Whether we frame this year in terms of the virus that stalks us still, or the economic catastrophe that came in its wake, the victim in our mind tends to be human. Even when economic sectors are thought of, what comes to mind are humming networks of activity: the movement and productive interaction of material and people. Rarely do we think of something inanimate. Yet, there’s something that underlies all of the above. ‘Commercial real estate’ sounds like a niche, even if a large one—just one subset of one sector, with its set of players. But it’s the very ground—literally—of economic activity.
When Covid-19 came like a classic black swan event, this was one sector fated to feel the cumulative pain—and it’s still grappling with the jolt months later. A prolonged lockdown and the normalisation of the Work From Home (WFH) culture meant a massive, unforeseen contraction in demand. The very fact that numerous companies are considering #WFH as a regular mode would seem to scatter the seeds of doom into the future. It’s a global sickness, of course. A study by JLL shows direct commercial real estate investment fell 29 per cent across the world to $321 billion in the first six months of 2020, compared to the same period last year. Investment volumes in Asia Pacific dropped 32 per cent. And yet, India’s internal yearning and capacity for growth is such that optimists expect the segment to bounce back with a vengeance, once this health crisis is over.
If (or when) that resurgence happens, what it has to surmount is daunting indeed. The cash flow problem leading to inability to pay rents, coupled with a fear of global recession, has had a severe impact on India. According to Savills India, a leading property consultancy firm, our top six markets—Delhi NCR, Mumbai, Bangalore, Chennai, Pune, Hyderabad—have seen a significant year-on-year decline in office absorption and supply. “From nearly 32.3 million square feet of space absorbed in H1 2019, the H1 2020 absorption fell to nearly 13.7 million sq ft. Similarly, the cumulative supply addition was 13.5 mn sq ft in H1 2020, compared to 26.6 mn sq ft in H1 2019,” says the Savills ‘India Market Watch - Office’ report.
“From an investment point of view, commercial real estate was yielding high returns due to their high-cost index, but post pandemic both sub-segments of commercial real estate—malls and office spaces—are adversely hit due to the lockdown and the WFH trend,” says Manju Yagnik, Vice Chairperson,, Nahar Group, and V-P, NAREDCO (Maharashtra). With around 6 mn sq ft of office space lying vacant, she feels commercial real estate may take some time to recover and, accordingly, that may keep the rate of return low. Some industry observers, on the other hand, believe the medium to long-term impact of the COVID shock may not be too severe. They feel this is a transient phenomenon, and its effect will last at best till the pandemic lasts. Either way, this will not be a simple matter of restoring status quo ante: this moment of crisis could be fundamentally transformational.
The Future Office
The new normal—a shorthand for all the observed effects COVID season has brought—could lead to a shakeout in the commercial space. But some effects could be counterintuitive, even unpredictable, because the impact of the pandemic on the sector has been rather varied. For instance, some feel the demand may in fact pick up because companies may need larger office spaces to ensure social distancing norms are followed even after the pandemic. And while hotels and retail malls have suffered the most due to reduced travel and footfalls, warehouses and offices have been quick to bounce back after the initial dip in the second quarter of 2020. Indeed, in the medium to long term, growth in e-commerce and increase in logistics outsourcing are likely to drive the growth in warehousing. If the prospect of a major shakeout is real for anyone, it will be hotels and retail malls—they are spaces that will remain affected at least till a majority of Indians are vaccinated against the virus. This is so even if, as Google mobility trends show, India has reached around 60 per cent of the pre-COVID levels when it comes to visiting places like restaurants, cafes and shopping centres.
Manav Singh, Chairman, Imperial Holding, says high quality commercial real estate is here to stay but they will have to reinvent themselves to the new normal. “The same office will be used by multiple companies on different days, therefore decreasing the net cost of the lessee and at the same time, possibly, even increasing the net revenue to the lessor. This will allow several more people to rent good properties that were out of their budget six months ago. Equally, Grade-B properties may struggle as those tenants would have moved to Grade-A at a lesser cost,” he says.
What about office as a work space, a salient mental category for all of us? Disaggregated working, a minor trend born via IT and outsourcing and with us for a few years now, had not won many converts—primarily because the quality and intensity of (formal and informal) interactions in one physical space was seen to be by itself a factor of productivity. But Singh says offices were a real need only when means of communication were nonexistent or primitive—indeed, having a telephone was a luxury. “However, old habits and traditions, so deeply ingrained, could not be broken. I’ve been working from home for the last six months and feel my productivity, creativity and overall satisfaction are significantly more than before. If you map the daily life of an employee, s/he spends two to four hours a day travelling to and from work. This creates a huge imbalance in life as s/he is unable to spend enough time with family, friends or pursue other vocations,” Singh explains. He’s “100 per cent convinced” that #WFH is here to stay. “In line with this conviction, I am of the view that commercial real estate will take a huge hit,” he says.
Ashish Bhutani, CEO, Bhutani Infra, concedes certain changes are definitely inevitable. “The movement of the commercial segment to Tier 2 and 3 cities will gain more steam as companies are looking to cut costs and smaller cities offer better options. The demand for larger office spaces is also likely to increase as big corporates will stick to social distancing guidelines,” he explains. This may actually spur a buzz of activity: as space requirement goes up, developers will have to come up with projects at favourable locations. At the other end, the churn will also have a concentrating effect, he predicts, as “tenant-landlord agreements will lean more towards lease and revenue-sharing”. Some of these models existed earlier also, but will now attract some urgent focus, he feels.
But Bhutani also foresees the concept of “co-working” changing as people opt for flexibility and multiple locations. Kunal Moktan, CEO and Co-Founder, PropShare Capital, doesn’t entirely agree. He sees #WFH as a cyclical wave that will ebb, not a structural shift in the behaviour of companies—especially for MNCs that have captive backoffices in India. He cites several reasons. “Indian homes are not suited for #WFH for extended periods of time. Indian families are bigger in size and it’s difficult for people to have a dedicated workstation and work with children or parents around. Then, the infrastructure: frequent power cuts as well as patchy internet connections make it extremely difficult to work efficiently. The recent power failure across Maharashtra is a prime example. Grade A commercial offices have power backups, which enable employees to work without issues,” he explains.
The resilience in India’s commercial real estate, Moktan says, also lies in the fact that here the cost of working from offices is not very high. “For MNCs, a per seat cost of approximately $100 is not very high. In fact, this cost hasn’t increased for them significantly over the last decade, essentially due to rupee depreciation against the dollar, while revenues for the companies have grown multifold during this time. That is why MNCs like Microsoft, Amazon and Apple are using COVID as an opportunity to get into long-term leases at lower rates,” he says. “The continued attractiveness of the Indian office market in terms of low operating costs and availability of low-cost, skilled workforce is likely to keep the demand high. Strong rental collections (98.5 per cent in Jul-Sep and 99.9 per cent in Apr-Jun) seen by Embassy Office Parks REIT shows office real estate has been quite resilient to the pandemic,” Moktan adds.
Green Shoots
After the severe dent on India’s booming office leasing market in the first half of 2020, the second half is witnessing green shoots of revival, feel experts. With metro rail, inter-state travel opening up and the panic having subsided, people are ready to return to normalcy. “The initial exhilaration related to #WFH has now subsided and people are missing the team camaraderie and boardroom brainstorming,” says Ankit Kansal, Founder and MD, 360 Realtors. “Employees and employers have realised that #WFH cannot be a long-term substitute. People are returning to work. This is good news for commercial real estate players. In the second half of the year, we have started witnessing a demand bounce-back. It’s slow, but maybe by next year the momentum will pick up.” The revival will also come from a spread effect—from opportunities in untouched Tier 2 and 3 markets, where demand for organised retail and office space has become an absolute necessity, feels Abhishek Bansal, Executive Director, Pacific India. New segments like co-working spaces and logistics will also help. “This shift from traditional to modern developed commercial structures has been majorly driven by the need for hygienic, contactless and automated surroundings. As people are getting on with their businesses, they are looking for commercial spaces in places other than Tier-1 cities. This has already kickstarted demand in peripheral areas,” he explains. Pre-leased properties are one sub-segment that may see some demand, though properties with over 70 per cent vacancy will need to be reviewed. As a sub-sector, retail has got the hardest blow as the malls were closed for almost half the year and people are still apprehensive of going into enclosed retail spaces, especially when they can get everything they need at their doorstep. “Smart retailers are banking big on an omni-channel strategy—which integrates different methods. Malls have started witnessing an uptick in food and beverages but till such time as multiplexes and family entertainment centres open, malls will keep facing a dearth of footfalls,” Kansal says.
What’s in it for small investors?
Small investors have been insulated from these ups and downs because the big ticket sizes involved in commercial real estate normally confines it to the affluent class and institutional investors. The segment has given better returns than residential real estate in the last few decades, but profits from these price appreciations and higher rental yields have hitherto eluded the small investor. But now innovative fractional investment instruments allow even small investors to consider commercial property. This concept, prevalent in the US and Europe for a decade, is now picking up in India. Fractional investment enables one to buy a portion of a property, thus partaking of a fraction of the benefits of owning a commercial property without any of the hassles or upfront expenses. Kansal says it enables small investors to invest in even premium commercial properties to earn a monthly rental yield and build long-term wealth. “Virtual spaces are not trending anymore as customers are looking at clear ownership and bankable, tradable products,” he says. Bhutani agrees. “The investor can start earning once the property is fully-funded, enjoying the benefits of value appreciation, and also sell off his part after six months. It is, in fact, a wise way to earn extra money without the hassles,” he explains.
Fractional investing comes with its own risks, though. Moktan says the onus is on the investors to manage their risk. One key precaution would be to invest in assets that are completed, tenanted, and now diversifying across different asset classes and locations. Kansal adds that selling fractional property is more tedious and not as streamlined as whole ownership. “Some of the other challenges are higher maintenance and building common consensus on space. Collaborating with co-investors may pose challenges for some fractional investors.”
Moktan has a hot tip: returns, he says, are made at the time of investing, not while selling—investing in times of uncertainty normally leads to good returns. “Research published by Cambridge Associates, a US-based firm, which studies global funds across asset classes, shows real estate funds launched during the recession in 2001 and 2009 rewarded investors with the best returns since the turn of the century, giving an average annual return of 24 per cent and 18 per cent respectively,” he adds. In short, as the strange caravan of 2020 trundles towards its end, we may be left with newer ways of going to office.
vishav@outlookindia.com