Where will REITs invest in India?
There is a compelling case for REITs to create a vibrant market for commercial real estate
The budget was a watershed for real estate. After years of regressive state and central regulations contributing to the stagnation of the sector, finally there was positive regulation in the form of real estate investment trusts (REITs) being opened up after almost six years since the first draft of the guidelines were released in 2008.
There is a compelling case for REITs to create a vibrant market for commercial real estate. Today, bulk of the developers shy away from commercial real estate primarily for two reasons. Firstly, it is not easy to sell in the absence of institutional investors or retail buyers. Secondly, the opportunity cost of holding such assets for a developer is in early single digits versus residential development, which can yield upwards of 20% per annum.
Even for buyers, REITs hold a lot of promise. Retail participation in real estate is an exciting prospect. With 33% savings rate, this reality may not be too far now. Moreover, induction of much needed and hard to find foreign investment in the sector will give relief to to developers, who are presently struggling with 20%-plus financing cost.
Before we get ahead of ourselves, let us take a closer look at the commercial real estate space in India. Upon inspection, it highlights a potential build up of an asset bubble which can possibly ruin the party for both offshore investors and retail investors.
Limited outlets
Given the low penetration of organized retail and lower margins in hotel operations, these assets will not be able to generate the yield expected by a retail investor, which should ideally be better than her bank fixed deposit rate. Therefore, I feel the first stage for REITs would be restricted to commercial office space.
Here, too, the market is split into investment and non-investment grade office assets. Simply put, investment grade office assets would be those where the entire building is held by a single owner, is maintained well and occupied by AAA-rated tenants.
Unfortunately, majority of the central business districts’ (CBD) assets across all major cities in India do not qualify as investment grade because they have strata titles. Multiplicity of ownership is also a big reason behind most of these buildings not getting the face-life that they are in dire need of.
This leaves us with office campuses built primarily for the services sector, importantly, information technology (IT)/IT enabled services. This entire segment would qualify as a worthy investment avenue for REITs but most leading companies own their own campuses, which have been built on granted or subsidized lands and hence either are not tradable without cost implications or the owners are so cash rich that they have no desire to part with this appreciating asset.
In effect, a calculated guess shows that no more than 30% of the entire stock is available for REITs to buy.
In few hands
A further slicing of the commercial space throws up a few more interesting observations. Of the 30% investment grade office space available, most of it is concentrated in the top five cities, with Bangalore, Hyderabad, Delhi-National Capital Region and Pune taking the bulk as well as being hot beds of the IT revolution.
Within these cities, each has about 2-3 developers that control most of this supply and thus the expertise to develop, rent and manage such assets. In all, the universe of veritable builders does not go above 10.
Of these 10 names, some are too large and self-sufficient, such as a DLF Ltd. Or, they already have global financial partners, be it the Blackstones, Brookfields or Ascendas of the world.
Moreover, all these companies have avenues to list in India or internationally, chasing the best value for their dollar. This, therefore, concentrates the assets into very few hands who may be able to potentially control pricing in the medium term, thereby making REITs an effective exit route for the highest value, which is something that retail investors need to be wary of.
In essence, this means that though you have managed to open the gates for investments to come into the sector, the reservoir of investible assets is rather small and the potential spillover can flood the catchment areas. In financial parlance, this could create an asset bubble, which the investor will pay for in terms of diminishing yield and capital values running up ahead of time in the medium to short term.
Jasmeet Chhabra, managing director, Red Fort Capital Advisors Pvt. Ltd.
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Business NewsOpinionWhere will REITs invest in India?
First Published:19 Aug 2014, 05:56 PM IST
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