It's dull at the office- Business News
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It's dull at the office

The commercial real estate market is in the doldrums, thanks to a huge supply overhang.

  • December 16, 2010  
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There's nothing commercial about it these days. If you think demand for residential property is sombre, the market for commercial (and retail) spaces is in the doldrums. There is no dearth of new projects, but they are finding few takers. And that has got developers like Mayur Shah, 48, Managing Director of the Mumbai-based Marathon Group, in a blue funk.

"Historically, commercial properties have fetched 1.25-1.50 times higher prices than residential," says Shah. But it's a different story in Lower Parel in central Mumbai at Shah's premium commercial project, Marathon NextGen Innova. Prices here range between Rs 18,000 and Rs 22,000 per sq. ft. Shah points out that residential prices in this area are higher, in the Rs 30,000-35,000 per sq. ft bracket. Roughly, 30 per cent of Marathon's projects are commercial.

The grim scenario is not restricted to the country's financial capital. Elsewhere, too, in key commercial real estate markets, lease rentals are witnessing little appreciation (lease rentals make up for 95 per cent of the commercial and retail segment, with just five per cent coming from outright sales). Whilst rentals are flat in the National Capital Region and Mumbai, they've inched up in some other metros, but at a slower rate than in the residential market.

Supply, meantime, shows no signs of letting up. According to Knight Frank, a Mumbai-headquartered real estate consultancy, by the end of 2011, 183.1 million sq. ft of Grade A office space will enter the seven major cities in India. Demand for such property, however, is estimated to lag at 146.5 million sq. ft. "There is an oversupply in all major markets," says Prakrut Mehta, National Director, Office and Industrial Agency, Knight Frank India.

Another study, by Jones Lang LaSalle Meghraj, a real estate services firm, reveals that demand has lagged supply in 2008 and 2009, and that trend is expected to continue in the current year, as well as the next (see Oversupply Ahead). In 2009, absorption of new projects was roughly half of total supply in the market, and that figure isn't going to change much in 2010.

"The potential supply is huge, which is putting strain on prices and rentals," says Prakash Kalothia, CEO & MD, Sun-Apollo Real Estate Advisors, a real estate-focussed private equity fund based in Mumbai. Kalothia is of the opinion that the information technology (IT) story in India was oversold. Commercial inventory built up over 2006-2008 for the IT sector is in the range of 30,000-35,000 sq. ft, although current demand for properties is for under 20,000 sq. ft. "It will take time for this supply to get exhausted," says Kalothia. The growth rates predicted for the IT industry have tapered down and therefore the supply that was created based on those predictions has led to a massive overhang.

Alarmed by this, some developers have already shifted into go-slow mode. Nayan Shah, President for Operations at the Neptune Group, points out that no commercial project has kicked off in Mumbai in the last one year. He is of the view that this may create a reverse problem in the medium term - that of undersupply - as it takes three years for a commercial project to be completed. "Two years hence, no fresh project will be available for possession," says Shah. He may have a point.

The Jones Lang LaSalle study (see Oversupply Ahead) expects demand-supply to even out by 2012. That many commercial projects are being converted into residential ones may also help demand catch up with supply. The good news for developers is that prices can't go down from here. "The only way is up, although it won't be a substantial rise," says Shah of Neptune. He expects pricing power to return in two-three years, "but that's only if demand picks up now". For those looking for a good deal on commercial space, there may be no better time than now.