Nowhere is immune from the global credit crisis, India included. Paul Benjamin assesses how the global downturn has affected the real estate markets of the economic powerhouse

While much of the world has been staring into a credit-crunched abyss for well over a year, until relatively recently India was hoping that its billion-plus citizens were going to escape the worst of the economic fallout, and that it was sufficiently strong, big and different enough to have decoupled from the US and Europe.

Wishful thinking. Instead, over the past six months or so the economy has slowed significantly, people are worried about jobs, and the real estate market has taken a hammering. It has been a shock for India which, along with China, has become accustomed to the turbocharged growth rates reflected by an impressive five-year annual average of 8.8% GDP growth.

Although India does not face a Western-style recession of negative growth rates just yet, the Economist Intelligence Unit believes that global deleveraging and moves to reduce risk exposure will hit India hard, and it forecasts real GDP growth will slow to 6.2% in the fiscal year 2008/09 and 6.1% in 2009/10.

Consequently, the government has cut interest rates and is looking to measures to encourage foreign investment and stimulate the property market. But these things will take time to feed through, and the slowing that is already well underway has created cash flow problems and a crisis of confidence among property investors, developers and buyers.

Pranay Vakil, chairman of Knight Frank India, says: "The volume of transactions has fallen drastically. Developers in India are used to handling issues of pricing but are not used to handling a complete lack of volumes. When you're used to selling 40 apartments a month, you might plan that 20 to  25 will be sold. But if you then sell only four it throws your whole cash flow out of gear.

"Coupled with high interest rates we are seeing a huge cash crunch for developers, some of whom are defaulting on loan payments. Developers are retrenching and delaying projects under construction."

Anuj Puri, chairman and country head of Jones Lang LaSalle Meghraj, says that many developers had been in denial about the severity of the downturn and that it was only after the huge annual national festival of Divali in October 2008 that attitudes changed.

He adds: "What is frightening is that prices and home loan rates have come down but demand hasn't picked up. That's because of increasing nervousness about the overall economy and about whether developers are going to survive."

Developers desperate to shift units have taken to some aggressive marketing tactics - including special financing deals, throwing in a free Mercedes, and even offering to buy back an apartment at cost price in three years if its value has fallen. Anshuman Magazine, chairman and managing director at CB Richard Ellis in India, says: "Consumers are trying to catch the bottom. Buyers feel that prices may correct further, and sellers are still trying to reconcile themselves to the new situation. Only six months back some sellers had people chasing them big time, and at a much higher price."

The Indian story of recent years has been of a complex and ancient civilization undergoing rapid economic growth, in large part due to a booming service sectors, particularly in information technology (IT) and IT-enabled services (ITES). Global back offices were outsourced to India's well-educated, English-speaking and cost-effective labour pool, creating call centre farms in Bangalore.

The population, although still heavily rural and agricultural, has urbanised on a massive scale, and a new middle class with disposable income and aspirational tastes has emerged. The successes and foreign acquisitions of Indian companies, most notably Tata, marked a turning point in India's image and signalled the arrival of a real global player.

Much of the development of interest from foreign investors has been centred on India's three main hubs: Mumbai (Bombay), Bangalore and the capital New Delhi, which along with its prosperous satellites is known as the National Capital Region. Each of these centres has seen heavy office, residential, retail and logistics development in recent years, but the global slowdown has put the brakes on, and there are signs of oversupply in some areas, especially retail and high-end residential.

Following these three key markets are the second tier locations of Pune and Hyderabad, which absorb a spill-over of office and worker housing from first-tier sites. Additionally, in tier-two there are the geographically separate regional capitals of Chennai (Madras) and Kolkata (Calcutta), which are near-significant ports and are, respectively, the main cities for the north-east and east coast.

In a recent report, Jones Lang LaSalle (JLL) stated that, in the first half of 2008, 63% of announced real estate investment took place in tier-one cities, 33% in tier-two and 4% in tier-three. JLL also identified 30 cities as third-tier opportunities. In a country with such a huge footplate and with a high population, there are inevitably many sizeable regional centres that many foreign developers will never have heard of.

JLL discovered that demand levels, city size, transport connectivity, human capital and - interestingly - the transparency of regional government, all varied significantly among these 30 cities, such that it tipped five cities as standouts - Ahmedabad, Chandigarh, Kochi, Jaipur and Nagpur - and named a further five in the more prosperous Southern India as sites to watch.

Anuj Puri says: "Tier-three cities will take a bit of a hit this year. They were gaining momentum because of IT, as Bangalore was getting expensive and companies were making savings by moving into tier-three. But the cost of living has come down in Bangalore and, where previously there was a high level of labour attrition and turnover, there's now more stability of talent. Of tier-one cities, Delhi is suffering more than the others, as the market there was more speculative. Bangalore is suffering the least."

Looking at the whole of India across 2009, the general feeling is that prices will fall but will eventually be met by demand, and that supply in many sectors will slow drastically, particularly in retail and office.

Poonam Mahtani, national director of knowledge systems and residential services at Colliers International (India), says: "Office rents that peaked in 2008 H1 are forecast to trend downward over the next three to six months. The residential sector continues its subdued mood in the last quarter of 2008. However, the positive side is that there are definite end-user buyers waiting on the sidelines.

"The residential leasing market continues to be circumspect in prime housing locations, with demand passive for expatriate relocations due to cost restrictions across various businesses. However, transactions are moving forward and we expect sentiments to improve from the beginning of 2009 Q1. Across the real estate sector, a sentiment of needing much more much faster prevails, giving a positive kick start to 2009."

Pranay Vakil says: "People are getting tired of waiting to buy. Developers are getting tired of holding onto original pricing. There's a tug of war and it depends on who blinks first. Developers are thinking out of the box with new promotions, and 20% price reductions have been successful in places. That only proves the market is price-sensitive and there's underlying demand. And if sanity and health are restored to the market then the buyer will come back. Towards the end of 2009 we will see better volumes at lower prices, and people accept normal returns as opposed to the abnormal returns of the past few years.

"So far as offices are concerned 80% of demand in India comes from IT and ITES, and that is heavily dependent on offshoring by other countries. In 2009 much depends on the rupee-dollar exchange rate. Any protectionism by the US and other countries may impact on offshoring, and that in turn will reduce the demand for office space.

"Two years back there was complete euphoria about the retail sector, and predictions that 250 to 350 malls would come online. In the end less than 150 have come up. A lot of investment got diverted into creating malls with extremely high rentals, but over the past two years people have realised it's not a cakewalk. Now every mall owner is under pressure to reduce rents. This is one segment which is seeing a maximum correction. People are beginning to realise you cannot start a mall without adequate homework and demographics."

Big-box shopping centre developments have proven popular with India's growing middle class, but there are signs of oversupply, and, even with the growth of the past five years, organised retailing only accounts for 4% of the total retail market.

Furthermore, foreign direct investment restrictions ensure that, although single brand stores like Nokia can open, those selling multi-brands like Wal-Mart, face barriers. Analysts expect these to ease, but the government is likely to continue to be mindful of protecting the ‘little guy'.

Residential developments account for a massive 80% of the Indian real estate market and analysts say that many developers are trending towards affordable housing. This view was confirmed recently by DLF, India's largest real estate company, whose stock has fallen sharply and which posted a 69% drop in net profit in the final quarter of 2008. Rajiv Singh, vice chairman at DLF, expects prices for new property to fall between 10% and 15% in the next three months, and said prices had already slumped 30%.

He says: "Our focus will be on the mid-income homes and commercial complexes, with deferment of high-margin launches in luxury homes and retail space. We plan to test the market initially with a few launches in these segments and then go ahead with other product categories once the markets achieve stability."

Puri says: "Affordable housing was always there, but the margins were tighter and it was hard work. But we've discovered there was small demand for luxury apartments, and too much supply. We're talking about apartments that cost around $100,000 (€77,000) apiece and, although it will take three years to complete many of these projects, developers can start marketing straight away." Commenting on the whole industry through 2009, he says: "Weaker developers will consolidate and there will be a return to quality and affordability. Valuations are coming out right. Many developers have asset valuations that exceed their market capitalisation, and that's an opportunity to invest and have a play over the next three to four years."

While logistics projects are likely to slow as the economy and manufacturing levels are hit, the leisure industry is already showing the strain. Knight Frank says foreign visitor growth was marginal over much of 2008, and that will have dampened spirits in key draws like Goa, Kerala and the classic sights of Rajasthan, as well as for business travellers in the big cities like Mumbai. Anuj Puri adds: "Hotels are a pretty grim story. Capital intensive projects often driven by egos have taken a huge beating and many are being shelved."

Tourism may also have been affected by the terrorist attacks in Mumbai in November 2008 that left more than 170 dead. Security and relations with Pakistan are likely to feature in the general elections this May, and the policies of a new coalition government could shape real estate development for years.

Magazine says: "The election will be key. It makes a huge difference to sentiment. Further reform in opening up or stimulation in infrastructure projects depends on the government. "In the past few elections the economy has become more of a topic, but it is one of many. There are a lot of regional parties fighting regional issues, and whatever government is formed will be a balance of different interest groups. The reform process will definitely continue, but the pace may change. Real estate mutual funds are now allowed, and REITs [real estate investment trusts] are inevitable."

One area in which the government could make a difference is infrastructure, which has often been flagged as the Achilles heel of the Indian growth story - especially compared with China where the planning process is much less democratic. Power cuts, bottlenecks in roads and a shortage of good airports have all caused complaints.

Magazine says: "We cannot deny that China is far ahead in terms of infrastructure. The awareness at government level is huge and a large amount of capital is being allocated. The big issue is implementation.

We've had some success in telecoms, ports, some airports and smaller projects - like urban metros. But there have been a lot of unsuccessful stories where highways and power stations have not been completed. It's a major challenge, and a target for India." But he adds: "The long term story of India is still strong, and India will recover earlier than many places."