Perspectives on commercial real estate portfolio allocation in India

September 17, 2013 / By  

Many factors influence decisions about buying or leasing property. Real estate costs represent a significant business expense. Not only Fortune 500 companies but also mid and small-cap companies are undertaking portfolio reviews because they impact any future own versus lease decision. We look at some key factors for occupiers in their decision-making.

Flexibility: Two things are desirable for an occupier: first, taking advantage of the property cycle and second having assurance and comfort of critical functions not getting disturbed owing to end of lease tenures. This can be achieved by ensuring flexibility through a combination of owned and leased assets with specified allocations to ownership and short-term, medium-term and long-term leases. This type of allocation ensures that occupiers can vacate sites with near-term lease expirations at any time. Alternatively, some percentage of ownership acts as a hedge against increasing leasing costs.

Capital Allocation: It is important to separate the real estate capitalisation decision from the business unit site location decision. Often, business units are measured on a financial reporting basis and skewed towards an ownership preference based on the lower expense profile associated with a long depreciable life and the low or no cost of capital charge. A more efficient approach is to charge business units with a fair cost of capital on capital employed and apply a suitable depreciable life. In addition, occupiers also need to substantiate the following capital allocation implications:

  • Is there sufficient cash reserve on the balance sheet?
  • Is the short- and medium-term capital expenditure significant against reserves?
  • Is the hurdle rate higher than property yields?

Property Market Implication: Timing plays a vital role in an occupier’s decision to buy or lease. While cyclical lows in financial indicators of rents and capital values support owning or leasing of commercial assets, owning a property is typically for a longer holding period and the cyclical peak discourages buying and supports short-term leasing with renegotiation clauses. The occupier’s decision to occupy or lease is influenced by the following property market implications:

  • Is the micromarket susceptible to significant property cycle risks?
  • Are there significant environment management issues related to ownership?
  • Are there significant restrictive covenants applicable?

In the period from 2Q10 to 3Q11, India’s office real estate provided a strategic window of opportunity for both buying and leasing commercial real estate, with both rents and capital values at their cyclical lows. From 2010 to mid-2013, the country’s leasing and buying volumes together breached the 100 million sq ft mark, and this is forecast to cross 120 million sq ft by end 2013. Market conditions are likely to remain generally neutral in the short-term, although the latter part of 2013 is likely to see moderate increase in rents and capital values in select locations and further strengthening is expected post 2013. The Bangalore office market is expected to lead the recovery, followed by Mumbai and NCR-Delhi.

Moderately rising rents and capital values have given occupiers in India an unusually long window so far for decision-making, and with supply correction in place, this window will not be available for long. Hence occupiers must take their real estate decision sooner than later to ensure benefits of the current situation.

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