India Real Estate Report Q2 2012

Real Estate Market Analysis Office

Supply And Demand
Cushman & Wakefield reported on January 5 2012 that absorption of office space in 2011 was up 8% on 2010, reaching 3.3mn m2. However, total new space brought online declined by 20% over the same period. In the short term this is a positive development, as existing vacant space is being utilised; particularly in light of Jones Lang LaSalles assessment that one-quarter of Indias office space lies vacant. While there is a clear disparity between the two figures, the implication that demand exceeds supply is the same. Despite 2011 seeing a decrease in the completion of new office space, take-up is clearly still not reaching the necessary level. At the same time, labour and steel costs have reportedly increased since September 2011, so developers have been reluctant to entice renters by lowering their rental levels.

Rents And Yields

Mumbai remains one of the countrys most desirable locations for investment, and our in-country sources have indicated that the south of the city is attracting the majority of tenants, forming a commercial epicentre. In early 2011 it was Mumbai that saw the largest drop in minimum rental levels, to INR269 per square metre (m2) per month from INR538 in mid-2011. Our latest round of in-country interviews conducted in December 2011 show that these levels then surged to an estimated INR700/m2 per month, causing year-onyear (y-o-y) growth of 30% by the end of 2011. At the same time maximum rental levels moved conversely; overall year-on-year growth was 2%, ending 2011 at INR3,850/m2 per month. But this growth does not take into account the whopping growth between late 2010 and early 2011, to INR5,380. Those levels clearly proved to be unsustainable, as evidenced by the drastic re-adjustment. This implies that early 2011 saw an optimism in the market where renters were looking to grade A property over that of lower quality that has since dissipated. However, it could also indicate that lower quality properties are undergoing improvements to increase their value, which may have increased demand in this area and reduced the unsustainable high prices at maximum levels.

Gurgaons office market has maintained a much more stable level of rents; between late 2010 and early 2011 there was a steady increase at both minimum and maximum levels, which our in-country sources estimated has remained stable throughout the year. However, Gurgaons grade A office rents remain lower than those of Mumbai, Hyderabad and Bangalore at INR960/m2 per month, so although the stability in the city shows promise, the other three cities clearly remain the more desirable. It also appears that Gurgaon is going to great lengths to attract new occupants, as developers in some properties are reportedly offering one to four rent-free months a year. This is in comparison with the other cities offering an average of only one rent-free month.

Aside from a minor adjustment going into 2011, Hyderabads maximum office rents have also remained stable, although growth has been minimal at just 3% y-o-y. Minimum rents, however, have dropped by almost 50% since the early part of the year, to an estimated INR280/m2 per month at the end of 2011. This implies

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that demand for lower quality property has dropped as renters hope to secure grade A premises for their businesses. Maximum rents were already the second highest of all the cities we survey (INR1,325 at the end of 2011), and the risk to developers of pricing themselves out of the market may explain why there has not been a proportionate increase despite the potential demand.

Maximum rent changes in Bangalore since early 2010 have been higher than in any other city we survey. Bangalore saw a maximum increase of 82% y-o-y, perhaps reflecting its status as an emerging location for investment. At an estimated INR1,290/m2 per month (from only INR710 in 2010), Bangalores top quality office space now only trails that of Mumbai and Hyderabad; both established commercial centres. Minimum levels have also grown, although at a much steadier rate of 12% y-o-y, implying that demand across the board in the city remains promising.

The picture in Chennai over 2011 was mostly bleak. Maximum rents actually increased between late 2010 and early 2011, to INR1,076/m2 per month, but dropped back so drastically by the end of the year that they posted an overall decline y-o-y. Minimum rents also dropped, although they remained stable across 2011. It would appear that there has been a corresponding drop in demand for office premises in the city, which could be a result of the more desirable property in cities with a better commercial reputation.

Rental yields are the ratio that shows yearly rental income as a percentage of the propertys sale value. In Mumbai, Gurgaon, Hyderabad and Bangalore our sources are forecasting a drop in yields in early 2012. For Mumbai in particular this means that as rents are predicted to surge at the top end, so could capital values, and by a greater margin. Once again, whether or not this increase will be sustainable is uncertain in the current investment climate. The other two cities yield decreases represent a more proportionate increase in values, but still shows that an adjustment could follow. Yields are then predicted to settle on a slight increase at the end of the year. They will remain at steady levels of around 10%, but it does imply some of the cities may see values decrease once more.

Table: Historic Office Rents 2010-2011 (INR per m2/month)

2010 (Jul-Dec) Min Mumbai Gurgaon Hyderabad Bangalore Chennai Source: BMI 538.00 430.40 540.00 382.57 710.00 Max 3,766.00 860.80 1,290.00 710.00 820.00

2011 (Jan-Jun) Min 269.00 590.00 545.56 430.00 376.00 Max 5,380.00 960.00 1,324.54 1,290.00 1,076.00

2011 (Jul-Dec) Min 700.00 590.00 280.00 430.00 376.00 Max 3850.00 960.00 1324.54 1290.00 646.00

% Change yo-y

30%, 2% 37%, 12% -48%, 3% 12%, 82% -41%, -21%

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Table: Net Office Yields, 2011-2012

2011 (Jan-Jun) Mumbai Gurgaon Hyderabad Bangalore Chennai 12-15% 9-10% 9-10% 10% 10-11%

2011 (Jul-Dec) 12-15% 9-10% 9-10% 10% 10-11%

2012 (Jan-Jun) 6-12% 8-10% 8-12% 6-10% 10-15%

2012 (Jul-Dec) 15% 10% 10-11% 10% 10-11%

Source: BMI

Table: Terms of Rental Contract/Lease H211

Lease terms (in years) Mumbai Gurgaon Hyderabad Bangalore Chennai 2-5 1-3 3-5 2-9 1

Rent free months (if any) 1-2 months per contract 1-4 month per year 1 month per year 1 month per year 1 month per year

Source: BMI

Industry Forecast Scenario

Once again, our sources are forecasting a surge in maximum rents in Mumbai in early 2012, to INR7,700/m2 per month. If this is a repeat of 2011s pattern it may be that these levels are unsustainable, but currently we are predicting a minor increase in the second half of the year. The proposed international airport in Navi Mumbai is reportedly attracting investment, and may help to keep these levels high despite an apparent saturation in the south of the city. The predicted levels could also mean that the vast oversupply currently being reported in office space will catch up to Mumbai in the middle of the year, but that increased construction costs will keep developers from being able to lower their rents as a way of increasing demand.

Our in-country sources have identified Gurgaon as one of Indias fastest growing cities, so comparative rent increases will continue to be high as it develops as a commercial hub. In fact, it is the only city

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predicted to see rental increases of more than 10% towards the end of 2012. Meanwhile, our prediction for Bangalore is that its office market is saturated, which currently goes against consensus. It could be that Bangalore will continue to see increased rents, but perhaps not at the expected level.

Yield forecasts show a stabilisation from 2012-2016. However, this will depend entirely on how stable rental levels remain in light of existing debt fears and oversupply of space.

Table: Forecast Office Rents 2012 (INR per m2/month)

2012(Jan-Jun) Min Mumbai Gurgaon Hyderabad Bangalore Chennai 800.00 700.00 280.00 430.00 379.00 Max 7,700.00 1,100.00 1,450.00 1,290.00 675.00

2012(Jul-Dec) Trend Increase Increase Increase Increase Increase % Change 0-5% 3-20% 0-10% 0-5% 1-5%

Source: BMI

Table: Forecast Net Office Yields, 2008-2016

2008 Mumbai Gurgaon Hyderabad Bangalore Chennai 5-7% 4% 5% 6-7% 8-11%

2009 7-9% 4% 6% 6-12% 7-12%

2010 7-8% 6-11% 8-9% 6-9% 7-8%

2011e 12-15% 9-10% 9-10% 10% 10-11%

2012f 15% 10% 10-11% 10% 10-11%

2013f 15% 10% 10-11% 10% 10-11%

2014f 15% 10% 10-11% 10% 10-11%

2015f 15% 10% 10-11% 10% 10-11%

2015f 15% 10% 10-11% 10% 10-11%

2016f 15% 10% 11-11% 10% 11-11%

f = BMI forecasts. Source: BMI

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