Many landowners prefer to lease land for different types for commercial developments, rather than enter into JD/JV’s or outright sale agreements. Landowners receive 4% to 6% of the land market rate as the annual rent and they receive an annual rental escalation of between 3% and 5%; the agreed lease term varies between 20 years and 45 years based on type of development.
This is a more suitable option for landowners; however, this is not as suitable an option for developers nor investors.
This type of arrangement is generally preferred for prime CBD properties due to scarcity of land and high demand and therefore few developers opt for the same. As per our experience, the land-lease model for commercial development has the following attributes:
This type of arrangement works well if the developer is also the end user of the property. In many cases, the developer needs such property for self-use. In that case, the developer agrees for such arrangement if other land options are not available.
Many of the government owned properties offers a public-private-partnership (“PPP”) model, where the private investor (developer) needs to develop the property and enjoys leasehold rights for 30-50 years. But the response for such opportunity is limited owing to the above reasons and we find such properties poorly maintained in long term.
Therefore, we suggest, that a partnership model in which both parties have freehold property rights is best. This will motivate partners to work together for positive property value, benefiting both parties.
Investors buying one or more units in a commercial or residential development do need to consider the “UDS” component of the land that is associated with these units. The UDS evaluation is more important in respect to older properties which are in prime locations of the city as it is expected that older properties which are past their presumed economic life may be chosen for a redevelopment and then the residual value would reflect as the land valuation of the property, only.
Many times, older properties have not utilized their current available FSI, and in a few cases the available FSI associated with these older properties is lower when compared to the current as-built area. Therefore, it is important for an investor to do a computation, establishing the FSI available and the current as-built area; if the FSI available is higher than the current as- built area, then what must be reflected is the additional value of the property. However, UDS must not be confused with ‘exclusive use’ areas, that may be bought and sold and if properly identified, can be of substantial value to the seller.
In CBD areas of cities especially, many sellers value their properties considering the current market value of UDS and depreciated building value. Even though on a yield computation basis these properties are providing a rental yield of 5% or even less. Market transactions happen at a lower yield rate and associated UDS is often not considered and valued hence these yields are lower.
Therefore, for long-term investors the principle of UDS is an important parameter to consider while making the investment decision.
In last 2 years, plotted development has witnessed high absorption levels and most of the developers are having multiple projects across different growth corridors of the city. High interest of developers in this segment is owing to low development cost, shorter project cycle and higher margin compared to other residential products.
There are two terms which are widely used when it comes to understanding the profit for a plotted development – Gross Profit of the project and Return on Equity (RoE).
Gross profit (or, EBITA) of the residential project varies between 30% and 40% of the total project revenue. This band is similar for Joint Development Agreement (JDA) and own land (considering current land value).
Return on Equity (RoE) for a JDA project is 3X to 4X of the total equity infused over the period of 18 to 30 months. Generally, developer’s project equity for JDA projects is sum of deposits payable to landowners, due diligence expenses, transaction costs for JDA, approval expenses, initial designing fee and token advance to the contractor. Beyond these expenses are financed through bank finance (if required) and sales receivables.
RoE for own land projects is around 2X and here developer’s project equity includes land price in addition to the other costs indicated above.
Passionate real estate owners always are looking for creating a landmark project. It is comparatively easy to create a good project in established locations, but it is tricky to do the same in peripheral or emerging locations.
Based on our experience, we suggest property owners to develop real estate with low investments. These developments will not consume entire available FSI and life cycle of the structure may be only for a decade or so in compared to 60 years economic life of a typical real estate developments. The reason behind this is the location will be matured in next 10 years or so and then owner may intend to redevelop the entire property based on the market dynamics.
The owners need to pay more attention to the target audience, usage, story (development theme), branding and marketing of the project. The owners need to identify the target audience very carefully considering accessibility and motivation of the users. Like any other developments, usage is a dynamic factor. Most of the times it would be F&B, hospitality, or retail focused use. Finally, the story of development is very important in creating the brand of the property. Sometimes, people borrow theme from location, culture, local traditions, and other inspirations.
It is suggested owners to be directly involved in development from inception to operations for these developments. The owners need to keep higher branding & marketing budget in compared to other developments. Here, it is about creating a product not just real estate development.
The owners need to compute ROI considering cost of development only not adding land value to it. As owner can realize the land value once the location is matured. As mentioned earlier construction cost to be spend considering life cycle of 10 to 20 years. As per our experience, the ROI of these types of development over 20%. Generally, the breakeven is achieved between 2 and 5 years.
Flexibility, guaranteed returns, cashflow and protecting future generation’s interests
Real estate transactions are comparatively more tricky than financial transactions. Yes, in real estate transactions also, transaction value (or cost) is the key enabler but there are other factors for different stakeholders which drives decision. Aspects including regulations, financial capabilities and others are hygiene factors of any transactions and they have been considered satisfactory by involved parties.
Based on our experience we have understood most important factor for occupiers, investors, developers, and landowners which is equal if not more important compared to transaction value. Few times some stakeholders have other pressing issues but the below identified factors are true in over 80% of the cases.
Occupiers’ places commitment aspect in lease transaction of importance. They look for flexibility in lease transaction and negotiate heavily on lock-in period or other binding terms. For investor it is guaranteed returns and exit terms are important aspects other than transaction value. Therefore, debt or minimum guaranteed return in India are more market aligned compared to pure equity terms.
Property developers look for cashflow and business development aspiration in the transaction. Therefore, we witness more joint development with refundable deposit in land transactions. Whereas landowners always look for creating wealth for its future generations. They like commercial rent yielding assets more compared to development assets. Landowners always like to protect their family interest and financial freedom for future generations. Landowners are emotional about their property; it is not just a financial transaction for him. Also, here it is important to understand, landowners who have many properties tends to place importance to cash flows and business development as that of developers.
We have experienced in many transactions, involved stakeholders reaches over 90% of the consensus but are short of one or two points, if one understands the thinking patterns for the other stakeholder in a transaction, it helps to create a win – win scenario for two involved parties and results success in the transaction.
I have had an opportunity to work with many successful promoters/ decision makers of real estate development firms. It has always intrigued me on what aspects of development would these promoters focus on? I have observed a pattern among different decision makers on how and where they focus daily. Though there is no fixed formula, but similarities do exist.
There are multiple aspects in the real estate business that need attention – land, regulations, finance, design, construction, marketing & sales, and CRM.
Decision makers of larger & established organizations spend most time and focus on three subjects namely regulations, finance, and construction. Coming second are land acquisition, and marketing & sales. They do keep time for design and innovation subjects but in regular intervals. The choice signifies highest priority is given to the risk management followed by growth and innovation aspects of the business.
Decision makers of emerging organizations spend most of their time in growth aspects of the business namely land, product design, and capital. Followed by regulations and construction. But post achieving stabilization phase, they also start focusing likes of decision makers of established organizations. Having said, people management is a subject that promoters of small as well as large firms constantly work upon.
Therefore, risk management followed by growth and innovation is on the minds of our successful real estate decision makers.
Landowners with lands located in weekend getaway locations in proximity to Tier 1 cities reach out to us for partnership models for a resort development in these locations.
Joint development in resort development is not a feasible option considering land accounts for just 10% to 15% of the total development cost compared to a hotel in city where land value ranges between 30% and 45% of the total project cost. From the developer’s perspective it is better to invest in land and development both compared to hassles of JD model.
It is not recommended to develop resort on leased land considering initial capital infusion and regular upkeep maintenance charges of the property. It is suggested to have a freehold land purchased on an outright basis for resort developments.
Suitable partnership model for a resort development is Joint Venture. Here, two or more parties infuse capital for land and development; sharing ownership is decided based on capital and responsibilities undertaken by different partners. This model is also suitable for both operations and exit.
The partners can decide on suitable operational model: self/ franchise/ management contract based on their requirements.
Ascertain, Acknowledge, Adapt
What is the future of office? One of the most discussed topics, that has been discussed across various platforms since 2020. Media is shouting at its highest pitch that office leasing is back at brisk rate compared to last two years, which is partially true. However, it is important to understand the situation more objectively not just perception.
Office leasing in H1 2022 is high compared to the last two years when net absorption was less than 50% compared to that of 2019. Technology sector has been largest occupier. The sector has performed well since 2020 and has witnessed substantial hirings during 2020 – 22. Technology sector in the coming years is likely to continue its growth trajectory, however, the most optimistic projections for the year 2022 are lesser than net absorption during 2017 – 2019.
Is all unmet demand being back to market? I don’t think so. If we were not having WFH/hybrid workplace culture as a permanent solution by now companies would have signed for the spaces for workforce hired during pandemic. The hybrid workplace is the new normal and the current demand is mainly met by managed offices/ coworking space.
Currently, all the tech parks are having lower occupancy compared to pre-COVID levels. Despite COVID regulations easing up, employees have not returned to work 5 days a week. The new hires are specific on flexibility of workplace and companies are providing the same to attract the talent. The companies are fine with WFH or hybrid culture. In last two years, many large IT firms have retained their footprint even though none of them were using the space due to uncertainty on future strategy. In current phase, it is expected many IT firms will test their workplace strategy in real time and would take the decision for future.
Property owners and developers will have to be prudent on considering newer office developments. For an instance, if the property is in a micro-market suitable for corporate offices and non-IT Clients, outlook is stable whereas micro-markets with higher share of IT/IteS companies are likely to retain a WFH / Hybrid model. Future will be dominated by talent, and it is certain that technology will only improve going forward & workforce will only get younger. It crucial for the for the property owners, investors, or developers to strike a balance between changing behaviour of the workforce and requirements of the large occupiers.
HNIs and retail investors can consider investing in farmland around Tier 1 cities of India. This asset class can provide attractive returns. Yes, it is a long term (minimum holding period of 10 years) investment product but has attractiveness hard to be ignored.
So, why invest in farmlands?
First and the foremost benefit is access to fresh and healthy produce. Secondly, one can get involved in to farming and enjoy the rural environment. Also, it is an opportunity for the younger generation to learn about farming.
From the financial returns’ perspective, low investment quantum compared to other real estate product types. Second, estimated IRR for good location can be annual IRR in the range of 18% to 20% and in some cases over 40% if any major infrastructure project is announced in proximity to the farmland or change of land use permitting residential or industrial development in future. Third, low annual operating expenses, agricultural land has less annual property taxes compared to converted properties.
Flexible work schedules and increased prioritization on health coupled with quite a few states allowing purchase of agricultural lands by non-farmers are likely to push development of farmland projects in proximity to tier I cities.
It is an ideal time to have a farmland property or an agricultural land in one’s real estate investment portfolio.
Offering residential units within budget, convenience & more usage of space
In recent times, real estate market has witnessed entry of furnished apartments. Furnished apartments include offering plug and play residences. These are usually offered where in the project size exceeds 150 units and has smaller sized units - 300 sqft studio, 450 sqft 1BHK, 620 sqft 2BHK and 800 sqft 3 BHK.
In this product, developers are selling units with fixed but flexible furniture. The flexible furniture includes wardrobe, foldable dining table, sofa-cum-bed, kitchen cabinets, convertible study table and others. Most of this furniture is flexible and has multiple uses. The units are likely to have moveable walls along with flexible furniture, helping to serve different functions during the day and the night.
This product is well received by the buyers. The buyers with a budget less than INR 60L are evaluating standardized offering and are happy with plug and play apartments within their budget having latest design elements. The developer charges approximately INR 800 per sqft towards fit-out expenses and is reasonable from customer perspective as they end up spending more for this quality furniture.
Currently, developers are mostly using international vendors to support this type of product. But, as the market grows, Indian companies will be able to cater to this requirement. It is a good product offering for the developer not only from the profitability perspective, but it also improves their unit designing and overall project planning. As a lot of hydraulic systems are used, success and scalability of the product are dependent upon regular maintenance and quality of the product offered.
In coming 1 – 3-year horizon, this product type is likely to be restricted to smaller unit sizes and may see a penetration in built-to-rent projects.
An opportunity for current landlords and small development firms
Investment for land has increased substantially post outbreak of COVID-19. Demand for residential and agricultural plots has seen steep uptake in the recent past. This has resulted in many developers lining up launches of plotted development across major growth corridors of the city.
There is a sizeable demand for land priced between INR 3CR to INR 10 CR from UHNIs, HNIs and NRIs planning to buy few acres of land along major growth corridors of major cities. Investors want to hold these land parcel for long term (10 years and more) and either trade or do a joint development post holding period to unlock the value of the land. However, supply of such land parcels is limited.
This set of investors are comfortable paying 20% to 35% premium to the ongoing prices of large land parcels. Price of current supply of plotted and farmhouse developments are based on sqft basis. As developers of these developments need to add infrastructure development, amenities and land holding costs. The investors are looking for acquisition based on acre basis. Investors are looking for a land with road access with electrical, water supply and drainage infrastructure. They do not need any other amenities or infrastructure.
It is an opportunity landlords/ land aggregators holding lands. They can bifurcate large land into plots of small parcels. Landowners can also formulate a partnership with development partners & marketing agencies, required to cater this demand.
Retail investors keep asking us for options for investing in commercial properties. Most of them have typically same requirement: Grade A development, MNC Client, rental yield of 8% - 9%, good location, new property, long lock-in period and fit-out investment from tenant. Trust me, satisfying all these parameters is next to impossible.
Currently, pipe of good investment in commercial properties are limited. Few parameters of the above list and rental yield of 7.5% - 8.5% is a realistic expectation.
Our recommendation to the investors also includes evaluating investing in a greenfield commercial property located in good location and developer of repute. In these developments, investors can avail entry rental yield between 9% and 11% on investment. Yes, it has vacancy and development risks. But these risks can be mitigated through construction aligned payment terms, good selection of development partner and location.
Co-Living sector witnessed a lull immediately after the breakout of pandemic. H2 2020 until year end 2021 was an uncertain phase where the operators were extremely cautious in expansion strategies. With businesses returning to normalcy, operators are now considering expansion. A few changes that are witnessed across most of the co-living transactions are:
Occupancy levels in strategically located Co-Living facilities are back to pre-COVID-19 levels. A few facilities as of April 2022 are logging in an occupancy level of 85% - 90%. However, last one year witnessed closure of facilities that were facing low occupancy or management issues. The operational stock is estimated to have reduced by 15% as compared to March 2020. Property and bed rentals are poised to increase if the offices resume 5-day working offline.
With uncertainties, year 2021 witnessed largely revenue or profit sharing proposals. With colleges starting offline and people returning to work, Co-Living sector has witnessed traction as compared to what it was during the year 2020 – 2021. Asset owners (land owners) can now expect pure rental proposals from the Co-Living operators. The operators today are willing to discuss pure rental proposals while offering 3 month – 4 month rentals as security deposit. Brownfield developments in proximity to office clusters and colleges continue to be preferred over greenfield assets.
As an end user (occupier), one can expect reduction in the security deposit amount that is payable to the operator. Prior to March 2020, the end users were expected to pay 60 days – 90 days rentals as security deposit. As of now, end users are expected to pay a minimum amount equivalent to 30 day rentals.
Property owners and occupiers often ask the question - "how to assess lease rent for a vacant land?"
The fundamental question here that needs to be answered is "what is the income potential of the vacant land?". Sometimes it is easy to assess while many a times it is difficult.
The most suitable method to understand the lease rent for vacant land is the capitalization method. Capitalization rates for vacant land are usually 2% - 4% lower compared to on-going capitalization (cap) rates for a commercial (office) property. For example, if the average cap rate for an office building in the micro-market is 8%, the cap rate for a vacant land shall vary between 4% and 6%.
Another method to understand the prevailing monthly rentals for vacant lands is the direct comparison method. However, getting a comparable transaction with accurate information is always a challenge.
Hence, most of the times in practice, both the methods are used to arrive at market land rent.
Office assets have witnessed annual rental appreciation of 5% - 8% during 2015 to 2020 across different micro-markets. Historically, Grade A office space rentals have witnessed an annual escalation over 5% even in long term. Going forward, this is likely to continue for Grade A assets.
Today, occupiers of Grade A industrial and warehousing assets are committing annual escalation of 5% or 15% every 3 years.
Knowing industrial assets are cost centres for occupier, rental values of industrial and warehousing assets may not increase at their previous rates. In medium term to long term this asset class is expected to command annual escalation between 3% and 5% (in open market). Therefore, one needs to capture future annual escalation considering demand - supply, location and quality of construction for computing ROI and terminal value of the assets.
Foreign institutional PE funds are investing in commercial & industrial assets including office, warehousing, mixed-use but vary to invest into residential which constitute almost 75% of the total real estate industry in India. There are 4 major reasons:
Therefore, overseas investors are keen on commercial and industrial assets in India.
Investors have always had avid interest in commercial real estate which includes office, retail, warehousing, and hospitality. Investor focus towards social sectors has been historically low, despite these sectors being relatively stable than conventional real estate classes. Commercial real estate is more closely linked to the performance of economy than education and healthcare sectors.
Education and healthcare properties seek a longer commitment ranging between 30 years and 60 years from the occupiers; whereas typical lease terms for office and other commercial assets range between 3 years and 9 years. At the same time, rental values for social sectors are usually 15% to 30% lower compared to prevailing commercial space rentals (in the comparable micro-market) and annual escalation is between 3% and 5% compared to 5% that of commercial assets.
Social assets are more specific to occupier needs and therefore either the occupier prefers to buy or lease a Built-to-Suit property. In case the occupier defaults in paying rent for education and healthcare assets, it generally takes longer period for investors or owners to get property vacated because Government rules offer protection as these assets serves the social needs of the society.
Social assets can be built on red (public and semi-public use) zoned properties whereas commercial assets can be built only on commercial use properties. In most of the cases red zoned lands are cheaper compared to commercial zoned properties. Therefore, owners of red zoned properties can lease premises at lower rentals to occupiers.
In past, most of the education institutes and healthcare facilities are owned or donated by Government organizations. But with increasing property prices and use of technology, there is an opportunity for investors to participate in this sector more aggressively. Investments in social assets are likely to balance the overall real estate investment portfolio.
There are two terms which are widely used when it comes to understanding the profit for a residential development – Gross Profit of the project and Return on Equity (RoE).
Gross profit (or, EBITA) of the residential project varies between 15% and 25% of the total project revenue. This band varies for different types of residential segment projects: luxury, premium, mid-segment and affordable.
In terms of absolute numbers, gross profit for developers usually ranges between INR 800 and INR 3000 per sqft; higher gross profit on per-sqft-basis is for luxury or premium segment projects and lower for budget constrained housing projects.
Return on Equity (RoE) for a JDA projects is 3X to 4X of the total equity infused over the period of 3 to 5 years. Generally, developer’s project equity for JDA projects is sum of deposits payable to landowners, due diligence expenses, transaction costs for JDA, approval expenses, initial designing fee and token advance to civil contractor. Beyond these expenses is financed through bank finance and customer advances.
RoE for self-developed projects is 2X to 3X and here developer’s project equity also includes land price and other costs mentioned above.
India’s real estate story is more than 2 decades. It is a good time to look back and assess property cycle lengths in India. As per our experience, in India currently different asset classes enjoys a growth period of 4 to 7 years followed by downturn period of 3 to 5 years based on maturity of the segment. These periods are dependent on various parameters including economic indicators, real estate market dynamics & others.
For example, the commercial segment did very well during 2004 to 2009 and from 2014 to 2019; while the residential performed well from 2010 to 2015 and now has again started picking up from 2020 onwards.
Emerging sectors has comparatively longer growth phase followed by shorter consolidation phase. For example, the warehousing is expected to have growth cycle of 5 to 7 years followed by consolidation period of 3 years.
These property cycles may change over the next decade or two based on economic outlook for the city/ country.
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