Office Realty Comes Full Circle

PE inflows into office realty indicate renewed confidence in the asset class; value of funds in 1H2016 has already crossed the total seen in 2015

Anuj Puri – Chairman & Country Head, JLL India

When we analyze the distribution of private equity (PE) funds across various asset classes from 2010 to date, the sector-wise distribution is a good indicator of how investors viewed each of them at different times, based on their performance during those particular periods.

Immediately prior to the global financial crisis (GFC) in 2007-08, the office market was blazing with healthy leasing transactions and bustling construction activity. However, all this traction came to a virtual standstill as the GFC erupted, leading to a host of unfinished buildings and a perceptible lack of space demand. Consequently, there was a sharp decline in office market rents and capital values over the subsequent periods.

Even before the office sector began to come out of the woods and display some green shoots of recovery in 2011, the residential sector had already picked up the slack and was driving the industry forward. Increase in new project launches, sales and price appreciation became the norm and there was enhanced investor activity as well. The asset class became the darling of institutional and private equity investors who were looking to make good their losses from the commercial office sector.

That said, some strategic investors did realise the growth potential that commercial office asset class had in the long-term in India, and that the lull was a temporary one as occupier activity would again emerge stronger when India regained its edge as a preferred back-office destination and also becoming a bigger centre for high-end software development and financial services. These investors banked on the lower capital values and high yields for rent-yielding assets in 2010 and its upside potential.

In 1H2016, the total of PE inflows into office realty has crossed the annual total seen in 2015. It may even cross the previous five-year high seen in 2014. It, however, still remains way behind the residential asset class, which still gets the maximum share of PE inflows into real estate as a whole. Whether 2014 (when office overtook residential as PE funds’ favourite) will repeat again, still remains to be seen. However, it is clear that the PE momentum seen in recent years in this sector looks set to continue.

Large investors keen to look at equity positions again

What is also interesting to note here is that equity flows in the commercial sector turned stronger, indicating that large investors are keen to look at equity positions again, although the right asset remains a key consideration. The increasing share of equity financing is a key indicator that investors are looking to become project partners and points towards their strong positive sentiments for commercial assets.

A major consideration in recent times for commercial assets has been the REITs guidelines and further incentives from the government to support REIT listings.

On the other hand, in the last three-four years, equity flows have reduced in the residential sector and made way for largely debt and structured instruments. This is due to the relative slowdown that this sector has faced over the past two-three years, which had made investors somewhat conservative by turning to construction debt, last mile funding and receivables bundling to ensure that their investments were protected against the lien of the asset.