Building blocks: The Indian real estate sector is witnessing an eased investor environment in 2017
NEW DELHI: In 2016, India’s real estate industry witnessed enhanced level of investment activity concentrated in the office, residential and retail sectors. At the same time, investors showed interest in the warehousing and hospitality sectors as well. The past year was also particularly positive from an investment regulatory perspective, with initiatives such as RERA, Easing of FDI norms, demonetization, andREITguidelines –all expected to increase transparency and enhance consumer and investor confidence in the real estate sector.
This coupled with the fact that asset valuations are at their most attractive levels is resulting in a renewed interest from offshore equity investors, large Indian corporates and HNIs who feel that finally the industry has reached a level playing field, offering attractive returns. This sentiment was further endorsed by a cyclical decline in interest rates in 2016, which has reduced the cost of doing business for all investor classes. Even ‘structured debt’ has evolved from being a “high- cost source of funding” to being a very viable source of funding with successive interest rate cuts.
The following sections highlights the investment outlook for each real estate segment in 2017: With a strong thrust provided to affordable housing in the Union Budget, we are seeing an increase in demand from end users in this segment. In the second half of 2017, we expect to see the supply side also strengthen as more private players foray into the segment. With the government also introducing meas- ures to ease taxation for residential real estate as a whole, including reduction in the holding time for long term capital gains, we expect to see easier monetization of historically-held assets.
The combined effect of the various policy initiatives is expected to result in an improvement in corporate governance which in turn will attract more equity investors.
While investors continue to invest in completed assets, a key trend has been the focus on development equity. Leading private equity players have been raising funds for greenfield projects, a trend that we expect will pick up pace this year as well. Also, developers are particularly keen on the commercial segment and have been displaying increased interest in commercial projects. This is not without reason as in 2017, the office sector is likely to maintain its growth momentum with an anticipated absorption of 40 million sq. ft. With the availability of well leased assets across core locations, private equity funding in these assets is likely to continue. Going forward, we expect a slight compression in rental yields in the short term, however despite the compression, core assets will continue to remain attractive for investors.
The retail landscape in India witnessed a significant rise in private equity investments by foreign funds in 2016. Given the stable economic and political environment, active leasing by retailers, and rising consumer demand; the investor community continues to remain bullish about India’s retail real estate landscape. As the launch of REITs gets closer, we expect to witness a greater interest of private equity players in core retail assets. With a supply pipeline of almost 7 million sq. ft. of quality retail expected in 2017, we hope to see more investments/buyouts going forward. With global as well as domestic e-commerce players looking to take up big box, quality spaces, and private equity players wanting to partner with local developers to invest in the segment, the current scarcity of quality warehousing space across the country has been a key challenge. With GST to be implemented from July, 1, 2017, India’s warehousing sector will move towards amoresystematic mode of operation, thereby providing the necessary confidence for investors to re-look at the segment. In the long run we can expect the inflow of institutional funding and formal sources of capital. We also expect that with the emergence of local and national players in the warehousing segment; deployment of capital in these fewer, better quality assets is likely to become easier. While some may argue that reform may prove to be detrimental for the smaller players, in our opinion it is likely to allow the smaller players to develop better quality assets or enter into joint ventures with larger players.
During 2017 and beyond the key drivers for the investments market in India will continue to be attractive asset valuations, improving transparency, improvement in quality of assets, rationalized cost of structured debt and consolidation of developers. We expect to see an interest of patient capital from large sovereign and foreign institutional players. The policy thrust of the government in 2016 to ease the funding andoperating environment in the country is expected to work in favour of spurring organized sources of capital into real estate in the long term.
RERA will play a fundamental role in determining the economic framework of demand and supply in the real estate industry. Supply will reduce because developers will now launch only those projects which they are likely to complete within the promised timeframe. (Post RERA, the penalty for time over-runs by developers are huge.) Demand will remain robust but witness a redistribution. Since risk on residential investments will be mitigated, so will reward. This is why we will witness the incidence of high risk- high returns investors thinning down on the ground. Investors will also be low-key because they need to see increase in prices accompanying increase in sales - something they have not witnessed of late.
Instead, there will be more end-users in the market, as consumers’ confidence in developers is a critical component of market sentiment and these are the primary beneficiaries of greater transparency.
These end users will largely hail from the middle-income and low-income categories who will look closely at affordable housing.
Apart from the demand and supply dynamics, the holding cost for developers is likely to go up. Essentially, no new projects can now be launched before all approvals are in place. The window of price escalation between ‘pre-launch’ and ‘official launch’ which was earlier available to developers is now shut. This additional holding cost will potentially be passed on to buyers, adding to their overall cost of purchase.
The cost of land will go up within city limits as post demonetization, there will be no leeway for diversion of surplus cash from other businesses towards purchase of land. The force- fed transparency post RERA will further make it necessary for developers to use legal funds to purchase land. This will add to their overall input costs and therefore lead to increased end product prices.
On the positive side, end-user demand is stable and some recent reductions in home loan rates by banks will see that the trend continues.
Overall, we anticipate a marginal upward increase in pricing for residential units in a market backed by genuine buyers and a lower yet predictable and good quality supply pipeline.
DEVELOPERS HAVE BEEN DISPLAYING INCREASED INTEREST IN COMMERCIAL PROJECTS
The retail landscape in India witnessed a significant rise in private equity investments by foreign funds in 2016