Real estate developers may have to write back profits with onset of new accounting rules
As per IND-AS 115 (applicable from April 1, 2018), real estate companies will now have to switch to the Project Completion Method from the existing Percentage Completion Method (POC).
Previously, payments made by home buyers on purchase of under construction flats were recognized as sales & net income generated from such projects was declared as profit. However, under the new rule, home buyer payments toward ongoing projects will be treated as advances or loans and not as income from sales.
New accounting norms will impact not only revenue recognition but also have consequential impact on net profits and net worth of a real estate company, as:
- They will be forced to write back profits made over the past few years from all projects that are not complete leading to significant changes in the opening balance sheet and re-recognition of the same in ensuing period.
- Such a change is likely to happen in Q1FY19 and would lead to a hit on the net worth and lead to a temporary spike in companies’ debt-equity ratio.
Consequently, credit rating & borrowing capacity of these companies will be negatively impacted leading to higher borrowing costs.
Besides, higher tax outflow is expected considering prevailing tax provisions (primarily minimum alternate tax) in India for such entities.
How will the stocks be impacted
Real estate stocks will be negatively impacted if entire profit is to be reversed in Q1FY19. However, such an impact will be temporary as in the long term businesses continue to thrive and the impact of new policy stabilizes.
Stocks like DLF (CMP: 203, Mcap: 36,234 crores, P/E 31.4x FY20E), Oberoi Realty (CMP: 514, Mcap: 17,456 crores, P/E 11.2x FY20E) may have to take a one-time hit on its net worth in Q1FY 19 with a writeback of profit booked from existing projects not 100% complete under IND-AS 115 definitions. However, developers have written to the government seeking relief.
Whether any relief would be provided or not should be watched out for in the coming days.