The Covid-19 pandemic has caused immediate disruption in the real estate industry. Let’s analyse each asset class in real estate and its short and medium-term outlook and strategies for investors.
The Covid-19 pandemic has caused real immediate disruption in the real estate industry. Everyone now talks about Work From Home (WFH) as if it was a standard nomenclature existing for years and its merits/advantages have suddenly been a talking point in almost every conversation concerning real estate. Let’s analyse each asset class in real estate and its short/medium-term outlook and strategies for the investors.
Office assets have been directly impacted by the WFH phenomenon. Offices are operating at low occupancy levels (in most cases even lower than the levels prescribed by the state governments). Corporate occupiers have been deferring/re-strategising expansion plans due to Covid-19. The proven efficacy of remote working will lead to a gradual recovery in demand for fresh leased office space. Occupiers, who are looking at expanding, will likely look at city fringe districts with lower rentals. While Bangalore is likely to remain one of the most sought-after office markets in Asia, Mumbai and NCR are likely to see muted growth.
Most investors are/will be building in more muted levels of rental growth projections/assume some stagnancy at current levels and cap rates for such assets are likely to be be negatively impacted by about 50-75 basis points in the current calendar year. This is to factor in uncertainty over vacancy and rentals. In the medium-term, however, we expect office assets to come back strongly though the impact would vary between cities. WFH, while becoming a norm for a certain percentage of the workforce for some occupiers, will not replace the office environment as we know of it. Young workforces and workplaces also need physical interaction – all of which don’t happen on Zoom and the like calls. Also, conservatism in space requirements would be offset by the larger employee footprints required to meet social distancing requirements, which would also trigger the shift for out of city center locations with lower rentals. These areas are likely to see better demand and less pressure on rentals.
Retail Assets, especially malls, have seen their models turned on their heads. With malls having shut down for 2-3 months and some re-opening now, footfalls are still muted in these cases and would inch up only gradually. Mall owners and occupiers have sat down and thrashed out new arrangements, ranging from rent waivers to a move to total revenue share models. Retail will see dips in revenues in 2020 and consequent to that, which will lead to lower rentals/revenue shares. This will definitely impact capital values in the short/medium term and investors would want a higher risk premium while acquiring these assets given the uncertainty around them. For investors, it is an opportunity to pick up marquee prime assets at values, which could have been unthinkable pre-Covid-19.
Hotels are another asset class, which have been badly impacted with hotels in most cities still in a state of lockdown and they (in some cases) being used as Covid-19 quarantine facilities. Occupancy is expected to be extremely muted in 2020. There would be pressure on capital values in hotel assets (because of the higher risk premium attached) and more so because a lot of these are leveraged to the hilt in India. However, history in Asia has shown us that hotels rebound very strongly after a crisis and if we are able to restrict and see off the worst of Covid-19 in 2020, we could see a strong recovery in 2021. In the short and medium term, there would be pressure on the hotel owners to liquidate assets – where they are weighed down by severe borrowings on the asset, and hence the opportunity for the investors to look at very reasonable valuations and gain from a possible rebound in 2021.
Warehousing/Industrial is an asset class that has actually bucked the trend and continues to see strong activity. We expect to see e-commerce/3PL (3rd Party Logistics) players continue to expand and there will now be focus on setting up (within city limits) fulfilment centres of specialised types of goods in the cities apart from the normal large facilities set up outside city limits. We also expect data centres to proliferate to comply with the Government of India norms on data storage (for financial services and some select services) in the country. There will continue to be frentic deal making here and these segments would continue to see strong investor interest, with leasing rates/cap rates/capital values remaining strong.
The residential sector has been trying to recover for the last 3 years and has been hard hit in the aftermath of Covid-19. Most buyers are preferring to wait and watch with other more pressing items like job security and cash flows on their minds. This has seen fresh sales coming down to a trickle. However, one fact of the lockdown post Covid-19 was the easy embrace of WFH for most employees. This, however, came with its own set of challenges – lack of an availability of space to do the frequent Zoom/Video calls that everyone became accustomed to. We would likely see interest emerging starting September-October‘20 with a lot of decisions being centred around upsizing/moving closer to work as WFH got us spoilt with the commute from our bedrooms to our living rooms. Residential classes like affordable units would continue to see strong demand also emerging after the current hiatus. For investors, there are opportunities to pick up bulk inventory at discounted rates and then sell these over the next 2-3 years as demand/prices firm up compared to the washout of 2020.
The new growth segments of co-working and co-living/student housing should fare differently in the short and medium term. Co-working workspaces will face short to medium term challenges given that they are open workspaces (designed for communal interaction) and they have a large number of users with very short term (monthly) rental agreements – which makes stickiness an issue. They would actually need to remodel their layouts to ensure that social distancing norms can be safely adhered to. Co-living and student housing should gain in the medium term as people start paying a premium to stay in such facilities which accord a high level of safety, hygiene and technology aided processes. There could, however, be a move from sharing accommodation to single rooms. Investments should continue to find their way in the co-living/student housing segment.
(By Gagan Randev, National Director, Capital Markets and Investment Services at Colliers International India)