While the cracks in the Indian economy had begun to show well before the pandemic and its ensuing lockdown, the impact across all sectors was surely amplified by the kind of situation created by the pandemic and its increasing stronghold. There was a huge liquidity crunch in the market, the market saw an unexpected migrant labor exodus, the Purchasing Managers’ Index (PMI) hit record lows, and then some.
Needless to say, pretty much all sectors across the country have felt the heat of the COVID-19 pandemic; and falling in this bracket is the segment of commercial real estate in India.
Via this article, we aim to analyze how the commercial real estate sector was performing before the pandemic hit India and caused an industrial seizure across sectors, the factors which caused the commercial real estate sector to slow down in its growth during the lockdown, and whether this means a virtually non-recoverable nosedive for the sector or is there some hope for a recovery?
We start off with a general backdrop about the sector, where we discuss commercial real estate by talking about the kind of spaces it includes and who leases / rents / buys them. Primarily comprising of office spaces and co-working spaces, commercial real estate has been a key component for any business operating in India, be it a multinational company, an MSME, or a startup. Companies with a relatively small workforce often make use of co-working spaces, an office style which has been recently popularized in tier-1 cities in India and involves various businesses operating out of a rented space, albeit with allocated sections / tables of their own.
Another component of commercial real estate includes malls and entertainment / leisure centers, a part of the system which had been visibly witnessing a halt even before the national lockdown began, owed to the spreading risk of the COVID-19 virus, as the Government decided to shut down such centers of mass gathering.
The lockdown getting lifted recently might change a lot of things, or it might not. The recovery process will surely take its sweet time, and it is not something which will follow a V-shaped trajectory. However, there does exist some hope across various industries, but that is a topic for another day.
Now, a critical aspect of the lockdown was the closure of the malls and the dilemma about how the mall owners and those who rent the shop spaces would negotiate their rental agreements or make use of the force majeure clause. The income of the mall owners (primarily the rent from the store owners) had been plummeting, owed to virtually nil sales in the stores and with rents already excruciatingly high, both the stakeholders in this aspect were left in a state of limbo.
Moving to office spaces, the lockdown saw businesses across various domains switch to a work from home model, with some even looking to permanently shift to the same and contemplating the need of an office at all, in the long run. Tech-enabled businesses had it relatively easy, while others saw it as a challenge and took it on the chin to adapt.
Now, while there is of course the perception of how the sector had been performing before COVID-19, there are also various dormant factors which can be missed by the eye. In a normal scenario, commercial real estate property gives an average rental yield of 6–10% as compared to 1.5–3.5% rental yield of a residential property[1].The same publication reporting this trend talks about how commercial real estate, in the year 2019, witnessed private equity investments to the tune of USD 3 billion for the first 3 quarters itself. Now, while there is a belief of investments pouring into the sector alone, one can’t help but speculate the impact of the pandemic on the general lifestyle and mindset of the people.
The kind of social distancing protocols which will be enforced in urban working centers, the change in building designs and the kind of new architectural and structural changes which are being evaluated by the industry might not hold water on their own if the industry players decide to go for a work from home model on a majority basis. A worrying trend has been reported by JLL India as well, where it has stated that for the quarter ending in March 2020, institutional investments in the real estate sector compared to last year have reduced by a whopping 58%[2].
And to combat the increasing slump in the sector, the Reserve Bank Of India (RBI) has had to actively step in to ensure the value of the sector, which it provides to those who wish to invest/do business in the sector – still holds in the future and present.
The reduction in the reverse REPO rate from 3.75% to 3.35% has been projected to improve the liquidity situation, and the revised moratorium period on loan payments for 3 months, as well as a 1-year extension on repayment of loans availed for commercial real estate projects have also been treated as welcome moves by the industry.
The curious case, however, is the fact that these measures are focused on the “now”, rather than keeping in mind the long-term value of the industry. While there is no shortage of belief that the sector will hold once things normalize, office spaces will not be the same again and that is something which cannot be ignored.
The dichotomy of the situation is that while net leasing of office spaces this year is anyway projected to fall to 25 million sq. ft. as compared to 45 million sq. ft. in the past year[3], industry analysts have predicted this to be a blip in the system rather than an unprecedented downfall. Another case of unpredictability is how new rental agreements will be drafted and the old ones revisited, causing a reduction anywhere between 5–10% in their costs, which can further replicate across the sector. The belief in commercial real estate holding its long-term value also stems from the fact that India, as a country, doesn’t currently have the required technological infrastructure required to think of working from home as the first choice of various businesses, an angle which is mitigated by organized office spaces.
Theoretically, with new businesses looking to set up their presence in India as well, the requirement of office spaces is expected to go up. As for malls, with the recent national lockdown being lifted and the general public looing to resume life, there is a ray of hope. But with the COVID-19 cases on a linearly increasing curve, the civil health aspect can also kick in and can perhaps result in another lockdown as well.
While there is no set formula to predict the recovery path of the commercial real estate sector in India, we can surely witness custom-made property models, longer deal cycles, flexible rental agreements and more to ensure that the current players continue to thrive.
As for predicting a sure-shot recovery, it’s as big a shot in the dark as any, since the sector is capital intensive and requires the entire ecosystem comprising of lenders, borrowers, and other stakeholders to work in cohesion with.
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