Winds of change are blowing through the commercial real-estate segment in India. Property ticket sizes are up and a new class of buyers is emerging.
'In the first half of 2018, we have seen 31 deals made at an average investment of $158 million (Rs 10.5 billion), almost four times the $40 million (Rs 2.6 billion) average in 2011,' says Viral Desai, National Director, Office Transactions, Knight Frank India, citing the company's newly released Capital Markets Report.
Who are driving these investments? 'Bigger cheques (for real estate) are predominantly being written by institutional investors, global entities including private equity, sovereign wealth and pension funds with a long-term vision and, hence, with an average holding period of 15-18 years,' says Anuj Puri, Chairman, Anarock Property Consultants.
And, what sort of commercial real estate are these investors buying? 'Stabilised assets with minimum risks,' answers Puri. 'Institutional investors are showing a growing appetite for matured yield-producing assets in India, with established rentals and occupiers.'
In practice, Puri says this preference sees a lot of the institutional capital chasing the limited investible Grade-A office stock across the country's top seven property markets, a property category that enjoys the lowest vacancy levels. 'We are interested in Grade-A commercial property in major urban cities, typically large-format properties we can add value to, by scaling up the development and/or by offering tenants a higher quality of service than what they have been used to,'says Ankur Gupta, Country Head (India), Real Estate, Brookfield Asset Management. 'Our investments in Powai and Equinox (Mumbai) and Candor (NCR) are good examples.'
With analysis by Knight Frank India showing that 89 per cent of the $7.9 billion (Rs 525 billion) invested in office space in the first half of 2018 was into ready assets, of which developers pocketed 95 per cent, it is apparent that India is witnessing the institutionalisation of commercial realty, the transfer of ownership and operations of commercial property from developers to institutions.
Gupta sees the ongoing institutionalisation as the continuing evolution of a trend that started in the late 1990s when domestic institutions started to enter the hitherto unorganised real-estate development market, and were followed by corporations such as Godrej and Tata a few years later.
More recently, structural reforms, including demonetisation, the GST regime, and the Real-Estate (Regulation and Development) Act (RERA), has spurred further evolution. In 2017, the new reformatory environment was seen to boost private equity investments, a move that persisted through 2018, observes Puri. 'What we are seeing now is the impact of the positive sentiment created among global investors; essentially, reforms have reduced their perception of investment risks.'
'The liberalisation of FDI, the advent of Real Estate Investment Trusts (REITs), increased transparency and better corporate governance have provided much needed comfort to institutional investors such as Blackstone, Singapore's GIC and Brookfield,' notes Gagan Randev, National Director, Capital Markets & Investment Services, Colliers International India.
Some of these investors, such as Brookfield, which Gupta calls 'a developer, investor and operator, (so) owning, operating and investing are all in our DNA', are doing it alone.
Others are partnering with Indian developers. For instance, Blackstone has entered into partnerships with Panchshil Realty and the Embassy Group, to name a couple of companies.
Commercial trumps residential
Strong business fundamentals are an underlying factor for commercial real estate to have trumped residential real estate as an investment class.
'Overall, commercial real estate is a more stable asset class (than residential real estate) because it is used by large established multinational companies with strong business interests,' explains Desai.
Also, the Indian commercial real-estate development space is populated by fewer, more mature developers, say five to ten players per large cities, who understand the business and have evolved their product offering over time, observes Desai. 'In contrast, the residential space tends to be made up of smaller players, and tends to be fragmented. Even without RERA, this standardisation as it were in commercial real estate gave the segment some self-regulation.'
Higher yield from commercial real estate as against the cost of such property also goes in its favour. As an asset class, Desai reckons it delivers about 8 per cent gross return as against 2 per cent from residential real estate.
This is not to say that yields are equally high across different commercial properties. 'I would not pinpoint a number because every situation is unique, the yield from a fully leased property could be different to what one could expect from the resulting lease up of an empty building,' explains Gupta. 'We look for appropriate adjusted yields from every investment.'
Partners in development
The institutionalisation of commercial real estate will impact every stakeholder in the property: Developers, tenants and the investors themselves.
Calling this development 'a positive trend for Developers,' Bijay Agarwal, Managing Director, Salarpuria Sattva Group, says 'the participation of institutional investors will bring capital, deep domain expertise and the much-needed professionalism and discipline into an industry that was not much organised.'
While more capital would especially be a good thing for developers facing liquidity issues and a funds crunch, 'the influx of overseas funds will (in general) take the pressure off developers, which, in turn, bodes well for the quality of construction,' notes Desai.
As a result of the focus on professionalism, 'unorganised operators should be weeded out, while genuine developers can operate at a higher level of transparency by adopting the financial reporting systems that financing partners insist on, to ensure essential information is available for decision-making,' says Agarwal. 'We treat institutional investors not just as financing partners but as partners in our growth, as their involvement improves information storage, decision-making and transparency. This should be the growth strategy of any developer.'
'As the numbers of institutional owners increase, the commercial real-estate sector will continue to witness a paradigm shift towards better governance, corporate practices and professional services as per international standards,' agrees Ram Chandnani, Managing Director, Advisory & Transaction Services, India, CBRE. Puri expects the current trend to bring much-needed governance into the commercial space. 'Commercial real estate will no longer be driven by the whims and fancies of a single man and rather be more structured and transparent.'
Enhanced investment climate
Money begets money, it is said, and not without reason.
If institutionalisation is the expected outcome of institutional investment, it is also an enabler of smooth investment transactions by introducing more internal controls and transparency in an organisation and, thus, boosting investor confidence in developers' robustness of processes and operational efficiency, explains Karun Verma, Executive Director, North India, DLF Offices.
Consequently, 'institutionalisation may reduce the turnaround time for the execution of investment transactions,' adds Verma.
'After the initial feasibility review and valuation activity for an investment under consideration, the process of financial and technical due diligence will gradually see a shorter time span.'
In the coming years, Chandnani expects the upward trajectory in the office market space to intensify on the back of demand from national and international corporations and for co-working spaces, as CBRE recently predicted in its report, India Office MarketView Q2 2018.
'In particular, demand for quality spaces will increase, and institutional investors will play a significant role in balancing this supply, which will, in turn, ultimately affect rentals and contractual terms,' says Chandnani.
'Contractual terms for Grade-A office space, the preference of institutional investors, will also be considerably more structured and transparent, and rents will most likely see a steady rise despite such projects becoming the focus of developers,' adds Puri. That said, Chandnani also expects significant infrastructure development across all major cities and across the office, retail, warehousing and residential spaces.
Naysayers may believe that higher rentals would go against tenants. Not necessarily. 'If the institutions holding the assets manage the properties well, as Brookfield does, the occupants can expect a better overall package,' explains Gupta. 'In that instance, institutionalisation could result in higher returns for property owners or managers.'
If tenants grow accustomed to a higher level of services, the demand for Grade-A office space can be expected to intensify, a case of one advantage fuelling another. Agarwal expects to see the corporatisation of rents and contractual terms of commercial real estate, a development that would infuse confidence and stability in the segment, and bring more properties into the rental market, to the benefit of the tenants. Another potential outcome, greater transparency in the rental agreement structure with sound legal backing, would also be to the advantage of tenants. Verma sees the segment moving towards a win-win scenario.
'If commercial properties see high growth, occupiers can expect to enjoy flexible terms, while high absorption would support owners with optimum RoI.'
Impact of REITs
The first REIT listing anticipated this year by the Blackstone-backed Embassy Group is touted to be as much as $1 billion depending on what assets are finally included. Just as commercial real estate has already proven to be a better asset class to residential properties for its higher rental yield, Puri expects REITs in commercial assets to be more attractive for investors. However, after REIT listings show some traction, he expects that the interest of investors may further percolate to retail. So, as REITs attract more capital in the next three years, Randev expects the institutionalisation of commercial real estate to complete. 'Essentially, we expect REITs to be a game-changer, bringing in professional management, data transparency and international standards to income-yielding commercial assets,' he says.
Industry voices affirm that the greater availability of capital is likely to be the biggest outcome of REITs, albeit this will unleash other advantages.
'REITs will fuel significant capital for various applications, commercial real estate as well as other verticals such as residential and industrial,' says Chandnani. 'It will encourage small and big investors to adopt best practices and enhance quality. Price appreciation, better returns and improved monetisation of existing property will be other outcomes.'
'REITs should infuse greater liquidity in the commercial sector, much needed as banks showing high-level NPAs have been quite conservative in funding real estate over the years,' observes Verma. 'This would give developers the option to exit projects, including those developers facing a financial crunch.'
'Better organised and structured savings will bring in globally accepted funding platforms besides strengthening investor interests,' agrees Puri. 'REITs will also further help developers to improve their liquidity by unlocking the value of their assets and raising capital, and focusing on their core area of development.'
And, if a combination of retail investors and fund houses invest in REITs, Verma believes developers will get the risk minimisation cushion they have been looking for. A lot depends on enforcement. With RERA bringing in the right platform of regulations for REIT, the prospects for the industry are extremely positive if both of these are enforced in true spirit, he concludes.
- Charu Bahri