Real Estate in India

Strong Foundations for Future Growth?

Overview

In a rapidly developing country like India, the investment opportunities in Real Estate has caught the eye of many Indians and foreign investors. As incomes rise, new properties are built and exciting new projects are being introduced, the real estate market has been gradually growing over the past few years. Although prices have not risen much in this time, plans by the government and other real estate giants seem to hold promise for the future of Indian Real Estate.

Some of the major investments in property across India comes from Non-Resident Indians (NRIs). Indian expatriates in other countries look to buy homes all over India to serve as holiday homes, retirement homes, etc. As more and more of these NRIs are looking for real estate investments in India, the industry has begun to grow and innovate, with new projects such as the “Smart City Mission” being introduced by the Ministry of Housing and Urban Affairs. In this article, I will be exploring Smart Cities and their potential for high return, high-rise and the development of office space, alongside Indian REITs available within the industry and potential risks and how we mitigate them.

Smart Cities

The Smart City Mission involves building Smart Cities in several states across India. So, what is a Smart City? According to the Ministry of Housing and Urban Affairs in India “The answer is, there is no universally accepted definition of a smart city. It means different things to different people.”[1] The simple explanation is that a Smart City is a mixed-use real estate project which is designed to act like a mini-city within a city. Smart Cities aim at developing the entire urban eco-system, which is represented by the four pillars of comprehensive development — institutional, physical, social and economic infrastructure. Smart Cities combine residential and commercial real estate to give the inhabitants an immersive experience of being in a city. New modern buildings and villas, coupled with malls, office spaces and sometimes even schools are just some of the numerous facilities these new projects have to offer, which has piqued the interest of many real estate investors across India.

The safety of living in a bubble, accompanied by the convenience of having a variety of facilities within a 10-minute walk has turned many heads towards these Smart Cities and has increased its promise as an investment opportunity. The Smart City mission is expected to drive economic growth and improve the quality of life of people by enabling local development and harnessing technology to create smart outcomes for citizens. It is a giant leap in tackling the challenges of rapid urbanization in India. For example, Smart cities try to tackle traffic congestion in a number of ways, including levying congestion charges or introducing electronic road pricing systems, which are smart tolls that vary according to traffic. As such, it may even aid in the growth of other real estate projects as other urban planners use this growth to innovate. Overall, the evolution of real estate in India is still ongoing, and Smart Cities are a milestone in this process. It is believed that these types of projects are likely to encourage and inspire other innovations in the industry, which could potentially lead to more safe investment opportunities. These projects not only pose as real estate investment opportunities, but the new technology being used in the construction of these as well as the potential sustainability of the whole project also provides different avenues of investments. For example, land prices in and around the locations of the proposed projects would surge and potential transportation links could emerge.[2]

High-rise offices and buildings

In addition to these Smart Cities, India has seen a large rise in office spaces and high-rise buildings. High rise buildings account for over 50% of 1816 new housing projects launched across 7 big cities[3] which has been seen as signifying a movement towards more traditional or western architecture. Moreover, despite a slowdown in economic growth, the absorption of commercial office space in the top six cities of the country grew 22% to a record 57.7 million square feet in 2019 compared to 47.3 million square feet in 2018[4]. According to consultancy firm Savills India’s report, the year 2020 is also expected to witness strong demand for quality office space, driven by expansion, consolidation and upgrades to an employee-centric workspace. It estimated that in 2020, the six cities — Delhi, Mumbai, Bengaluru, Pune, Hyderabad and Chennai — would absorb 61.2 million square feet of office space, showing a growth of around 6%[5]. In 2019, a surge of leasing activity by information technology companies backed a rise in the deal volume in India’s office space market. The country’s office leasing volume rose 27% year-on-year to an all-time high of 60.6million square feet in 2019[6]. At a time where the information technology sector and the banking sector are growing in India, the demand for these office spaces continues to rise and investors are looking to take advantage of this opportunity while they still can.

Amid this rise in the leasing of office spaces the residential market too showed resilience as the number of new residential units grew 25% to 112,150 units in the second half of 2019, with Mumbai, Pune and Bengaluru the states seeing the greatest growth.[7]According to a report based on data from eight cities — Mumbai, New Delhi, Bengaluru, Pune, Chennai, Hyderabad, Kolkata and Ahmedabad, Bengaluru clocked the highest jump in sales at 10%. Of the eight cities under coverage, only Mumbai and Pune saw a fall in yearly sales growth during the second half of the last year.[8] Further to this, Fitch Solutions (a subsidiary of Fitch Ratings), said that it expects the country’s residential and non-residential buildings sector to expand by 6.6% in 2020 in real terms[9]. They believe this will be driven by fiscal support and a continued focus by the government on providing affordable housing in urban areas. Along with government policies which support the housing market, there has been a forecast of heightened activity within the logistics, retail and industrial building sectors.

Real Estate Investment Trusts (REITs)

2019 also saw India’s first publicly listed REIT by Embassy Office Parks[10]. Backed by Blackstone Group LP, the REIT had a successful IPO after which it continued to boom. Although this may seem insignificant, there has been debate about whether this could lead to a potential rise in REITs in India. Embassy Office Parks’ successful offering could pave the path towards the rise of REITs. “The Embassy REIT is also paving way for how investors view real estate assets. In the next two years, we are expecting at least 5–6 more REIT offerings,” said Arjun Lall[11], partner at Cyril Amarchand Mangaldas, the law firm that was involved in the structuring of the REIT. Embassy REIT raised 420,300,000 USD earlier this year through listed non-convertible debentures maturing June 2022, with a yield to maturity of 9.4%[12].

But the question still stands: How will REITs help the real-estate sector in India? Currently, developers incur huge capital expenditure especially in Commercial Real Estate (CRE) on land, construction, interior fit-outs, etc. which remain locked, even after the asset is complete until it generates returns to break-even. Through REITs, the developers and private equity funds can exit from the completed asset, and focus on development activity, which has a different risk-return profile. This is possible as REITs improve liquidity in the sector and help attract investment from local and global investors, who prefer a recurring, safe and moderate yield income.

As the real estate sector in India continues to show growth, more people are turning towards REITs to manage their investment in the sector. Many heads of research are forecasting a “slew” of REIT IPOs to hit the market in 2020, which could potentially lead to more investment into real estate from foreign investors. [13] REITs act as an excellent portfolio diversifier that can help reduce overall portfolio risk and increase returns. As such, this development has turned the head of a lot of high net worth Indians who are looking for liquidity in their investments but have not had the opportunity to invest in an Indian REIT till now. Furthermore, the introduction of REITs means that smaller investors can now also get involved in the real estate investment scene. Any investor who has a ‘small appetite’ for investing in real estate in India can now think of investing in Grade A commercial real estate and consider adding real estate to their investment portfolios for a much lower amount than prior. The ease of investing in REITs, combined with the fast capital appreciation in the next few years through this investment has caught the eye of many investors, and the success of this REIT seems to be inspiring the emergence of others. There are many in India that believe that the entry of REITs is a step towards institutionalization of real estate assets in the country. Some of the dynamics that REITs would bring to the table such as regular updates, research coverage and mandatory valuations could lead the market to transparency. This, in turn, could help the Indian real estate market mature and become more professional in times to come.

Other real estate opportunities

India is a rapidly developing country, always coming up with new solutions and trying to keep up with the Western world in an attempt to satisfy its population of 1.3 billion. The sight of factories and manufacturing plants are nothing out of the ordinary for those who live in India. The growing manufacturing sector has led to a rise in opportunities in industrial real estate investments. In fact, warehousing stock has grown 25% year on year, and the total stock is expected to pass 375 million square feet by 2023[14]. Furthermore, foreign capital has been rising and the contributions of foreign investors have been, and are forecasted to remain, an integral part to the significant predicted growth of India’s logistics and warehousing sectors.

Potential issues and problems that could arise

With the sector seemingly booming, potential investors have started looking towards viable investment options in Indian real estate. Although it may look like an investment might bring you great returns, there is another side to the story. On a surface level, the aforementioned investments seem like the right idea for people who are trying to invest in Indian real estate and break into a new market. But there are other factors to consider when looking into a country like India. One of the main talking points when it comes to India in the present is its economic volatility and the potential effects the actions of Prime Minister Narendra Modi is going to have. With fears of backlash to many of his policies and strikes and protests, as a result, the implication on the real estate sector is uncertain. The political climate risks could further deter foreign investors from potential opportunities in India, which could drive the industry into decline.

The economic slowdown has not helped the sector either. It has led to a slowdown in the absorption rate of many new projects, as new launches have dropped by 10% on a year-on-year basis. In October to December of last year housing sales fell 9% across nine cities to 60,453 units due to the economic slowdown and liquidity crisis[15]. PropEquity (an online real estate and data analytics platform and a subsidiary of PE Analytics), reported that “Residential real estate continues to be an end-user driven market as ready to move-in or nearing completion properties are being preferred. Consumers are now looking for developers with excellent track records in terms of quality and execution.”[16]

The economic stagnation, combined with the illiquidity of many of the assets in the current market has made it difficult to judge where and when to invest. Some believe that now is the best time to invest, predicting that future growth may fuel greater returns. The main way to find the right investment is to ask yourself the question: are you buying the property for end-use or for investment? If the answer is end-use, now is the time to invest. “The residential market, specifically, is better placed this year as speculation-led investment activity has reduced significantly. Residential prices have remained stable in most cities over the past few years. Increased transparency in the market and eased investment norms has made the market more attractive for NRIs. Developers too are offering customized solutions for this segment by developing ‘smart’ homes with international appeal,” said Abhinav Joshi, head of research, CBRE India, a real estate consultant.[17] For investment purposes, commercial real estate may be a better option. A good commercial property can give an average rental yield of 6–10% against the current residential property rental yield of 1.5–3.5%.[18]

Another potential issue with the Indian real estate market is that many states have seen a fall in the number of home sales.

As home prices rise, and the economy slows down there has been less demand for homes. Nonetheless, there have also been states which have seen an increase in this category. “Home sales may see some improvement in the times to come with the Reserve Bank of India lowering repo rate to record low,” said PropTiger, an Indian real estate advisor.[19]Additionally, tax breaks and lower interest rates on home loans have been proposed and implemented (the effects of which are yet to be noticed), which will most definitely boost demand.

Conclusion

Overall, the real estate sector in India seems to be booming. However, the future seems dicey. With the wider implications of Modi’s policies unknown, and the extent of the economic slowdown and liquidity crisis uncertain, it is hard to predict what the future holds for the real estate sector in India. Regardless of these aspects, on a numbers basis the real estate sector in India seems to be rising. With commercial and residential real estate projects in India taking off and the absorption rates of these properties potentially rising, there is no doubt that foreign and local Indian investors alike will start looking for bigger and better opportunities within India. Nonetheless, house sales do continue to fall as house prices continue to rise. As new innovative ideas arise and developers begin to build up a reputation and track record, investment in the sector will seemingly grow. As India continues to develop and bigger and better projects start arising all over the country, there is no doubt that heads will be turned towards the opportunity of investing there. However, the sector will see its biggest gains once some of the smaller states start developing more modern infrastructure and the influence of the Western-style real estate continues to spread throughout the country. In conclusion, the real estate sector in India seems weak at this point in time amidst economic slowdown. Despite this, it has shown some resilience and promise and could potentially be an investment opportunity for the future as the industry continues to grow, adapt and expand.

Varun Anand is a Research Analyst for Alternatives at the London School of Economic’s Investment Research Group, reading Mathematics and Economics.

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