Catherine Chen sits down with Saurabh Shatdal and Somy Thomas to explore the growth opportunities in the Indian commercial real estate markets

Catherine: India is forecast to see GDP to grow by around 10% this year. What are the primary economic drivers and how will this impact commercial real estate investment in India?

Saurabh: One of the GDP drivers will be India’s massive domestic consumer market. India’s Q4 GDP has already come back to positive territory, at 4.1%, thanks to effective monetary and fiscal policies that were enacted in Q3. We see further growth of the economy in 2021, driven by India’s buoyant domestic consumer market, and government expenditure on large infrastructure projects. In addition, we have seen positive results posted by most of the listed entities, and some of them have also announced CapEx plans, which is definitely a sign of growth and recovery.

From a real estate perspective, India will remain a large outsourcing market and the pandemic will likely continue to drive the outsourcing needs from global companies into India, further fostering demand for quality office space. In addition, we are seeing an increasing number of built-to-core offices, and growing investment into office development. We expect that in the next two to three years at least $18 to $20 billion USD will be invested into India’s office market.

As a result of growing demand for office space in India, demand for residential and retail will likely grow together. Shopping centers in India are increasingly seen as “destination retail”, driven by strong local consumption and increasing income per capita. The industrial and logistics sector will also experience growth with increasing adoption of e-commerce in India.

Catherine: India sits among the strongest growth markets, and currently offers one of the highest yields among the Asia Pacific markets. Is there any potential risk associated with these high returns, especially in the office sector where the future supply seems quite high?

Somy: Office absorption in India remained robust in many markets despite the COVID-19 pandemic, although we have seen marginal increases in vacancy rates mostly due to the new completions. It’s worth noting that office vacancy in most markets, especially those institutional Grade A office buildings, remained in single digits. The exceptions are some aged buildings, which experienced difficulties in maintaining occupancy levels.

From an overall return perspective, we believe the office sector will remain attractive to investors. On the supply side, given some developers are now facing funding constraints, we will likely see construction delays and therefore the future supply levels will likely be lower than expected. Hence, balancing both supply and demand factors, we expect India’s office assets to offer a robust return framework for the listed commercial REITs as well as the future REITs that are being planned in India. The current dividends for the three listed office REITs – Embassy, Mindspace and Brookfield, are in the 6% to 6.5% range, which has gone up to 7% in recent months due to temporary softening of pricing. In addition, the reduction in the cost of debt in the last six months had also helped increase the Net Operating Income (NOI) yields for investors.

Catherine: Thank you Somy. Since you mentioned REIT performance in India, could you share a bit more on the current trading yields and outlook for the next two to three years?

Somy: In the office sector, we believe there is strong pent-up demand, especially when we look at the recruitment numbers of most Indian and international IT companies – showing strong indication of future expansion. This strong underlying growth of business will drive growing requirement for quality office space post-pandemic. Certain portfolios with non-office assets such as hospitality will likely experience some pressure.

Apart from the dividend yield which will likely remain in the 6% to 6.5% range, we can expect an average return of double digits once the market recovers likely in the second half of this year given the current vaccination progress in India. We believe most people are going to return to office starting July, and reach full momentum by October, November of this year.

Catherine: We mentioned various property sectors in India, such as office, logistics and retail, how about the residential market? Is there opportunity for foreign investors given the financing challenges faced by some domestic developers in India?

Saurabh: Yes absolutely. India’s developers have been facing a severe liquidity crunch over the last two to three years, and some of them are running out of cash to fund the projects either at the platform or at the asset level. For the last two years, we have seen an increasing number of foreign players looking to tap into India’s debt market.

I feel that there is a window of opportunity over the next two to three years for international investors to participate in India’s residential market either directly or indirectly. It has been a mixed experience for residential developers in the Indian market, there have certainly been some successes which sales accelerating in Mumbai, Bangalore, Hyderabad and Pune markets. However, there is fierce competition in the sector and we have seen some consolidation over the past two years, which we expect to see more of.

When looking at the dollar returns, I would expect somewhere between 17% and 22% IRR, especially for the early movers, such as SSG Capital acquiring Alticoin India, and Kotak Investment Advisors managing ADIA’s capital in India. Some of the other funds that are currently actively looking include Hong Kong based PAG and Oaktree Capital.