Future economic historians may remember the month that just ended as Black September. Lehman Brothers collapsed; the Bank of America acquired Merrill Lynch; AIG was nationalised; banks such as Washington Mutual and Wachovia were wiped out.

As credit and finance markets around the world tumbled like ninepins, so did stock markets in India, with the Bombay Stock Exchange Sensitive Index (Sensex) falling 3.35% or 469 points on September 15. The worst affected was the realty index which dropped 7.6% on the same day. Since then, while stocks prices in India have seen massive swings, shares of real estate firms have remained depressed, falling a total of 20% as of October 1.

In addition to housing stocks, home prices are taking a beating. By some estimates, prices have dropped by 25% in certain urban markets. While in the US -- and also in Britain -- the subprime mortgage mess has seen home prices fall dramatically, in India, such slowdowns have been rare -- at least in the past. Prices may soften, sales activity may slow and occasionally a distress sale occurs, but there has not been an overall fall in home prices.

"India has not seen a boom-bust cycle in real estate mainly because the industry is still nascent," says Anurag Mathur, joint managing director of Cushman & Wakefield, a global real estate solutions company. "India has not seen a boom and bust cycle in almost any sector," adds Rajesh Chakrabarti, a professor of finance at the Hyderabad-based Indian School of Business (ISB).

"While there have been variations, we have not had cycles of the kind we see in the developed countries. It is only after liberalisation that the Indian economy has been seeing more cyclical movements."

According to Irfan Razack, chairman and managing director of the Prestige Group, a Bangalore-based real estate developer: "We have boom and bust cycles in India but because of our huge population, the demand keeps growing and that sustains the industry. You can build for the next 100 years and there will still be demand for housing in this country."

India has inadequate data on the real estate sector. For instance, no one tracks housing starts, an indicator that is regarded in many countries as an important yardstick of economic health. However, several real estate companies have gone public during the past couple of years, which makes information more transparent. Secondly, equity analysts have begun tracking these companies and the real estate industry.

Still, confusion continues. Consider the reaction of the markets to the Lehman collapse. Real estate was hit for two reasons. Lehman had invested $200 million in DLF Assets, a company belonging to DLF, India's largest real estate company. It had also acquired a 50% stake in Unitech's Mumbai project for $175 million. (Unitech is India's second largest real estate company.) Among other Lehman investments or proposed investments were those in the Mumbai-based Peninsula Land Ltd. and Housing Development & Infrastructure Ltd. (HDIL).

The market was worried that if the money had not already been received, the projects would be in limbo. Most companies (Unitech, for one) claim that the cash is already sitting in their bank accounts so there is no cause for concern. Others, like HDIL, have said the deals were not with Lehman Brothers but with sister companies. These are unlikely to be affected.

The crunch might hit in the future. "With banks reducing their exposure to real estate, coupled with rising interest rates and volatile stock markets diluting the confidence of retail investors over the past one year, private equity investments have emerged as one of the most important sources of capital for real estate developers," says a FICCI-Ernst & Young (E&Y) report on the Indian real estate market released in early September. "The overall private equity investments reported in the real estate sector in India from August 2007 to July 2008 are estimated to be more than $5 billion." This tap could be turned off as a result of the financial crisis in the U.S.

Real estate investors in India were also worried that Lehman might resort to a fire sale of its assets. While India has a three-year lock-in period for foreign direct investment (FDI) in real estate, it is unclear whether this applies when a company declares bankruptcy. The government is holding a meeting to decide the norms in such cases. The other issue is that Lehman holds small stakes -- bought from the market or in bulk deals -- in real estate and infrastructure companies such as IVRCL Infrastructure, Consolidated Constructions, Orbit Corporation and Vijay Shanti Builders. Here, too, there was the possibility of a fire sale, encouraging other investors to bail out.

Temporary slowdown

Amid this gloom and the real estate-bashing that is going on in the market, many people are optimistic about the sector. Even the bears see only a temporary slowdown. "The Asia-Pacific property markets, which have seen a rapid run-up in rents and capital values in recent years, are now entering a slowdown that will continue over the next 12 months at least," says a report by real estate consultants Jones Lang LaSalle (JLL).

Shobhit Agarwal, joint managing director (capital markets) of JLL Meghraj (JLLM), the global company's Indian division, says there is still some pain left. "There is now a period of stagnation, soon to be followed by a fall in prices in certain sectors and locations.

Certain overheated micro-markets will see a 5% to 15% price decline. A correction of up to 10% is also expected in South Mumbai, some locations in Mumbai's suburbs, and certain areas of New Delhi that have seen unrealistic price trends.... The market will eventually consolidate."

"In the short term, we expect the market to consolidate," echoes a spokesperson of DHL. "We have not been impacted by any slowdown. We have launched many premium residential projects across the country during the past six months and have gotten a very good response. We feel that the market is moving in the right direction and there is no bubble to burst."

"In the past three to four years there has been a huge inflow of companies and funds in the real estate sector," says Chakrabarti of ISB. "It is possible that there may be a bit of a shake out and consolidation now. Given the fact that we have already seen a 20% to 25% correction, I don't expect prices to fall much further. It will probably now grow at a decent enough rate. Also, infrastructure development is a major area of emphasis and this will fuel real estate prices, especially in the smaller towns."

The problem seems to have affected residential property rather than commercial real estate or infrastructure developers. Several factors have contributed to this. First, the Reserve Bank of India (RBI) has been raising interest rates to tackle inflation. As a result, housing finance companies have had to raise rates on loans. In 2004, interest rates on housing loans were 7.75%; they have now gone up to 12.75%. On a $50,000 loan borrowed for a period of 20 years in 2004, the interest burden was around $48,000. This has now gone up to more than $100,000.

Most housing loans in India are at variable rather than fixed interest rates, which means that monthly mortgage payments -- or EMIs (equated monthly installments), as they are called in India -- go up when interest rates rise. As a first measure, housing finance companies increase the term of the loans. When that period extends beyond the working life of the home buyer, the EMIs are increased. Housing finance companies typically consider EMIs up to 50% of net income. If, in extreme cases, these payments double, home buyers can be left with nothing to live on.

Understandably, defaults on loan repayments are increasing. While specific numbers are hard to come by, bankers say this could develop into a crisis. The financial meltdown in the US -- and the turmoil in the finance sector, which is a key market for information technology and IT-enabled services -- has seen a large number of finance professionals lose their jobs. These young, upwardly-mobile executives were the new generation of house buyers. They are now saving for the proverbial rainy day -- which has arrived. Confidence levels are down and house purchase plans have been put on the backburner.

Finance companies and banks are also being careful about approving loans. Their vetting process is taking more time. Even people who want loans and have the capacity to service their EMIs are being put through greater scrutiny.

Business as usual?

India's largest mortgage company, Housing Development Finance Corporation (HDFC), however, says that it is business as usual. As Renu Karnad, HDFC joint managing director, told CNBC TV 18: "The demand story is a compelling one. Its plot is often repeated by HDFC's senior management that younger and younger Indians are opting for home loans.

The average age of borrowers is down from 40 years to 35 years. Thanks to tax breaks, the effective cost of a loan works out to a moderate 6%. Unquenchable housing demand has the country short of 25 million homes. The loan market is a vast untapped one yet. It has taken 30 years for mortgage penetration to grow from 2.5% to 6% of GDP. With middle India kicking in, HDFC is confident that unlike other consumer goods, home loans are not that vulnerable to a slowing economy."

The FICCI E&Y survey agrees. "Despite the momentary slowdown witnessed over the past 12 months, 62% of developers foresee Indian real estate embarking upon a high growth trajectory in the long term," says the study. It does, however, point to one change. Real estate had become a speculators' haven.

Now, seeing no hope of quick returns, they are bailing out. Builders believe it's the speculators who are responsible for the perceived slump. Once they are squeezed out -- many are selling at whatever price they can get to take care of their stock market losses -- things will return to normal. The study notes, "Respondents believe that genuine end-users have taken over from investors and account for 80% to 90% of sales in their current projects."

What are real estate companies doing to deal with the downturn? Well, they are putting their eggs in different baskets. In a way, it is a replay of the rush into real estate. Over the past decade, companies with no experience in property development had entered the market.

Some had legitimate reasons. The textile mills in Mumbai, for instance, had been priced out of the market because of high labor costs. One of the first off the block -- Phoenix Mills -- has converted itself into a commercial, residential and entertainment complex. In August this year it raised 200 million euros from German real estate fund MPC Synergy for further development. Morarjee Mills has moved its operations to smaller (and cheaper) cities. Its properties are being developed by its real estate wing -- Peninsula Land.

In addition to the textile mills, 70-year-old Nesco Engineering, a moribund company, is today thriving because it has set up an exhibition center on its Mumbai property and has plans for an IT park. Media Video, an electronics games manufacturer and distributor, has recently listed its real estate subsidiary MVL. Its market capitalization at $87 million is eight times that of its parent. The Kolkata-based Emami group, a FMCG player, has moved into malls and housing complexes.

Now, real estate companies are exploring new investment opportunities. Builders of residential property are taking to developing commercial space. Others, such as Raheja -- a leading homebuilder -- are constructing special economic zones. Omaxe is modernizing and maintaining airstrips. DLF, Unitech and Omaxe are bidding for road projects being offered by the National Highways Authority of India. The Brigade Group is building a health spa in Chikmagalur near Bangalore. It will run the spa in tandem with Singapore-based hospitality brands Banyan Tree and Angsana. Sobha Developers already has an ayurvedic spa offering the traditional Kerala ayurvedic massage at Sobha City in Thrissur in Kerala.

Overseas markets

The second trend is a move abroad to market real estate companies' products, raise funds, source raw materials and launch projects. PRA Realty has set up shop in Chicago to be closer to venture funds. It has also opened a marketing office in Dubai. According to JLLM, non-resident Indians (NRIs) are major buyers of Indian properties, accounting for up to 25% in certain categories.

Sobha Developers has opened an office in China, from which it sources a lot of raw material. It is building a five-star hotel in Dubai. Parsvnath Builders has a subsidiary in Singapore. Puravankara Projects has started operations in Sri Lanka to build super luxury villas on the outskirts of capital Colombo.

It already has a presence in the UAE. "Considering that every market is subject to fluctuations, diversification is certainly the best hedging tool for avoiding the pitfalls of sudden downward movements in any sector," says Agarwal of JLLM. "If one component fails to generate anticipated returns, others will compensate."

Other real estate companies are casting their nets wider and embracing every opportunity that comes their way. Unitech has already made a foray into telecom. It is now eyeing insurance. Preliminary talks are on with a foreign major. Omaxe is moving into steel and cement. It has on its drawing board plans for a medical college and a hospital.

Mantri Realty has earmarked $500 million for a thermal power plant in Nagpur. The Hyderabad-based JR Realtors has aquired a 10% stake in Pennar Aluminium. Indiabulls Real Estate is setting up a solar power plant in the Bastar region of Chhattisgarh. Sobha has even moved into retailing mattresses under the brandname Restoplus. IT major Infosys has already placed the first order.

HDIL has lined up a whole array of diversifications. It is getting into entertainment under the Broadway brand name. It plans to invest $200 million in a chain of 150 theaters. It is also building a coal-fired power plant. It will begin power trading soon. In perhaps the oddest move, it is bidding for oil and gas exploration blocks being auctioned by the government. "Although oil and gas is completely disconnected from our core business and what we are doing now, I can say that it will help in providing better services to customers who we serve in our projects," Sarang Wadhawan, managing director of HDIL, told business daily Mint recently.

"In the long run, given that the India growth story is likely to continue, real estate prices will certainly increase," says Chakrabarti of ISB. "However, they will not see a meteoric rise as they did earlier. It will be a more stable market. Real estate companies are therefore diversifying into different areas where they expect better growth (like telecom).

This is probably not so much by choice as by compulsion. It also reduces their risks. In some sense it is sensible given that the market conditions have changed, but whether it plays out in the long run remains to be seen. In general [not just with regard to real estate] unrelated diversifications don't work out very well."

The efforts of various companies haven't had much impact on their share prices. As a high share price is necessary for fund raising, some companies are trying financial engineering. DLF, for instance, has announced a share buyback, but it is also seeking fresh funds. Analysts wonder how the two can go together.

"Promoters work in the best interests of the company," responds a DLF spokesperson. "The DLF share has been quoting much below its intrinsic value. We see the share buyback decision as a highly attractive opportunity for our shareholders and a strategic move of sharing returns with investors." HDIL, meanwhile, has come out with a 2:7 bonus issue. All this doesn't appear to have helped sentiments much; both the shares -- as with most real estate companies -- are quoting below their original IPO price.

"The companies that went public rode the boom, and they will bounce back once the markets and the sector picks up," says Razack of the Prestige Group. "At that time the valuations were so aggressive that we were also tempted to go public. We didn't do it because one can't really show quarter-on-quarter growth in real estate. It becomes more [like] window dressing."

Affordable housing

Another major area into which many real estate firms are moving is affordable housing. Puravankara has set up a wholly-owned subsidiary -- Provident Housing & Infrastructure -- which will build 64,500 homes in Bangalore, Chennai, Hyderabad and Coimbatore over the next five years. Omaxe has set up the 100%-owned National Affordable Housing and Infrastructure, which will invest $20 billion over the next five years in building one million such homes. Many other builders are also climbing on the bandwagon.

The rush is partly explained by the response to government-led housing programs. The public sector Maharashtra Housing and Area Development Authority (MHADA) plans to sell 600 low-priced apartments in Mumbai around Diwali. They will be priced around $50 a sq. ft., at a time when market rates are four times as high. MHADA expects 200,000 applications; there will be a lottery to decide the buyers. Demand for such housing is obviously very strong. A similar prgram earlier this year for 900 apartments attracted 65,000 applications. In Delhi too, the Delhi Development Authority has received 850,000 applications for 5,010 low-cost apartments.

"Affordable housing, until now, was not a part of the Indian real estate sector boom," says the FICCI-E&Y report. "However, affordable housing has recently attracted attention from prominent developers and private equity players. The investment rationale for this asset class largely encompasses an early mover advantage, volume-driven profitability, priority-sector status accorded by government and subsidised land costs, among other drivers."

Yet skeptics see dangers here. First, affordable housing may end up as substandard housing as builders cut costs to maintain margins. Second, affordable housing will go to the less-privileged classes, financed by easier norms for bank loans. Earlier this year, the government wrote off $15 billion of farm loans, which severely impacted its finances. Some observers fear that "affordable home loans" could face a similar fate. They are, after all, subprime mortgages of the kind that sparked the housing crisis in the U.S.

The consensus view about Indian real estate is that the slowdown is temporary but lots of reasons exist for optimism about the future. "Short-term concerns on the sector remain," says a report by research house Enam Securities. "End user demand (is) subdued on account of high capital values and global uncertainty keeping the capital markets under check. Developers remain strapped for liquidity. However, the long-term outlook (is) still positive. Favorable demographics, increased urbanization and higher disposable incomes will result in continued demand." According to Mathur of Cushman & Wakefield, "If you believe in the India story, the outlook for real estate, which is a critical part of the whole development process, is bright. I am very bullish about it."

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