Good prospects for warehousing, data centres & reasonably priced office space

Vijay KR, Partner, Deloitte India, predicts that the new normal in commercial real estate could have limited and mature commercial real estate developers with deeper pockets and greater focus on safety, security, and transparency and occupier wellness.

TPCI: What is the expected impact of the COVID-19 pandemic on India’s commercial realty during 2020 (cost of inputs, demand, prices and profitability), considering weaker prospects for hotels and restaurants, malls, cineplexes, tourism, etc.? 

Vijay KR: India’s commercial real estate segment largely comprises of the office space portfolio with significantly lesser percentage space being occupied by malls, restaurants and other public entertainment areas. The public entertainment businesses are not likely to see many takers given the social distancing norms and other restrictions. It will take at least 4 to 5 quarters for the commercial realty demand cycle to come back to 2019 levels. There are also likely to be some structural changes to the real estate demand cycle, for example restaurants are likely to see significant uptake in the home delivery business, which may lead to location-agnostic operations. Similarly, tourism is like to see a sharp dip in customers in the next 12 month time frame, both due to customers’ desire to conserve cash as well as safety concerns and consequently hospitality assets will be under stress.

In the short term, malls and cineplexes are likely to see a drop in demand considering customers would prefer DTH online entertainment coupled with e-shopping. These changes will most likely lead to a dip in demand and pricing in prime areas and high street zones.

TPCI: How does this hamper prospects of projects under construction? Also, what impact will the exodus of migrant labour have and what solutions are being worked out?

Vijay KR: Under construction projects may see a reduction in their sales due to the downturn in the economy leading to challenges in completion of works. There are also likely to be significant cancellations and re-negotiation of leases even for completed projects – a phenomenon, which we are already beginning to see across the country today. This will have a significant impact on under construction projects, as they will come under far greater pressure due to increase in unsold/unleased inventory and the fact that they will have to compete with existing real estate space. We may see developers willing to offer different models to entice occupiers by offering enhanced revenue share models, increase in rent free period, lower security deposit etc.

Developers will begin to look at innovative pricing models that would require lesser amount of upfront payment and offer greater flexibility. However, attracting footfalls to new malls, restaurants and hotels may not be easy in the next 6 months.

The exodus of migrant labour is a major concern for the real estate industry, given its significant reliance on traditional construction methods that are largely labour-intensive. There are typically two types of labours used in a construction site, one being unskilled labour such as lifters, unloaders and skilled labour such as crane operators, masons, carpenters etc. Unskilled construction workers are generally migratory in nature and will hopefully come back soon after the monsoon season when construction activity picks up. Skilled construction labour are generally not involved in farming activities and will be most willing to return as soon as they feel the situation has stabilised and the fear and panic subsides.

As we approach the monsoon period that typically starts some time in mid-June, construction activity slows down significantly across the country due to the harvesting season. In recent times, labour availability has been a challenge in a construction project and this time around, it may lead to contractors increasing the use of technology (shear walls, mechanical lifting etc.) and alternate materials (steel buildings, dry walls etc.), to reduce the dependence on labour.

TPCI: What is the revival strategy that commercial real estate players are contemplating, and what are the possible scenarios (in terms of time taken for recovery and the trajectory it will take) being considered?

Vijay KR: We can safely assume that overall demand will reduce significantly in the next 4-6 month time frame with a plateau in sight only in early 2021 and growth in later part of the next year. Demand uptake will be slow and will entirely depend on the overall health of the economy and the expendable income available with the general population. While the ultra-luxury segment is unlikely to see any change, the survival and growth of mid-segment commercial estate will depend on strong customer retention and attraction strategies.

Commercial real estate has a significant leasing component associated with it and hence cash inflows are spread over longer periods in time, with large amounts being invested at the beginning. We may see significant deferment of new projects due to the lower demand. In case of operational commercial assets, such as hotels and restaurants, malls and cineplexes the strategies could involve one or a combination of the following:

• Rental deferrals and waivers schemes: Over the last few months we have seen significant resistance from property owners in this area, which is driven by their own liabilities aside from the fear of cash losses. While this may hurt in the short term, one has to remember that this crisis too, shall pass. What will remain is the experience brands and outlets had with the property owners in difficult times and translate into loyalty in the future.

• Increase in rent-free period and/or lower security deposit: In case of new commercial projects, it would be a good to entice brands and outlets with higher rent free period and lower security deposits or even agreeing to revenue share model and in a way linked to the outlets cash flow.

• Re-hashing the design and layout: Commercial real estate spaces might see a fair bit of space optimisation in the next few months. For examples, restaurants could see an increase in take away business with limited dine-in customers. Similarly, food courts and common dine-in areas would have fewer footfalls for the next few months. New ways of effectively re-using these spaces should actively worked upon.

Overall, the likely effect of the Covid pandemic will be felt over the next 12-24 months before it is relegated to memory. The extent of the impact will depend on the agility that property owners show to changing demand in addition to the resilience they show by managing cash flows effectively.

TPCI: Offices are now providing various work from home (WFH) options to staff. How do you view the impact of this trend on office realty space and on the rise of co-working?

Vijay KR: A significant number of organizations are likely to continue with WFH options for a large majority of their teams in the near future especially in the IT/ITES sector. This forced virtualization of the work space has clearly led to organisations and employees accepting the new normal with both seemingly benefiting by way of reduced commute time for employees and savings in office rentals for organisations. This new trend is likely to impact the absorption of commercial real estate, as organisations will shift to a leaner office space.

Having said that, there are contrarian views that the overall impact would be neutralised by the increase in office space needed to maintain the new social distancing norms of 6 feet and thus there would not no net shrinkage in overall office space.

In the current scenario, organisations are looking at alternative real estate models that provide flexible and safe working places with limited capital cost. Co-working spaces seem to provide a wide variety of customisable real estate solutions in terms of private offices, dedicated desks, hot desks etc. However, co-working spaces will need to address the new safety concerns, availability of more parking spaces (given the possible downturn in the use of shared transport), hygienic food options etc.

TPCI: With rise in some sectors like e-commerce, healthcare, food processing, and government initiatives to boost self-reliance, what new opportunities do you see emerging for the Indian commercial real estate sector? Which segments are expected to witness a faster revival?

Vijay KR: It is expected that warehousing, data centres and reasonably priced commercial office space (not necessarily in the CBD’s) will see a large uptake. Organizations which focus on providing reasonable options for organizations to operate on a smaller scale in more affordable locations are likely to take the lions’ share of the business.

With the growth in the e-commerce industry, warehousing may see an increase in demand. With the impending data privacy laws in India, data centres have already seen significant interest, but with a lot of the business shifting online and increasing online traffic, data centres within India may see a strong surge. 

We are yet to see any specific impetus from the government towards subsidising the capital cost for healthcare due to the COVID-19 situation, however, we expect a significant update from Government in this sector once the situation stabilizes. We may see strong growth in the affordable health care segment in the next few years.

TPCI: How do you envision the new normal for commercial real estate post-COVID, to adjust to customer demands? What efforts will be needed from industry and government to navigate this new normal?

Vijay KR: A situation such as the one that we are currently in, will forever change the way some of the business sectors operate. Commercial real estate is certainly one of the most affected, but as they say, with new challenges come new opportunities. Developers who understand the new needs of the customers and are nimble would have a lot to gain. The new normal will be a world with limited and mature commercial real estate developers with deeper pockets and those with focus on safety, security, and transparency and occupier wellness. However, the need for good quality commercial real estate space will always be there; as we will need such spaces as social beings to help us interact with others, express ourselves, relax and rejuvenate.

Overall, real estate sector was facing some challenging times even before the pandemic and the sector needs urgent and significant support from government, more now, than ever before in its history. The developer will need significant assistance in terms of cheaper capital to help manage the current situation and more so, financial incentives to improve the demand side. The sector like many other sectors, is very much dependent on the growth in economy and overall business sentiment.