The draft guidelines for trading in REITs in India have been introduced and allowed. For the very first time, there exists a tool to channel small savings into the Indian real estate sector. Not surprisingly, several owners of income-generating properties are now considering setting up REITs.
While commercial real estate projects have been popular assets to securitise worldwide, market dynamics in India currently suggest that the retail sector could be a beneficiary as well. Factors underpinning the potential success of REITs in retail include:
Low Vacancies In Superior Grade* Malls
Over the past few years, developers slowed down the supply of mall space in India because of rising vacancy rates following the economic slowdown. Prior to that, developers were churning out malls at a breakneck pace in response to a spurt in the organised retail business. Back then, few developers understood what the right ingredients for a successful mall are.
The overall vacancy rate today stands high at about 20% in retail malls across major Indian cities, while Superior Grade malls have vacancy rates averaging at only 10%. Given that international retailers will prefer to take up space in these malls, the shortage of quality space is evident and will be felt for some time.
Opportunity For Discounted Asset Purchases
For REITs to provide attractive yields, they have to purchase assets at a reasonable price, which then fetch attractive rents. This is particularly important for retail – an asset type that is perceived as riskier due to the lower predictability of income.
While upcoming Superior Grade malls will offer lucrative investment opportunities, some of the existing stock of lower-grade malls could be up for sale at a discount. For instance, of Mumbai’s 65 existing malls, only 20 are of a size suitable for securitisation in a REIT. Of these, five or six could be considered distressed assets.
These low-grade malls are underperforming due to poor design elements and the financial distress of their developers. Other factors such as location, catchment area and retailers’ interest are favourable in many cases. While REITs will not want to consider malls that are strata sold (another major cause of mall underperformance), malls that have everything other than design and finance going for them will be very attractive acquisitions.
Recent data made available by hiring firms (recruitments), automobile associations (car sales) and the central bank (home loan disbursals and reducing inflation) suggest that consumer sentiment has been on the rise in the past few months. This is good news for organised retail, and indicates a rise in consumer spending going forward.
When compared to the management of commercial buildings (which share common facilities and have relatively stable tenancy profiles), the management of retail malls is complex. Apart from catering to various brand categories, mall management also involves planning the right tenant mix, space optimisation and zoning, and constant adaptation to consumers’ shopping behaviour.
It is fairly certain that REITs would employ better mall management professionals and practices than the mall’s developer. This will increase the probability of their success.
Given the limited number of existing malls that fit the requirements, REITs that are quick to discern and capitalize on the opportunity will benefit. Those that latch on to the potential later will have to wait until new supply of suitable malls hits the market. Moreover, the rising consumer and retailer sentiment will lure REITs into seeking these low-hanging opportunities.
* Malls are classified as Superior Grade based on location, developer reputation, occupiers’ profile, business model, mall design and other qualitative features such as mall management, ambiance and experience at the mall.