum occupancy to increase the margins.
Oberoi Realty is having 88.12% Occupancy rate.
3) Asset Under Construction:
It is the total area under-construction. It shows the quantum of upcoming projects to meet the demand.
This ratio needs to be balanced concerning the existing demand and supply of the brand.
For Ex. Oberoi Realty is having Asset Under Construction of 4.5 Cr. Sq. Ft.
4) Operating Profit Margin:
It shows how much profit is being generated after variable and employee costs is been deducted from the total revenue.
It is the margin at which the company is operating its core business. Calculated as - Operating Profit/Revenue. Operating Profit= Revenue – (land acquisition+ construction/maintenance cost).
Higher the better as it shows how efficiently a company is managing its recurring cost.
The Operating Profit Margin of Oberoi Realty stands at 52% as of H1FY23
5) Net Profit Margin:
This is the ratio of Net Profit / Revenue for the period.
Net Profit Margin should also be higher.
For Ex.: Godrej Properties is having net profit margin of -1% while Oberoi Realty is having Net Profit Margin of 45% as of H1FY23.
6) Debt-to-Equity Ratio:
This is the ratio of debt undertaken by the company in comparison to the amount of equity on its balance sheet
The D/E Ratio of the company increases when any new CAPEX is to be done for expansion which increases the risk of the company.
Lower the better. Realty companies usually operate at high leverage.
It stands at 0.27 as of FY22 for Oberoi Realty
7) Return on Capital Employed (ROCE):
Return on capital employed is calculated as EBIT/ Avg. Capital employed during the year.
Higher the better.
For Example, The current ROCE of Oberoi Realty is 6.8%. Godrej Properties has a ROCE of 1%.
Factors that are moats in the sector:
Well-known brand name
Low operating margins and net profit margins
Demand for real estate popular in the country
Usually operate in high debt environment
Increasing demand for amenities and luxurious apartments
Changing environment and preferences from a standalone house to an apartment
Every type of Real Estate has its characteristics and parameters.
What Should Investors Do?
The above-discussed parameters of the Real Estate Sector are some key factors that an investor should carefully consider before making an investment decision in any telecom stock. Follow due diligence before making any investment decisions.
Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.
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