Mumbai: International property consultancy firm Jones Lang LaSalle India (JLL) has decided to scrap its plans to raise a 700 crore fund to invest in commercial property, said three people familiar with the development.

JLL is the third firm, after Milestone Capital Advisors and IDFC Alternatives Ltd, to put such plans on hold due to the uncertain outlook for commercial property and the shortage of quality assets to invest in. Instead, most investors remain focused on residential real estate.

“Commercial property prices have not gone up and pricing is reflective of the rents in the market. With clarity awaited on real estate investment trusts (REITs), it was best that we dropped the plan and focused on our residential platform. Also, investors are more keen to invest in the residential space than commercial one," said one of the persons mentioned above.

In May, Milestone Capital Advisors, with assets under management (AUM) of 2,876 crore scrapped its plans to raise 500 crore for a commercial real-estate fund. It is now on course to raise a 500 crore residential fund called Milestone Opportunities Fund 10.

Milestone officials had said the decision was taken after interactions with the investment team, investors and business partners.

“...the most important factor, above all, is the prevailing market sentiments and the growth potential of the real estate sector for the next 3-4 years. Commercial real estate has witnessed limited success over the last few years owing to the slowdown in demand from key office space occupiers," said Navin Kumar, executive director at Milestone Capital, explaining the decision.

IDFC Alternatives, the private equity arm of IDFC Ltd, put its plans for a commercial real estate fund on hold in September, as the management felt the timing was not right. “By the time we would have finished raising the fund, interest rates would have come off significantly and rentals would have moved up. We do not want to enter at the wrong side of the cycle," said M.K. Sinha, managing partner and chief executive at IDFC Alternatives, during an interaction on 29 September. Sinha added that the availability of quality commercial real estate is very low.

According to JLL, present stock of commercial office space stands at 390 million sq. ft., of which 320 million sq.ft. is leased, indicating 18% vacancy. Till 2011, developers added 42 million sq.ft. per year in the country, but this has come down to 30 million sq.ft. per year over the last four years.

Analysts said that along with the relatively low availability of high quality leased assets, the prospect of REITs will mean that developers may choose to monetize these assets themselves.

“The commercial real estate segment has become over-crowded and the availability of quality assets is less in the system. Ultimately, you have to exit these assets and capitalization rates are still between 9.5% and 11% depending on the property," said Addhidev Chattopadhyay, research analyst at HDFC Securities.

Funds are also holding back on commercial real estate as investors have shown greater comfort in investing in structured debt transactions in residential real estate.

“Domestic investors understand debt products and they want to give money to funds who will invest in high-yield debt segment. It is easier to go out and raise a residential fund as investors feel that if it’s a debt transaction, they will get fixed returns and they have visibility on returns. They aren’t too keen on commercial asset vehicles," said the second person mentioned above.

Even though domestic players have put their plans on hold, international investors are increasing their exposure.

In May this year, global investment firm The Xander Group Inc. tied up with the Dutch pension fund APG to invest $300 million to acquire commercial office assets in the country; they can increase the capital commitment to $500 million. On 28 November 2013, Canada Pension Plan Investment Board (CPPIB) committed an initial equity amount of $200 million to Shapoorji Pallonji Group to acquire stabilized rental assets. CPPIB owns 80% in the venture.

On 11 June, Brookfield Asset Management Inc acquired Unitech Corporate Parks Plc (UCP). UCP, which is incorporated in the Isle of Man, is developing six special economic zones (SEZs) and information technology (IT) parks in India. It had formed a 60:40 joint venture with Unitech Ltd to develop these assets. The entire transaction value for this sale crosses 3,000 crore.

According to two international fund managers who have invested in commercial real estate assets in India, investments in this segment require large amounts of capital, which domestic funds may not be in a position to raise.

Both declined to be identified as they are not allowed to speak to the media.

“Over the last one year, we have seen rents move up by 5% and more, but we are expecting it to go up by 10% in next one year. If we see the broader picture, lot of supply has been coming up in the country, but there is acute shortage of good Grade A office buildings where rents are increasing. It is a good time to acquire assets but most of the international funds have already cherry-picked the good assets and the remaining funds will not be left with that choice to acquire good assets," said Ashutosh Limaye, head of research and real estate intelligence services at JLL.