India

Office market shows signs of revival in India, strengthened by global business interest

Synopsis

Demand for Grade-A office space in India has risen sharply, with leasing activity reaching 84.1 million square feet in FY24, up 7% from previous years. Global Capability Centers (GCCs) are driving this surge, leasing 22.5 million square feet as of FY24, with projections to hit 40-45 million square feet by 2025. Despite initial challenges, including a 14.5% vacancy rate and increasing office space supply, Real Estate Investment Trusts (REITs) remain optimistic, aiming for over 90% occupancy in their portfolios. Analysts foresee potential growth, buoyed by a recovering IT sector and government policies favoring commercial space conversions from SEZs.

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Demand for high-quality office space, known as Grade-A, is on the rise, with leasing activity increasing by 7% to 84.1 million square feet (msf) in FY24 according to Propstack data compiled by Kotak Institutional Equities. This is a significant improvement considering the decline witnessed in previous years.

A key factor in this revival is the growing interest from Global Capability Centers (GCCs). These are back-office operations and research & development centers set up by foreign companies in India. India's cost-effective commercial spaces, with Grade-A office rents averaging around INR 220 per square foot per month in Bengaluru, and skilled workforce are attracting these GCCs. This is reflected in a 17% increase in office space leasing by GCCs in FY24, reaching 22.5 msf, according to property consultant CBRE South Asia Pvt. Ltd. This trend is expected to continue, with leasing by GCCs projected to reach 40-45 msf between 2024 and 2025.

While the IT sector, a traditional driver of office space demand, has seen a slowdown, this trend is expected to reverse. Many large IT companies are encouraging employees to return to offices, which will likely lead to renewed demand for office space.

This rise in leasing activity, coupled with a government decision in December 2023 to allow conversion of vacant special economic zone (SEZ) areas into regular commercial spaces, is expected to bring down vacancy levels in office buildings. Currently, vacancy levels sit at 14.5%, down from 14.7% in the previous year. This is positive for REITs, which manage large portfolios of office properties, as higher occupancy rates translate to increased revenue.

REIT managers are optimistic about the future and are aiming for occupancy rates of over 90% in their office assets by the end of the next financial year. Currently, most REITs have occupancy rates between 82% and 89%. To achieve this ambitious target, REITs are expanding their portfolios. However, this expansion comes with a potential increase in net debt. Analysts at Nuvama Research highlight that net debt to Gross Asset Value (GAV) is a key metric to watch, and currently sits below the regulatory cap of 49% for all REITs.

Despite the positive outlook, there are still challenges. New office space supply is increasing, with 47.5 msf added in FY24, up 14% year-on-year. It may take some time for demand to catch up with supply, keeping rental prices from rising significantly in the near future. Additionally, borrowing costs for REITs remain high at around 8.5%. However, a potential interest-rate cut over the next year could benefit these companies.

Overall, the Indian office market is showing signs of recovery, driven by demand from GCCs and a potential return of the IT sector. This is positive news for REITs and investors looking for opportunities in the Indian commercial real estate sector, with the caveat that challenges remain in the form of new supply and financing costs.

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