Real estate on radar

Indian real estate is on the radar of fund managers with large institutional investors in long-term growth potential, said John Fitzgerald, chief executive for Asia Pacific at the Urban Land Institute (ULI).

He presented a joint report by ULI and PriceWaterhouseCoopers on “Emerging Trends in Reals Estate 2017 – Asia Pacific”.

Here is the report’s focus on Indian cities out of the 22 Asian cities listed.

Following the removal of various regulatory stumbling blocks, there appears to be real motivation at the central government level to make a deal happen. As ever, however, resolving bureaucratic issues in India can be complex and time consuming.

While managers at domestic and foreign investment funds active in India were positive about the prospects for a working REIT (Real Estate Investment Trust) framework to emerge within the foreseeable future — possibly the next 12 months — a raft of issues remains to be addressed.

These range from resolving ongoing regulatory disagreements between central and provincial authorities, to overcoming obstacles posed by the standard use of a lease rent discounting model to obtain bank financing, to listing REITs at cap rates that will be appealing for retail investors.

Again, how long these will take to resolve remains an open question.

Top Investment Cities

Bangalore – first in investment, first in development.

The big story for investors in Bangalore has long been the city’s role as India’s main hub for the business process outsourcing (BPO) and, more recently, IT industries, which have driven huge demand for new space as domestic and international companies flock to open both call-in and research-and-development (R&D) centers.

An expected supply of some 12.7 million square feet of new space in 2016 is massive by any standards, but is similar to levels delivered in 2014 and 2015, making the city by far the biggest source of office uptake in the country over the last five years.

Delivery of new space is expected to decline in coming years, however, with CBRE projecting 9.8 million and 3.9 million square feet in 2017 and 2018, respectively.

There is little doubt that catering to the expansion requirements of the Indian BPO industry has delivered big profits to investors who arrived early on the scene, with the sector delivering annual rental growth of 15 to 20 percent, along with steadily declining financing costs, according to a manager at one such fund.

Today it remains a compelling story because “you can still turn up in India and buy fantastic Grade-A office buildings at 9 percent yields with financing rates going down and tenant demand remaining strong.” The local market is now controlled by a top tier of larger local developers with access to institutional capital.

According to one interviewee: “The top ten guys have blue water” between them and the second tier, and will likely continue to drive the market going forward.

Still, peak growth in Bangalore is now behind it, and while strong demand from the IT sector is likely to continue, questions over the long-term prospects of the BPO sector have emerged.

“There are winds of change in IT outsourcing,” said one Delhi-based interviewee, who saw signs that the BPO wave was “not as strong as before” due to slowing growth in a sector now focused increasingly on automation and artificial intelligence strategies.

Should these changes be widely implemented, the streamlining of workforces could have a “major impact” on real estate absorption going forward, he said.

In Bangalore, according to one interviewee, the residential market “is driven by an ongoing increase in end users as more and more engineers are moving to what is now the top IT destination in India. But oversupply is a problem, so don’t expect an uptick in capital values over the next 12 to 18 months.”

In particular, Bangalore’s hotel facilities have seen significant improvements in the last couple of years, with some 7,000 rooms now in the pipeline for delivery over the next five years, raising existing room count by some 66 percent. Still, capacity and potential absorption in this market remain comparatively small.

Mumbai – second in investment, third in development.

Historically, geographical constraints have prevented easy expansion of Mumbai’s metropolitan area, which has made it both the most expensive city in India and the slowest growing.

As a result, the local government has committed itself to a major road and rail infrastructure program that will allow easier access to the city center from outlying areas, with most construction scheduled for completion before 2019.

The office sector continues to perform well. Mumbai’s high prices mean that transactions tend to be smaller than those in other cities, but the market in general now has a wider base and is no longer dominated by financial sector players.

Vacancies remain north of 20 percent, but occupancy problems tend to affect only less desirable buildings, with good-quality assets continuing to see strong demand and rental growth.

Although a hefty amount of new supply is now in the pipeline, demand for expansion is expected to grow over the near term as will the number of new businesses, in particular for back-office and e-commerce purposes.

For the longer term, attention has switched to the emergence of a new central business district (CBD) belt in suburban areas.

Transactions in this belt have recently increased, and a number of new commercial projects are about to be launched there.

Mumbai’s residential sector, meanwhile, continues to suffer through hard times. Inventories are high, transaction volumes have crashed, and prices that were rising rapidly for years have recently dipped 20 to 25 percent, according to anecdotal accounts, often via use of incentives.

With authorities unwilling to grant approvals, developers are focused on delivering ongoing projects, which they are anyway now bound to complete on schedule following the passage of new consumer protection legislation by the central government.

The pain is expected to continue for another two to three years. Meanwhile, “don’t expect rising prices,” as one interviewee put it.

Mumbai, meanwhile, is seen as the nation’s main business center — the Shanghai of India, perhaps — whose growth will track that of the national economy.

The scope of the opportunity therefore transcends the business park–oriented outsourcing market, extending to more general office use.

One way in which this theme can be pursued is via development plays that take advantage of the current stress in the India corporate and development sectors to obtain land to develop.

As one fund manager currently active in India said: “We think it’s a huge opportunity to buy land right now in India. The corporates are still quite stressed.

“Cash flow is still quite stressed. But many of them own a ton of prime land that you can get title to and develop in the next ten years, which is actually a quite limited asset.”

New Delhi – 13th in investment, tenth in development.

Markets in New Delhi continue to be affected by “major pain” in the residential sector characterized by oversupply and generally high levels of leverage among developers.

The biggest problems have been seen in Gurgaon, where projects have been delayed as a result of government failure to complete land acquisition requirements—a reflection of India’s generally weak legal processes.

Delays by developers have been common historically in the New Delhi area, with the result that end users have lost confidence in the system and have become unwilling to pay up for their properties.

This creates a vicious circle in that developers then become weaker financially, while banks become less willing to lend capital, or only at higher rates.

Although this has created an active market for last-mile financing that foreign and domestic investors have moved to exploit, “Delhi developers have acquired a somewhat negative reputation, with the result that southern India tends to be he preferred destination for institutional capital,” according to one locally based interviewee.

That said, the story on the commercial side is more positive. Vacancies remain high on paper, but good-quality buildings are usually fully let.

Rentals by IT companies are on the rise, e-commerce is booming, and warehousing demand has mushroomed as Delhi (and in particular the National Capital Region) emerges as one of the country’s most important logistics hubs.

In addition, a significant amount of new infrastructure work is underway, particularly in the form of high-speed railway networks into New Delhi.

This bodes well for demand for commercial facilities. fii-news.com