Reason for report: Thematic
* Delayed supply hits Q1CY18 net absorption, expect recovery in H2CY18E: The Indian office market clocked Grade A net absorption of just 4.4msf in Q1FY18 (down 16% YoY) across 7 tier I cities owing to delay in addition of fresh supply which stood at just 4.2msf for the quarter. This fall in absorption is optical and is similar to the trend seen in CY17 where pan-India net absorption was ~24msf owing to a corresponding fall in incremental supply in CY17 which stood at 23.5msf vs. completion of over 30msf annually over CY14-16. We expect net absorption to pick up significantly in the balance portion of CY18 as a lot of pre-leased supply hits the market. With significant pre-committed supply across Bengaluru, Hyderabad and Pune expected to be completed in CY18-19E, we expect pan-India net absorption levels to trend in the 28- 29msf level over the same period. We expect Global In-House Captives (GICs) and co-working spaces to continue to be strong drivers of demand over this period. The micro-markets of Sarjapur (Outer Ring Road) in Bengaluru, Madhapur in Hyderabad and Gurugram’s Central Business District (CBD) remain the strongest micro-markets in terms of demand-supply dynamics across India.
* Institutional capital continues to chase high quality Grade A office assets: Our argument of select office/mall developers in India being able to attract global institutional capital has played out with the promoter stake sale in DLF’s rental SPV to GIC Singapore being concluded in Q4CY17 and Phoenix Mills also diluting up to 49% stake in its Bengaluru mall SPV to the Canadian Pension Plan Investment Board (CPPIB) to build new malls. We expect further news flow in CY18 on this front with the management of Prestige Estates Projects having communicated that the company is in final stages of discussion with GIC Singapore to dilute stake in its annuity asset portfolio. .
* Prefer players with strong annuity asset portfolio: We prefer developers with a strong operational rental asset portfolio with reasonable debt levels and/or presence in mid-income housing. DLF (BUY), Prestige Estates Projects (BUY), Brigade Enterprises (BUY) and The Phoenix Mills (BUY) are our top picks in this segment. A ready portfolio of operational assets coupled with the ability to undertake capex for new annuity assets through access to institutional capital remains our key investment argument for these companies.
* CY18 may see the launch of Indian REITs: While the initial rules for formation of Indian Real Estate Investment Trusts (REITs) were formulated over 3 years ago, India is yet to see its first REIT listing owing to a number of procedural delays on the regulation and taxation front. However, we believe that with most of these issues now being sorted out, India may see its first REIT listing in CY18E. With REITs having the ability to deliver double digit returns through a mix of dividend yield and capital appreciation as office assets are perpetual assets, India’s current Grade A office stock of 454msf presents a large opportunity for developers and investors.
* Quality malls seeing uptick in rentals with higher mix of F&B/entertainment: Apart from Grade A offices, select malls have seen renewed traction in footfalls and consumption post demonetisation and have also shaken off the threat posed by online retail by incorporating a higher mix of Food & Beverage, entertainment options (multiplexes/gaming) and premium apparel stores such as H&M and Zara.
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