“Office space absorption may decrease by 30-50% for 2021, with rents to see marginal decline”

Chintan Patel, Partner and Leader – Building, Construction and Real Estate, KPMG in India, contends that commercial realty/office space sector will witness short term disruptions, especially with social distancing and the rise of the work-from-home (WFH) phenomenon. He adds that it will be difficult to make reasonable projections for recovery before the last quarter of 2020 or till a vaccine is found.

Chintan Patel

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

Chintan Patel: Unlike other businesses, which are related to discretionary spends, be it malls, retail stores, restaurants, gyms, clubs – offices are different. Offices are an integral part of the economy, so there is no question of them getting completely closed. There will now be material change from the way commercial offices operated in the past. Discussions are taking place between the tenants and landlords on how to reduce their occupancy costs. Various mechanisms are being considered – waivers, deferment, abatement, adjustment, etc.

The second point to consider, which will be a paradigm shift, is the entire work-from-home phenomenon. The margin of work-from-home is going to differ from organisation to organisation, sector-to-sector. There are companies doing 20-25% and at the same time, there are organisations that are planning for 70-75% of work-from-home (WFH). Whether this becomes a permanent phenomenon, that only time will tell. Definitely in the immediate future, we see WFH becoming a norm at least until a vaccine is available.

TPCI: How do we look at the scenario for commercial real estate which in 2019 had a record high absorption and growth in rent?

Chintan Patel: If you look at an estimate, 55-60 million sq ft of space got absorbed. Given that there will be a potential focus on managing the current business rather than growth, I think people will hold back from decisions pertaining to taking additional real estate space. Largely companies that have given commitments for space that could have been made in the pre-COVID-19 scenario, may take up new space. Experts project that there will be a decrease in absorption by 30-50% for the next year and the rent is expected to remain flat or decline marginally.

When it comes to hospitality, hotels are continuing to function, albeit at a very low occupancy level. My sense is when the lockdown ends and business starts coming back, especially the go to destinations or the local market where people can drive to for domestic leisure/business, will start to see some uptick happening. This will largely be in the 2/3 star category, followed by 4/5 star category. Last on the list will be the large convention centres/MICE hotels or your resort and leisure destinations that they have to fly to. 2020 will be a subdued year for hotels, but we see things starting to improve in the next 12-18 months.

This largely depends on whether a vaccine is found. Given the current situation, staying at a hotel will be more of a psychological decision as well. Until and unless people feel comfortable leaving their homes and staying in places, unless they believe that there can be in an environment that is completely sanitised or there is a vaccine, there can be no real uptick. But I see the urge of people to travel for leisure/business coming back in the medium to long term.

There are serious challenges on the restaurant front as the government is not allowing them to open. Once they do open fully, the entire question will be around social distancing. Time will tell whether you are able to open with 50 per cent of the seats or more, or if it will be less than 50%. The second aspect is how comfortable will people feel eating outside. Cases of cooking/delivering staff testing positive for COVID-19 has even scared people from ordering/take out from these restaurants. Even the larger restaurant chains are facing this problem. Unless, they are able to give complete confidence to their patrons that they are operating in a very hygienic environment, it will be difficult for people to trust them.

One of the things that I can see from malls and large restaurants chains is that they are asking their landlords to move from a fixed rental to a revenue sharing model to the extent possible. In times like this, at least they are not burdened with a fixed rental.

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?

Chintan Patel: Projects under construction face a two-pronged challenge. They have to be content with labour shortage as well as supply chain disruptions. So, the ability to procure steel, cement, tiles, electricals, fitouts, etc has been hampered. The constraints apply not only to their labour, but their suppliers’ labour as well. That is going to lead to a lot of delays in projects.

Hon’ble FM has proposed that this event be considered under the ambit of force majeure under RERA, which is largely for the residential sector where people have to abide by the RERA timelines that they have given. There is a potential suggestion to extend the period by 6 months. That is a good suggestion, but my sense is that we will need more than 6 months to get over the whole thing. Part of the problem with labour going back is also the timing issue. We are headed for the monsoons, so the labour that went back will look to stay there, do their farming. MNREGA is there to support as well.

As long as they return back post monsoon, this may not be much of a problem for real estate developers as it already slows down in the monsoon season, and new projects are anyways not getting launched.    

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?

Chintan Patel: A lot of landlords are looking at raising the safety and hygiene standards in a big way. They are looking to put up temperature readers, sanitiser showers, etc to ensure that the staff is coming in a sanitised environment. What may work in their favour is that while a lot of people will not be looking at growth, they will also not be looking at moving out. After spending so much in the fitouts, giving all that up and moving to a new location will be difficult without availability of labour or even supplies.

Second, is the entire social distancing phenomenon. While earlier, they were able to pack people tightly in the office space, they will not have the ability to do that anymore. If business comes back to normal with 100% attendance and social distancing norms are still prevalent, firms may have to consider increasing their office spaces. A lot of tenants are looking at how the entire balance of work-from-home and social distancing is going to play out in terms of space requirements.  

Offices cannot move to a revenue-sharing mechanism, unlike retail malls, because the businesses are very different. As far as I know, landlords are not looking at participating in the businesses of their tenant companies. They are discussing mechanisms across the table on how they can retain their tenants. On the other hand, the tenants are asking for possible relief mechanisms that can be deployed until their business comes back to normalcy. A lot of landlords have taken lease rental discounting, i.e. raised debt against the spaces that they have leased out. Today, if the tenants go back and ask for relief, landlords still have obligations to the banks. So, the degree of relief they can provide will vary from landlord to landlord. 

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?

Chintan Patel: Based on the conversations that we are having; co-working is going to face more challenges as compared to the traditional commercial offices. Employees are far more densely structured within co-working spaces. With the demand for social distancing, co-working may not be the most ideal model. Also, the model works on some kind of arbitrage between the tenant and the landlord. In coworking, the owner takes a larger space from the office landlord and sub-leases it to the tenant. So, if they cannot fit in the same amount of people that they could in the past, their economics starts looking a bit shaky.

Secondly, the leases are short term leases. For small/medium businesses and startups, which generally occupy these co-working spaces, I think that they will be facing a slightly more uphill challenge. When commitments are not high, these businesses may look for other options – they may try to bootstrap/work from home as opposed to paying rent. 

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?

Chintan Patel: Indeed, there are sectors that will be growing like e-commerce, pharmaceuticals, etc. Then there is the possibility of businesses relocating from China. But one has to note that most of the businesses moving from China will be industrial units and not taking much of office space.

Actually, office space will be largely in sectors like IT and BFSI. So, the actual recovery of office realty will be contingent on as and when the economy recovers. People talk about various scenarios, such as a V-shaped, U-shaped, W-shaped recovery, etc. Until, some of the traditional sectors like IT and BFSI will start consuming the same amount of space that they have done in the past, it will be difficult for the office sector to have the levels of absorption that were seen in 2019.

The quantum of work from home happening right now is actually a by-product of the entire COVID-19 scenario. People have learnt that work from home is not really a bad idea. In fact, it’s a win-win situation as a company is able to save expenses. It is not just a rent expense, but the other costs associated with operating an office including security, utilities, etc. Employees don’t have to commute every day. Today, the kind of commutes that people have gotten into, especially in urban areas, where you spend an hour and hour and a half commuting one way. If an employee can save that, there is an increase in productivity and the employee is able to spend more time with family members. This becomes even more feasible, if companies are able to provide the infrastructure from a tech and cyber standpoint like data security, internet connectivity etc. As economy opens up, this could be part of a new normal and people may come up with new innovations to support work from home. 

TPCI:  How do you envision the new normal for commercial real estate post-COVID-19, to adjust to customer demands? What efforts will be needed from industry and government to navigate this new normal?

Chintan Patel: There are different ways of looking at this. One is that companies could become more agile and decide for instance, that they are fine with just 20% of their staff working from home. That means they could potentially save 20% cost related to people. They can reinvest that amount in new technology, R&D, etc, that will help the company to grow. And if the company grows, it will require more people and more office space. Crystal gazing at the future is very difficult at the moment as new challenges emerge every day. I think it will take up to the last quarter of this year to understand the emerging scenarios and then see whether people want to stay with the new normal or move back to the way things were at the beginning of this year.

If a vaccine is developed, consumers will be more than ready to go back to what they have been missing over the months – restaurants, cinema halls, malls, travel, etc. They will also be more secure with the economy and job environment as compared to the present. So, in such a scenario, the whole demand cycle can easily come back.  

Chintan Patel is a Partner in KPMG and leads the ‘Building, Construction and Real Estate’ practice in India. Over the past 22 years, he has been providing advisory solutions to a cross-section of multinational clients (public and private entities) in evaluating risks and opportunities of their investments in real estate and hospitality projects. He has extensive sectoral understanding of the real estate market, both domestic and international, with vast experience across various asset classes including residential, commercial office, retail, hospitality, industrial, warehousing and data centres. He also has experience in assisting global funds, local funds, corporates and developers to perform financial, commercial and strategic evaluation on numerous real estate projects. He has also worked with various large private equity funds and assisted them in varied real estate transactions. He has also been advising clients on demand projections, optimum land use studies, financial feasibility assessments, project development strategies, business planning and financing strategies.

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Shyamkrishnan B
Shyamkrishnan B
1 year ago

What will happen to the exisiting office spaces? Maybe they will get converted to apartment complexes.

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