Mumbai are in a state of disrepair. There is a reason why the first-generation shopping malls in most cities are underperforming and deteriorating in quality.
The root of all this is super stratification of real estate. What does that mean? In simple terms, a large building or mall is usually sold in small units/shops to hundreds of investors, who lured by attractive rental returns that commercial and retail realty offers, buy the smallest piece available in market. Most large buildings and retail centres are then co-owned by a significant number of investors. At some stage in the life cycle of the building, the management of the building passes from the original developer to an association of multiple owners who then get distracted by individual objectives and lose focus on asset management, the key to driving sustainable value in the real estate sector.
Strata-sales is a prevalent practice in most Asian countries. Developers are motivated to do this for two reasons. One, it de-risks them from development since the ownership risk is passed on to small investors early in the development cycle. Two, it’s a cheap mode of financing land purchase where institutionalized financing from the banking sector is not available and it is also a cheaper mode of financing construction than bank financing. It’s a perfectly legitimate mode of financing and that of investment.
Problem in India
It works relatively well in the rest of Asia because the degree of stratification is far less. Mostly, it is one owner per floor and the association of owners is governed by a de-facto constitution, which dictates the to-dos. As compared with this, the average ownership size of commercial and retail real estate in India is between 1,000 sq. ft and 5,000 sq. ft. In a recent deal, we dealt with 105 different landlords to close a lease of 50,000 sq. ft for a single tenant client in Connaught Place. Getting a single lease document signed by 100-plus owners was a huge challenge and this was when the money would actually flow to these owners in the form of future rents. Now imagine negotiating with the same bunch of owners to part with some money so that the building can be properly managed and upgraded so that it can match standards in 10 years’ time—an impossible task.
What’s the solution
To create long-term value in property, there needs to be a coherent plan to manage the building—make choices that continuously upgrade the buildings, which in turn helps to continue to attract the right tenants and drives up the rent. The value of the building depends to a large extent on the capacity of the building to earn rent—higher the rent, more the value creation. While this is true for commercial buildings, this is even more relevant for shopping malls.
The approach to manage shopping centres has to be much more scientific. One needs to consider positioning and, therefore, the type of retailers you want in a shopping centre, locality, the flow of shoppers factors that will increase footfall, turning over underperforming outlets—everything to make retailers in the mall make more money, which should translate into higher revenue for the owner of the mall. A few good examples of such malls in India are Select City walk, New Delhi and R Mall in Mumbai. The concept of a single or majority ownership in real estate development is slowly creeping in—this is helped by improved availability of financing through both domestic funds and foreign direct investment (FDI).
The key challenge in realizing returns for developers/owners remains in finding a viable exit route, or sale of an asset to a third party after a period of time when the asset has a stable income. Today, the only viable route is focused domestic funds but they are very limited in number, or through a real estate investment trusts (Reits) listed overseas if FDI-compliant. The solution lies in regulating the capital markets both on the debt and equity side—on the debt side, to provide the industry with competitive construction financing, and on the equity side, by promoting instruments like Reits and real estate mutual funds, which will provide necessary liquidity to provide exits to finished products.
Till this happens, we will see more shiny boxes losing value over a period of time as the democratic nature of ownership could not agree on coherent asset management.
Anshul Jain is chief operating officer (India), DTZ International Property Advisers.