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Commercial Real Estate: On the cusp of a rebound

Along expected lines, the Indian Commercial Real Estate (CRE) office market has seen a 15% YoY decline in 9MCY21 (Jan-Sep’21) net absorption at 11.5msf. However, with a 21% QoQ pick up in Q3CY21 net absorption to 4.3msf, green shoots have re-emerged with the improved pace of vaccinations across India, select corporates recalling employees to offices (footfalls at 20-25% of pre-Covid levels as of Oct’21) and gradual pick up in international travel. With India continuing to offer competitive rentals of ~1USD/psf/month in IT/ITeS driven markets of South India and NCR/Pune and robust hiring plans of domestic/MNC IT/ITeS companies, we expect this to result in pickup in office absorption from Jan’22 onwards. We remain bullish on office asset developers and reiterate our positive stance on DLF, Embassy REIT, Mindspace REIT, Brookfield India REIT and Brigade Enterprises. Key risk to our call is the emergence of a third Covid wave across India and USA/EU geographies which account for two-thirds of office absorption in India.

* Leasing sees QoQ pickup in Q3CY21: As per Cushman and Wakefield, Grade A net absorption across India’s top seven cities increased to 4.3msf in Q3CY21 (up 21% QoQ) as pre-committed spaces (pre-Covid) and few new leases drove demand. Commentary from REIT managers and other large office developers indicate that leasing discussions which were on hold owing to the second Covid wave have now been revived again with existing occupiers talking about potential expansion and tenants who were looking to surrender space earlier looking to retain and possibly expand space.

* Recovery on the cards from CY22E: While vacancy levels may remain flat in Q4CY21, we expect this trend to reverse from Q1CY22E (Jan’22 onwards) with the improved pace of vaccinations across India, select corporates recalling employees to offices and gradual pick up in international travel. Broad consensus is that 15-20% of employees may permanently Work from Office (WFO), 10-15% of employees may permanently Work from Home (WFH) while the balance 60-70% of employees may work under a hybrid model of mixing WFO with WFH. While the jury is out on the eventual outcome of the back to office plans of various corporates, we model for panIndia net absorption of 18.5msf in CY21 (11.5msf achieved in 9MCY21) and build in a recovery in CY22E with net absorption of 26.8msf

* REITs offer attractive yields of 6-9% over FY22-24E: We have factored in a fall in occupancy levels of 200-300bps for the REITs in FY22E but expect the same to reverse by the end of Q3FY22 (Dec’21) with a full-fledged recovery from FY23E. We expect the three REITs to offer distribution yields of 6-9% over FY22-24E along with 10-22% capital appreciation as per current target prices. While a rise in global interest rates is the key risk, cumulative potential returns of 18-26% provides adequate valuation cushion, in our view.

* India’s long term advantages remain as a high-quality office hub: While near-term news flow may be negative, our view is that the Indian office market retains many positives such as: 1) Limited number of 8-10 pan-India developers capable of building quality rental assets; 2) India remains one of the more affordable office markets in the world, with average rentals for Grade A office markets in peripheral/suburban micromarkets hovering around 1 USD/psf/month or Rs70-75/psf/month; 3) India leads in STEM (Science, Technology, Engineering, Mathematics) talent for technology assignments with over 2 million students graduating each year

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