The introduction of draft guidelines for trading in REITs in India has allowed, for the first time, a tool to channel small savings into the Indian real estate sector. Several owners of income-generating properties are presently considering setting up REITs. While office assets have been popular assets to securitise worldwide, market dynamics in India currently suggest that the retail sector could be a beneficiary as well. Factors underpinning the potential success of REITs in retail include:

Low vacancy rates in Superior Grade[1] malls – During the past few years, developers reduced the supply of mall space in India because of rising vacancy rates following the economic slowdown. However, prior to that, developers had resorted to a breakneck pace of construction of malls in response to a spurt in organised retail business. Few developers had then realised the right ingredients for constructing a successful mall. Consequently, the overall vacancy rate today stands high at about 20% in retail malls across major Indian cities, while Superior Grade malls have vacancy rates averaging 10% only. Given that international retailers would prefer space in these malls, the shortage of quality space is evident, and this will be felt for some time.

Source: JLL Research

Opportunity for discounted asset purchases – For REITs to provide attractive yields, it is important they purchase assets at a reasonable price, which then fetch attractive rents. This is particularly important for retail, an asset type that is perceived as riskier due to the lower predictability of income. While upcoming Superior Grade malls will offer lucrative investment opportunities, some of the existing stock of poor quality malls could be up for sale at a discount. For instance, of Mumbai’s 65 existing retail malls, only 20 have the size that is suitable to securitise in a REIT, and of these, five or six could be considered distressed assets. These malls are underperforming primarily due to the financial distress of the developer, while other factors such as location, catchment area and retailers’ interest remain favourable. REITs may not want to consider malls that are strata sold, which is another major cause of mall underperformance.

Strengthening demand – Recent reports from hiring firms (on job prospects), automobile associations (car sales) and the central bank (home loan disbursals and reducing inflation) suggest consumer sentiment has been on the rise in the past few months. This is good news for organised retail and indicates a rise in consumer spending going forward.

Mall management – Compared to commercial buildings, whose tenants are relatively stable and share common facilities, management of retail malls is complex. Apart from catering to various brand categories, mall management also involves planning the right tenant mix, space optimisation and zoning, and constantly studying consumer shopping behaviour. There is a general sense that REITs would employ better mall management professionals and practices than the developer would, thus adding to the probability of their success.

Given the limited number of existing retail malls that fit the requirements, REITs that make a move fast would benefit, while other REITs would have to wait until new supply hits the market. In addition, the rising consumer and retailer sentiment will lure REITs into seeking these low-hanging opportunities.

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