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Slowdown in offices sector puts investors, REITS in a corner

REITs are also likely to see lower yields due to deferment of new office leases and zero rent escalation in the near term.  (Photo: Mint)Premium
REITs are also likely to see lower yields due to deferment of new office leases and zero rent escalation in the near term. (Photo: Mint)

  • As rentals and office absorption rates fall, firms that own rent-yielding assets will find revenues squeezed
  • Slowing growth, weaker spending power and rise in work from home may put pressure on rentals from commercial assets

The end of a seven-year bull run in India’s office development is expected to squeeze rentals and hurt real estate investment trusts (REITs), putting top property investors in a spot.

The boom in India’s commercial office properties was led by huge demand, foreign investments, falling vacancy rates and rising rentals. The covid-19 outbreak has delayed project completion, softened rentals and sapped demand, at least for the next few months.

Blackstone Group Lp, India’s top office space owner, has $19.4 billion assets under its real estate portfolio in the country, across 39 investments since 2006. As rentals and office absorption rates fall, companies which own rent-yielding assets will find their revenues squeezed.

Property developer Salarpuria Sattva Group, along with Blackstone, bought Bengaluru’s Global Village Tech Park earlier this year for around 2,500 crore in one of the largest office deals in recent times. According to Bijay Agarwal, managing director of Salarpuria Sattva, there will be a softening in office rentals by 5-10% for a couple of quarters, though a longer-term impact is unlikely.

“...Nearly 90% of the demand for office space is from MNCs (multi-national companies) and there may be a drop in demand as these firms may put their expansion plans on hold till things settle down," Agarwal said.

With US and Europe hit hard by the pandemic outbreak, global companies, which contribute the bulk of the office space demand in India, may rework their plans, delaying leasing decisions and prompting rental renegotiations by new and existing occupiers.

Blackstone is a majority shareholder in Embassy REIT, which has a 33 million sq. ft portfolio. Embassy Office Parks said it has faced minimal impact on business owing to its marquee tenant roster.

Mindspace Business Parks REIT—backed by K. Raheja Corp. and Blackstone—had filed its draft prospectus with the Indian markets regulator in December, but the initial public offering has not been launched.

A person familiar with the development, however, said Blackstone may not be affected much. “Rents may not come down sharply because vacancy levels are already low in cities such as Bengaluru and Pune. Most of Blackstone’s portfolio is leased and has long-term contracts with clients. Tenants may not look at moving out as they have capex in fit-outs," the person said on condition of anonymity.

Blackstone declined to comment to an email query.

Anarock Property Consultants in an April report said the net absorption of office space is likely to drop by 17-34% in 2020 from pre-covid-19 projections.

REITs are also likely to see lower yields due to deferment of new office leases and zero rent escalation in the near term, as the pandemic and lockdown curbs cripple companies worldwide.

Slowing economic growth, weaker spending power of companies and an increase in work-from-home practices are some of the factors that will pressure rentals for commercial properties.

“Though the occupancy and rentals for large commercial complexes may mostly remain stable for now, tenants may defer signing of new leases till they can recalibrate their needs to the post-covid scenario. In that case, the overall REIT valuations will be influenced by a combination of factors like low yield environment, defensive nature of the sector, stability of rentals and pace of new leasing or re-leasing of office space," said Subhrajit Roy, executive director and head, equity capital market origination, Kotak Investment Banking.

Roy added that while rent collections for large office developers in April have been over 95%, with most clients honouring their lease contracts, there may be some renegotiations on lease terms for tenants like multiplexes, retail malls and food courts.

An April report by Edelweiss Securities Ltd said that while office developers have the benefit of long-term leases, they will have to work hard to ensure tenant retention and revenue stability, with large occupiers and SMEs likely to seek more favourable lease terms.

“Construction delays will happen and occupiers will take longer to take decisions, resulting in a 20-30% drop in lease or absorption rates. However, because de-densification will be a huge thing, companies may need larger offices to accommodate their workforce," said Ramesh Nair, country head and CEO, JLL India.

According to Shobhit Agarwal, chief executive and managing director, Anarock Capital, most office developers also had to forgo their rental income from restaurants, food courts, gymnasiums and shopping in office parks, which typically could form about 10% of their office portfolios.

“...Once public markets open up, REITs may continue to be in demand among investors due to favourable yields in an otherwise volatile stock market," Agarwal said.

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