Techies’ return raises demand for office spaces

In a spillover effect of challenges facing the Indian IT sector, leasing took a beating given that technology companies have been top contributing tenants for Grade A offices until recently.
In a spillover effect of challenges facing the Indian IT sector, leasing took a beating given that technology companies have been top contributing tenants for Grade A offices until recently.

Summary

Aggregate gross leasing of key listed firms rose to a multi-quarter high in Q3FY24. For Embassy Office Parks REIT, 80% of the total leasing demand in Q3 was driven by GCCs. For Brookfield India Real Estate Trust, GCCs accounted for 54% of the new leasing.

The resurgence of Global Capability Centers (GCCs) has helped demand for Grade A office spaces make a comeback. This has meant an improved leasing trajectory for office asset owners, who have been grappling with muted demand lately.

In a spillover effect of challenges facing the Indian IT sector, leasing took a beating given that technology companies have been top contributing tenants for Grade A offices until recently.

Nonetheless, the tide is gradually turning in favour of commercial realty. "The gross office leasing in CY23 rose by 15% year-on-year across top eight cities resulting in absorption of 59.6 million square feet," said Viral Desai, senior executive director, occupier strategy & solutions, Knight Frank India.

On average, rentals in the top eight cities improved by 5-7% in CY23 and Desai foresees rentals rising in the similar range in CY24. This is likely to be driven by the rising share of GCCs in overall leasing pie.

Higher traction in overall leasing has aided the performance of companies in the listed space. Aggregate gross leasing of key listed firms rose to a multi-quarter high in Q3FY24. For Embassy Office Parks REIT, 80% of the total leasing demand in Q3 was driven by GCCs. For Brookfield India Real Estate Trust, GCCs accounted for 54% of the new leasing.

“Over the past couple of years, higher exits, predominantly from IT/ITeS companies have resulted in net leasing being negative; while exits continued in Q3FY24, the pace seems to be reducing. Consequently, net leasing was positive for all the major developers," said a Nuvama Research report.

Gross leasing includes renewals, while net leasing refers to new additions.

Encouragingly, management commentaries of listed REITs (Real Estate Investment Trusts)in Q3FY24 indicate that occupancies have bottomed out. Companies see this metric poised to head higher from here on, albeit gradually. For instance, the Brookfield management has guided that by FY25-end, its portfolio occupancy shall improve to around 88% from 80% in Q3FY24.

Notably, the Grade A commercial office assets in India are cost-effective for GCCs, which are typically companies of foreign origin that set up their back-office operations and R&D activities in India. The availability of skilled workforce and a favourable business environment are some additional advantages for GCCs in India.

In fact, the second half of CY23 particularly witnessed the highest GCC leasing activity since 2020, reaching 12.4 million square feet, showed latest data by property consultant Colliers India.

For CY23, the rise in GCC leasing activity was 14%. By 2025, Colliers anticipates around 45-50 million square feet of GCC leasing activity, contributing to about 40% of the total demand for office spaces in India, it said in a statement on 21 February.

Another factor that is expected to boost office space demand is the recent special economic zone (SEZ) floor-wise de-notification, which allows floor-wise leasing. This is aimed at boosting occupancies for office spaces in IT/ITES SEZ parks and should lead to lower vacancies eventually. While the benefits on the sector’s rentals will be visible gradually, it is sentimentally positive for now, especially for listed companies. But apart from the demand trajectory, investors in listed REITs also need to monitor the debt profile and borrowing costs as these companies are expanding their portfolios.

Meanwhile, the trend of returning to office being adopted by Indian IT companies is gathering pace, but unless the sector sees significant revenue growth recovery, its share in the overall office space leasing is expected to remain low. This could cap steep upside growth in occupancies and rentals in the near-term. Also, any economic downturn in the US or European Union could slow GCC demand for office space in India.

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