At a time when the worst for commercial real estate seems to be ver and recovery is visible, it is
important to examine how it will come about and analyse what this means for the future. For several stakeholders, it is about understanding the changes in the structure and composition of the market, and how they can fine-tune their business models to ensure their long-term survival and growth. This study by DTZ International Property Advisers, a global real estate advisor, reviews the last twelve months’ performance of commercial real estate markets across six cities (Delhi NCR, Mumbai, Bengaluru, Kolkata, Pune and Chennai) and compares the performance with the estimates made in November 2008. This report aims at predicting the recovery path and key drivers for each market. Though macroeconomic conditions have improved from the trough at the beginning of the year, revival is still some time away for most of the cities. This is expected to make the next five quarters challenging and decisive for the industry.

Delhi NCR
Marred by a liquidity crunch, slackening demand, piling inventory and falling rentals for over a year now, the Delhi NCR real estate market breathed a sigh of relief with visible signs of recovery towards the third quarter of 2009. Many under-construction projects were rolled over to subsequent quarters with negligible project launches from mainstream developers. Supply rationalisation was faster than expected, with the actual market supply of 12 million sq ft recorded over the last four quarters falling 25 per cent short of the adjusted supply estimate (2008) of 16 million sq ft. Stock levels went up to 52 million sq ft by the end of Q3 2009. Gurgaon accounts for a substantial 60 per cent, with Noida accounting for 30 per cent (increasing its market share by 5 percentage points year-on-year) of total Grade A office space. Upcoming markets like Faridabad, Greater Noida and IMT Manesar failed to attract any visible interest by occupiers, as rentals in prime micro-markets (Cyber City, MG/Golf Course Road, Noida Expressway, Noida Sector 62) eased substantially.

Absorption recorded at 3.6 million sq ft during the last four quarters was nearly 45 per cent lower year-on-year with a definite rise in occupational queries during the third quarter of 2009. Vacancy levels increasedupwards of 40 per cent, the highest among all seven key real estate markets in India. As a result, downward price pressure continued to remain high. Quoted prices corrected up to 25 per cent year-on-year across micro-markets, with negotiations occurring at further discounted rates.

Market recovery
The Delhi NCR market is likely to record healthier absorption levels towards the second half of 2010. DTZ estimates cumulative absorption of nearly 7 million sq ft in the next five quarters until Q4 2010.

A supply of 17 million sq ft is estimated to come up during this period, as against the announced supply of 23 million sq ft. At this pace of absorption, together with supply estimates, it will take another six months for the city to reach its threshold vacancy level, estimated at 46 per cent by Q2 2010, before it starts descending. As a result, the downward price pressures will continue to remain high until this period.

Recovery Path
At current rents, most of the market activity in 2010 will concentrate towards the prime micro-markets in peripheral business district (PBD) locations (NH 8/Cyber City, MG/Golf Course/Sohna Road, Noida Expressway, Noida Sector 62), while upcoming locations like Greater Noida, Faridabad and IMT Manesar are unlikely to attract active interest. However, these locations might pull companies for captive campus developments, setting up their campus facilities in Greater Noida. Although the growth in the vacancy level is likely to subside after reaching its threshold, it will continue to remain significantly high, preventing rents from strengthening. At best, rentals will stabilise after a marginal correction during the current quarter.

Mumbai
The last four quarters (Q4 2008–Q3 2009) have exceeded expectations as the city has been resilient in terms of absorption and optimistic in terms of supply. The market added nearly 14 million sq ft which was 40 per cent more than the adjusted supply estimate. This happened because developers were bullish and chose to complete under-construction projects rather than halt work. Of this new supply, 70 per cent came up in the PBD micro-markets of Thane, Navi Mumbai and LBS Marg; while the other micro-markets of Lower Parel, the Bandra-Kurla Complex (BKC) and Andheri-Kurla contributed 10 per cent each. As a result of the new supply being above expectations, the current stock went up to 48 million sq ft against an expected level of nearly 44 million sq ft, over 50 per cent of which was accounted for by peripheral locations. The cumulative absorption between Q4 2008 to Q3 2009 was 3.7 million sq ft comprising largely IT-ITES and Banking, Financial Services and Insurance (BFSI). This level was 25 per cent lower on a year-onyear basis. The combination of higher than expected supply and absorption levels has ensured that the vacancy levels in Q3 2009 touched 29 per cent as estimated by DTZ. The towering vacancy levels saw rents correct across all micro-markets ranging from 25–40 per cent, with Lower Parel and Andheri-Kurla being the worst affected.

Market Recovery
Going by the levels of space enquiries floating in the market, absorption is expected to revive in Q2 2010. The level of absorption is likely to stand at 5.5 million sq ft during the next five quarters until Q4 2010. It is expected to steadily increase during the second half of 2010 with supply estimates of 15 million sq ft during the same period, as against the 20 million sq ft supply according to developer announcements. The rentals in most micro-markets are expected to be stable in 2010 and may see some marginal upward movement towards the end of the year as the vacancy pressure begins to ease.

Recovery Path
BFSI and both front and back office functions in the ITES sector are likely to be at the forefront of absorption across all micro-markets. Other significant contributions will be from professional services and the manufacturing sector, particularly pharma and FMCG. Among the front office micro-markets, BKC is emerging as the preferred choice for BFSI and manufacturing companies looking for space. This trend, combined with the fact that less than 1 million sq ft of new supply is expected in this micro-market by 2010 is likely to give an upward push to rentals in this sub-market. Lower Parel and Worli are high on the wish lists of BFSIs. However, the central business district (CBD) will continue to be in demand with the BFSI segment as long as key institutions like the Reserve Bank of India and the Bombay Stock Exchange remain a part of it. Among other sub-markets, the Andheri-Kurla area and the Western Express Highway are likely to see stability through most of the year, with some upward movement towards the end of 2010.

Bengaluru
As the IT-ITES sector showed signs of improved growth rates post-recession, Bengaluru’s derived office demand promised revival. The city witnessed a large supply build-up, with a recorded addition of nearly 11 million sq ft during the last four quarters, almost in line with the adjusted supply estimate (2008) of nearly 10 million sq ft, raising the current stock to 76 million sq ft. More than 50 per cent of the new supply came up in the PBD-Outer Ring Road (ORR) region, resulting in nearly 60 per cent new supply concentration across the PBD regions. As the market showed signs of bottoming out in Q2 2009, absorption, which had fallen in the previous two quarters (Q4 2008 and Q1 2009), gained momentum in the latter half of the year closing higher than expected. The result of this demand-supply mismatch was manifested in the form of rising vacancies, which increased from 15 per cent in Q4 2008 to 23 per cent by Q3 2009. As a result, rentals corrected up to 25 per cent year-on-year across micro-markets and are still showing signs of weakening in the PBD region.



Market Recovery
Based on the enquiries floating in the market, Bengaluru is expected to show visible absorption revival from Q2 2010 onwards. Absorption levels, which have started to stabilise ever since Q2 2009, are estimated to remain healthy at 8 million sq ft over the next five quarters. This compares well with the supply estimates of nearly 9 million sq ft during the period, against 11 million sq ft as per developer announcements. At this pace of absorption, together with the supply estimates, the vacancy level is expected to reach its threshold of 26 per cent by Q1 2010 before getting some respite. This is likely to be a point of inflexion from whence the vacancy level will start to descend and price pressure will ease out. Despite falling vacancy levels in the second half of next year, a rent increase is unlikely given the high level of absolute vacant stock in the city.

Recovery Path
The market demand for Built-to-Suit (BTS) space and pre-commitments for large spaces from IT-ITES companies would continue to be the main driver of demand, however a noticeable number of enquiries from small to medium sized IT companies looking to expand will drive demand for mid-sized floor plates. A sizable amount of absorption activity is expected to be concentrated towards the PBD of ORR during the whole of next year, with some activity picking up in Whitefield, especially from the expansion of the companies already located there. Activity in South Bengaluru is likely to remain sluggish on account of improving growth in North Bengaluru. Rentals are likely to stabilise through the whole of 2010, with a marginal correction in the PBD region during the current quarter. Secondary business district (SBD) may be the only micro-market to see rentals strengthening towards the second half of 2010 due to low vacancy levels coupled with the consistent demand for space.

Kolkata
The Kolkata market started to look up much earlier than expected during the market slowdown. Construction activity remained slow through most of the 2008, as many under-construction projects were halted or stalled with civil structures standing ready for want of tenants. The actual market supply, recorded at 3 million sq ft, was nearly 40 per cent short of DTZ’s adjusted supply estimate (2008) of 5 million sq ft for the period. Stock levels went up to 13 million sq ft by the end of the last quarter, out of which PBD locations accounted for a sizable 80 per cent (Salt Lake Sector V and Rajarhat accounting for 46 per cent and 33 per cent respectively). The rental gap between the two locations was reduced.

The cumulative absorption level for the last four quarters was recorded at a little over 0.6 million sq ft, nearly 45 per cent lower than the achievable market average. However, there has been a visible increase in activity since the second quarter of 2009. Absorption levels, which remained significantly low till the first quarter of 2009, recorded modest growth in the next two quarters of 2009, averaging 0.2 million sq ft quarter on quarter. Salt Lake accounted for nearly half of the total reported absorption, while Rajarhat accounted for 40 per cent of this volume. Some sizable deals were concluded in telecom and ITES space. Though it stood the lowest among all of the six cities, the surplus stock was sufficient to exert significant downward pressure on prices in a market characterised by a limited growth rate. Prices have nearly stabilised in the last quarter, after correcting up to 40 per cent year-on-year.

Market recovery
Absorption is likely to strengthen towards the second quarter of 2010. On the supply front, the market is gearing to add nearly 5 million sq ft by Q4 2010 (against the 6.4 million sq ft estimated by developer announcements). However, it is to be noted that the pace of speculative supply addition in Kolkata has traditionally fallen short of expectations, given the city’s limited capacity for absorption. At the current modest to healthy rate of absorption and estimated supply addition, vacancy levels in Kolkata are not likely to see a respite through 2010. This is expected to keep any price growth under check.
 

Recovery path
Telecom, IT-ITES and the manufacturing sector, which primarily consist of engineering companies, will continue to drive absorption volume in the region. Salt Lake and Rajarhat are likely to account for over 80 per cent of the absorption activity, with Salt Lake remaining more attractive at the current price differentials. Most of the demand in the region is likely to be created from expansion or relocation of occupiers from Grade B buildings in CBD locations to Grade A facilities in these locations. Prices are likely to stabilise going forward for over most of 2010, with a remote possibility of strengthening towards the last quarter of 2010.

Pune
Characterised by a speculative construction boom, Pune commercial real estate is now caught in a vicious oversupply trap and is yet to see the end of this recessionary phase. Despite plummeting demand and efforts by developers to delay or stall projects, supply in Pune kept up a scorching pace, adding 10 million sq ft over the past four quarters. More than 50 per cent of the stock is concentrated in the PBD region, distributed between the Eastern and Western Corridors largely in the form of Special Economic Zones (SEZs), and characterised by large IT-ITES spaces. The CBD and off-CBD regions occupy nearly 20 per cent of the stock and have a mix of constituents,  making them less dependent on IT-ITES fortunes.

The absorption levels, which were falling since the beginning of 2008, remained low during the last four quarters, averaging about 0.47 million sq ft per quarter. Two thirds of the absorption took place in the PBD region and the rest in the SBD. Most of this was due to relocations and renegotiations into empty spaces, with the market not witnessing any pre-commitments. The gross mismatch between supply and take-up was reflected in the vacancy, with levels reaching an all-time high of 34 per cent, concentrated largely in the PBD region (higher than 2008 estimates of 32 per cent). Rentals corrected by 25 per cent and 40 per cent in the SBD and PBD locations year-on-year. Transacted rentals in prime projects bottomed out to as low as Rs 26–28 per sq ft per month.

Market Recovery
The number and volume of floating queries in the market strongly indicate that absorption will remain subdued in the near future, hovering at less than 0.5 million per quarter over the next five quarters. Nearly 9 million sq ft is likely to be added by Q4 2010, as against 12 million sq ft predicted by developer announcements. At this pace of absorption, vacancy is expected to reach0 its threshold of 36 per cent by Q2 2010 and stay at this level till the end of 2010, sustaining the high pressure on rentals. Pune would have to wait at least a couple of quarters more for an upward turn in rentals and absorption levels.

Recovery Path
Largely dependent on the IT-ITES sector for creating demand, absorption will now be supported by professional services and incremental growth in IT, particularly in small sized IT companies. A lot of large IT-ITES players are relocating to captive buildings. This is increasing marketable supply in the market and is likely to further build pressure on rentals. Most of the activity in 2010 is likely to be concentrated in the eastern corridor, with surplus supply available in prime projects within the region at rock bottom rentals. A significant demand-supply mismatch in Pune warrants high pressure on rentals. However, with current prices nearing the development cost, these are unlikely to fall further and will remain stable during 2010.

Chennai
The past four quarters in Chennai have been subdued, with IT-ITES companies, which account for over two thirds of the city’s office space demand, cutting down on expansion plans. The actual supply stood at 7 million sq ft against the adjusted supply estimate (2008) of 6 million sq ft (2008). This shows that developers have adjusted supply in the city as a reaction to faltering absorption and falling rentals. Current stock levels went up to 38 million sq ft by the end of the third quarter of 2009. Most of the new supply which came up in the past year was concentrated in the PBD micro-markets, increasing the share of PBD in total stock to 65 per cent.

Recorded absorption of 2.3 million sq ft over the last four quarters was nearly 45 per cent lower year-on-year. The demand during the last four quarters was largely driven by IT-ITES companies, but the share was slightly lower than usual at 67 per cent. Encouraging signs were seen in the telecom sector (10 per cent), while the manufacturing sector (14 per cent) saw activity from electronics, oil and gas and pharmaceutical companies. Vacancy levels spiked up during Q4 2008 and Q1 2009 on account of faltering absorption and stabilised during the next couple of quarters as the market adjusted supply and witnessed an absorption pick-up during Q2 2009.

Market Recovery
Any recovery in the city would require IT-ITES to step up its expansion and leasing activity. Estimates say that the city can expect absorption of nearly 4 million sq ft till Q4 2010. The announced supply in the market for the next five quarters is over 13 million sq ft, while the adjusted supply is estimated at 10.5 million sq ft. At the estimated rate of absorption and supply addition, the vacancy levels in the city are expected to go up to 37 per cent over the next two quarters. Fom there, it is likely to witness a gradual descent during the last three quarters of 2010 on account of relatively higher absorption during 2010 and reduced new supply additions. Despite this increase in activity, price growth will be checked.

Recovery Path
The driving factor in the choice of office space is proving to be the low rentals in the SBD and PBD locations rather than the location itself. Ambattur, with its low prevailing rentals of Rs 15–20 per sq ft, is high on the list, followed by the Old Mahabalipuram Road (OMR) region. Both these sub-markets are likely to see a revival in terms of absorption during the year. Rentals in the CBD are expected to correct further by up to 10 per cent given the high levels of vacancy in the completed stock. The SBD too is likely to see further correction in the short term, while new demand is likely to help it stabilise during the second half of 2010. Upward rental movement from current levels is unlikely in any of the micro-markets during the whole of next year.

In a nutshell
After a turbulent 12–18 months, Indian commercial real estate markets are now on a recovery path. As the worst is now behind us, the downturn, a product of global recession that was worsened by local market inefficiencies, will now be remembered more for shaping a paradigm shift in the industry than merely bursting another asset bubble. Markets will now tend to witness a convergence from a speculative to a fundamental growth pattern, both from an occupier and developer point of view. Occupier expansion decisions are likely to be taken after much more intense scrutiny than before. The marketable space and variety of product formats, now available in surplus, provide an opportunity for occupiers to align their real estate requirements to actual (rather than the speculative) business needs. This would ensure that the phenomenon of pre-commitments, that previously created speculative market expectations, remain subdued in the near future. On the developer side, rationality is likely to prevail in investment and development decisions, guided by a deeper understanding of the industry growth potential and the real needs of potential occupiers, rather than just prevailing market sentiments. Furthermore, developers could respond to these occupier demands, not through aggregative behaviour across all products, but through customer-specific accommodation in terms of building structures and floor plate layouts that result in efficient space planning.

The market regularity of basing decisions on the assumption of a linear and secular growth in underlying demand would now shift in order to account for irregular (and sometimes sharper) business dimensions. This would require clear feedback mechanisms between tenants and their business departments, developers and industry, to help all parties understand the shifts in business models, sectoral focus and resultant real estate needs. For the sustainable growth of the Indian real estate industry, it would be imperative that the lessons of this downturn are accommodated in the business models of all stakeholders sooner rather than later.

By Priyankar Bhikshu, Head, Consulting and Research (India); Shveta Mahajan, Assistant Manager, Consulting and Research; Pradeep W Fernandes, Senior Associate, Consulting and Research; Rejish TC, Senior Associate, Consulting and Research and Bikramjeet Singh, Manager, Consulting and Research, DTZ International Property Advisers Pvt Ltd