The private equity investment activity dropped to $238 million, with only five deals getting concluded in 2020 (YTD till May 31), a 93-per-cent drop in YoY comparison; according to the ‘Investments in Real Estate’ report launched by Knight Frank India. The drop can largely be attributed to the COVID-19 pandemic, which impacted investor sentiments as well as the slowdown of the Indian economy in 2019. The year has also seen 80 per cent drop in the number of deals concluded in the first five months when compared to the same period last year. Sharp slowdown in the domestic economy and specifically Indian real estate sector will keep the investors cautious. Moreover, with international funds reorienting themselves to attractive opportunities in the developed economies on account of drop in valuations due to recession would cast its shadow on the PE investments in Indian real estate in 2020.Big ticket investors bullish on annuity assets, commit substantially higher risk capital Private equity has been taking up equity positions in rent yield commercial assets (office, retail and warehousing) and their share in overall investments surged compared to that in residential which involves greater risk. In the residential sector, PE investors have increasingly turned toward investment via debt or structured debt instruments in an attempt to shun the risk associated with investing equity in development projects. Shishir Baijal, Chairman & Managing Director, Knight Frank India, said, “The decline in PE investments in real estate had started as visible in the 2019 when it fell by 23 per cent YoY to $6.8 billion. We are operating in uncertain times. Having enforced one of the most stringent lockdown measures globally, 2020 would be a challenging year for Indian businesses. The recall of undeployed capital by sponsors, emergence of attractive opportunities globally, increase in risk premiums, contraction in Indian GDP and COVID-19 related uncertainties would cast its shadow on investor sentiments and we expect the investor activity to be subdued in 2020. The warehousing segments would be the fastest to recover followed by office. With pay cuts and job losses becoming pervasive, the residential and retail segments would have to chart an arduous journey towards recovery.” Baijal continued, “Even though India continues to remain an attractive destination globally for companies to have their offices in, the prevailing business uncertainty and any event of recession forecasted in the upcoming quarters of 2020 will reduce overall demand and impede expansion plans of occupiers. Overall, private equity activity in Indian real estate is likely to be subdued in 2020.” Office market After rising for four consecutive years, the private equity investments in office assets declined in 2019. The lack of mature office assets is forcing investors to look at opportunities in under-construction assets and greenfield developments. So far, in 2020, only two deals amounting to $141 million have been concluded; 2.9 million square feet of office space got transacted in the year. Going ahead, the pandemic induced global recession will lead to a significant drop in asset valuations globally, throwing up attractive opportunities in the developed economies. Investors would prefer such opportunities as it does not entail any currency and other emerging market risks. The risk premiums associated with India and office assets would also increase due to the pandemic. Further, the cycle of strong office rental growth witnessed in India over the last few years is also expected to taper down or stagnate on account of lower occupier demand, impacting valuations. Moreover, the G-sec yields would not come down in line with the repo rate cuts on account of greater government borrowings and breach of fiscal deficit targets. Investors are in a wait and watch mode and are likely to slow down their investments in office assets in India and on account of all the above factors, the capitalisation rates are expected to expand from 2019 levels. Retail market In 2020, there were no investment deals in retail space. Due to the pandemic, many tenants in India have invoked the ‘force majeure’ clause in their rental agreements and demanding rent-free periods, other concessions to compensate for the shutdown. Even after easing of lockdown, the fear of contracting COVID-19, restrictions on entry into malls and the low propensity to spend due to job losses and pay cuts may keep retail footfalls low. As a result, retail occupiers are likely to push for greater revenue share arrangements instead of existing model of minimum guarantee plus revenue share. The year 2020 looks to be a bleak year for the retail segment and may not witness much investor activity over the next 12 months. Investors are now associating much greater risk with retail assets compared to office and accounting for longer periods of no rentals or lower rentals in their financial models in the near term on account of revenue share arrangements. Further, retail would be amongst the last to recover. Lower investor appetite, G-sec yields not compressing as much as repo cuts, rental degrowth on account of revenue share and heightened risk perceptions would lead to a significant expansion of cap rates for retail assets and take it much higher than office, which was contrary to scenario in the pre-COVID years. Warehousing market Private equity investors have invested over $7.3 billion in the warehousing industry in the previous decade with 78 per cent of the investments going towards creating new assets. The $5.6 billion worth of investments which has gone into new developments is expected to create over 300 million sq ft of warehousing space in the coming years. In 2020, only two deals were concluded, suggesting an overall investment volume decline in warehousing space due to COVID-19 induced lockdown. However, the adverse impact of the pandemic on warehousing segment will be relatively less compared to other asset classes. Warehousing segment will be supported by significant shift in supply chain management methods and renewed growth in e-commerce business. Also the rising share of e-commerce will to some extent mitigate the adverse impact of lower demand from the other segments. Investors expect the warehousing industry to emerge stronger from the COVID-19 crisis globally and expect it to outperform other asset classes in real estate in the near term. They expect warehousing to recover the fastest compared to other segments of real estate. Consequently, investors are directing greater amount capital to warehousing assets. Similar trend is expected to play out in India. Thus, despite increase in country risk premium for India, greater investor interest would keep the cap rates stable at current levels for the warehousing industry in 2020. Residential market In the past few years, private equity investors’ preference for investing in residential assets has shifted from equity to debt or structured debt instruments. In2020, there has been only one private equity investment in the residential sector worth $40 million. The beleaguered residential sector has been in turmoil for several years now and COVID-19 would act as another nail in the coffin. Residential sales were already slow and the demand from homebuyers is expected to dwindle in 2020. On the supply side, the segment is already witnessing consolidation. Overall, the recovery in this segment will get further delayed and the residential sector will find it further challenging to attract private equity capital. Read the full Knight Frank report here.