Exploring options in emerging cities for investment in commercial realty
Apr 02, 2014
Source : The Times of India

 

PUNE: The slowdown in major real estate cities of India, has resulted in the emergence of new markets around tier-II cities. Higher costs, liquidity problems and falling investor interest, have diverted the developers and investors, to explore new markets in the country. The immense potential in emerging cities like Indore, Ahmedabad, Nagpur, etc., has drawn a lot of attention from real estate buyers and developers. Experts believe that emerging markets have a lot of potential to deliver in the coming years because the rental yield in commercial spaces is still low and the infrastructure development is not anywhere close, in comparison to a metropolitan city.

Emerging markets to prove their strength in commercial realty

There is no doubt that emerging markets have great growth prospects but they are yet, to prove their strength in comparison to the metros. Anuj Nangpal, managing director – Investor Services, DTZ – India, says, “Over and above the seven major cities of India, there is emerging potential for commercial real estates’ growth in the cities of Indore, Bhubaneswar, Coimbatore, Ahmedabad and Nagpur. Emerging cities are yet, to see peak rentals and capital values that are endemic to the metro cities of India, like Mumbai and Delhi-NCR. As such, those industries that work on thin margins and would like to pare their costs, should actively scout for commercial office spaces in these emerging cities. Also, with the spread of good educational institutions in these cities, the issue of manpower availability is taken care of. Moreover, the metropolitan cities are already strained with respect to energy availability. Most of these emerging cities are energy surplus and hence, investing heavily on power backup is not a burden. Rental yields in the metropolitan cities range between 9-12 per cent. These are slightly lower in emerging cities.”

The increased reach of financial institutions and banks in the tier-II cities would further help them attract more investment in the real state sector of emerging property markets. Lalit Kumar Jain- CMD, Kumar Urban Development Ltd and chairman, CREDAI, shares, “All tier-II and tier-III cities have greater potential to grow than established metros. Cities like Baroda, Vizag, Coimbatore, Indore, Chandigarh, etc., will have greater focus on development amongst the emerging cities. These cities may not invite a lot of IT businesses, however, amongst the less costly destinations, these cities are expected to perform much better. There is no doubt that metropolitans are sure-shot markets where you don’t need to do much screening. Emerging markets would behave on the basis of infrastructure support and local policies. Emerging markets have a more-risk-more-return matrix; therefore, it can deliver higher returns than an established one.”

Factors to consider while buying commercial real estate in emerging cities

Experts believe that while investing in a commercial property in emerging cities, it is important to be aware of the nature of the asset being constructed, the tenant mix that it can attract, the location aspect and the developers’ reputation. “The investor has to also look at his own investment horizon and check whether it matches with the delivery timelines as promised by the developer. This is important since the returns start coming in only once the tenants start occupying the asset and rentals start flowing in. The risks of investing in commercial real estate in emerging cities, are more or less similar to those of investing in metropolitan cities. However, it will be slightly higher in emerging cities, as corporates are slow in taking up space in emerging cities and as such, the returns that the investors are expecting, may be delayed. Also, national level developers normally, focus on metropolitan cities and hence, other cities come low on their priority. These factors may affect the growth rate of the capital values and yields. A higher entry cost is a deterrent for the first time investor in commercial real estate”, opines Nangpal.

The biggest risk while investing in a commercial property is vacancy. In case, the commercial property is not occupied by a corporate, it will not result in returns on investment. Also, the longer the property stays vacant, the more it will be difficult for the investor to exit.

Jain further suggests that “Location and the potential to invite the lessee, are two important factors while opting for commercial real estate in emerging markets. In smaller cities, commitment is also very important because lessees change their destination plans very often. The brand presence is almost absent in the emerging markets therefore, property selection by the buyers, requires extreme care and proper due diligence. One must also check the design and versatility for modifications in future.”

Growth outlook in emerging real estate markets

Investors are looking for new avenues to park their funds and developers have space and liquidity constraints in the metros. Infrastructure support would further increase the growth pace in tier-II markets. Extending support to this view, Nangpal adds, “With metropolitan cities already bursting at their seams, investors in commercial real estate and the corporates, are actively scoutingfor space in emerging cities. Since the capital values are at the lower end of the spectrum, it offers greater returns on investment. However, such growth in emerging cities, will be contingent to the growth in infrastructure which will support business.” Smaller markets have less number of investors over end-users, in comparison to the metropolitan cities and this is a healthy indication of the stability of these markets. The occupancy rate for commercial real estate is high in emerging markets because of high end-user participation and therefore, there is less occupancy problem and sustained growth is also there.

Commercial real estate in emerging markets lacks support from the local authorities, in comparison to the metros and this is the reason that the real estate sector, in metropolitan cities, has consistently performed well.

Jain extends support to this view and says, “The central government and state government’s policy is very important in deciding the future of emerging markets because the whole growth story of these markets is based on the assumption of higher infrastructural support in the days to come. If governments live up to their promises to support in building a better infrastructure then the real estate market, in emerging cities, would do well.

In tier- II cities, any return below 15 per cent per annum, in the prevailing market situation, would be considered bad, similarly in metro cities, the return should not be below 12 per cent p.a.” The investor has to also look at his own investment horizon and check whether it matches with the delivery timelines promised by the developer. This is important since the returns start coming in only once the tenants start occupying the asset and rentals start flowing in. The risks of investing in commercial real estate in emerging cities, are more or less similar to those of investing in metropolitan cities. However, it will be slightly higher in emerging cities, as corporates are slow in taking up space in emerging cities and as such, the returns that the investors are expecting, may be delayed. With metropolitan cities already bursting at their seams, investors in commercial real estate and the corporates, are actively scouting for space in emerging cities. Since the capital values are at the lower end of the spectrum, it offers greater returns on investment.

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