The office real estate market has seen a strong demand from investors over the past few years. We have witnessed significant interest from institutions who are queuing up to lap up good quality, rent-yielding office assets. One of the reasons for this spike in demand was the acute shortage in supply of good quality large office space in top Indian cities.
The primary reason for shortage in supply was that developers had shifted most of their attention towards residential projects due to poor response from occupiers of office space from 2008 to 2012 as an aftermath of the global financial crisis.
Despite overall office space vacancy levels being in double digits in several of these cities, the good quality office spaces are still commanding premiums and are witnessing upwards pressure on rents on account of scarcity in supply and robust demand from occupiers. Moreover, in the prime business districts of the country in areas such as BKC and Lower Parel in Mumbai,
DLF Cyber City in Gurgaon and ORR in Benguluru, the scope for additional supply hitting the market in the next 12 to 18 months is low due to limited availability of land and the limits on the development potential.
# The investments in office space increased significantly, almost eight times since the beginning of the current decade, from $296 million in 2011 to $2,252 million in 2017 . The average investment per deal has also increased from $74 million per deal to $250 million per deal in the same period.
# In the first half of 2018, already $2,784 million has been invested. The number of deals has grown constantly over the years since 2014. In 2017, there were 9 deals in the entire year; however, there were 12 transactions involving office assets in the first half of 2018. Hence, it is quite likely that the full year numbers for 2018 would be higher.
# In some of the office assets that were acquired by investors, the current set of occupiers had taken up space in those assets during the weak office leasing market, i.e. between 2008 and 2012. Many of those assets are located at some of the most sought after business districts of the country. The market rentals prevailing that time were at the bottom of its cycle and the vacancy levels were very high. Hence, after many years of standard rent escalations (generally 15 per cent escalation every three years), the rents that those set of occupiers are paying is much lower than the market rents prevailing today, as the escalations had happened on a low base.
# Over the last three years, the office leasing market has been inching steadily towards its peak; demand from occupiers for good quality space has been growing, the rental growth has been strong and the vacancy levels have shrunk drastically and in some business districts it is even in single digits. Hence, when these tenancy contracts become due for renewal, the potential for rental appreciation during contract renegotiation is huge. Such office assets are becoming increasingly attractive to investors.
# The period starting from January 2016 to June 2018, represented an exceptionally exuberant period for office space landlords and the numbers reflect the same. In the coming years, there may be a slight dip in the annual investments. This is due to the fact that the investments in the last couple of years shot up on account of one-off big ticket transactions like – the Hiranandani-Brookfield deal in 2016, DLF-GIC deal in 2017 and the Blackstone-Indiabulls deal in 2018. Such transactions do not happen often due to the sheer size of assets that are involved in the transactions, as those assets have a long gestation period and take more than a decade to mature and become operationally efficient.
# The PE giants generally prefer acquiring controlling or complete stake in the asset, whereas the sovereign and pension funds prefer to take partial stake as they do not wish to take the responsibility or get into hassles of day-to-day management of the asset. The sovereign and pension funds prefer to partner with big local developers in a particular region who have the ability and expertise to become national players or become the dominant player in certain regions.
# Deals in 2017 witnessed involvement of a record 5.5 million square meter (59.6 million square feet) of office space; highest in the current decade. However, the quantum of stake (share in space) under consideration in those assets did vary across deals. For example, in the biggest deals of 2017: DLF-GIC and K Raheja-Blackstone, the quantum of stake purchased was less than 50 per cent.
# A large amount of overall investment in office space was led by PE funds (76 per cent) followed by sovereign funds (22 per cent). The sovereign funds and pension funds prefer rent-yielding assets with quality tenants on long leases, as they prefer annuity income assets to be a part of their overall portfolio. They have very long time horizons generally greater than 10 to 15 years.
Going forward, as ready rent-yielding assets become scarce, there would be some players willing to take risks and enter the sector at the project development phase. Although there are limited instances, some investors have indicated that they have started partnering or are in talks to partner with developers for their new office development projects.
Source: Knight Frank