Sometime in the future when the COVID pandemic will be comprehensively behind us, and when we will analyze how our world changed for good, real estate would figure out as one of the industries whose landscape changed in a big way. Like many other industries that would have undergone a generation change, thanks to the 2020 economic model, a serious consolidation should be observed in the real estate industry too.
The pandemic is a black swan event that has provided us with the parameters to model an entirely new economic landscape. We now know events like this can force the whole world to sit at home, taking down industries and jobs with it. It is from this perspective that a new economic model will be needed which can yield quick results. We do not have time to recover from such events using old economic models that take decades to build industries and jobs. In cricket parlance, if the old economic model was a test match, the 2020 economic model would be a T20.
The 2020 economic model needs to be agile which can be tweaked quickly into any shape as needed. We witnessed a classic example of it during a pandemic when a large workforce operated from home instead of the office. Its success can be ascertained from the fact that essential services continued to function even in shutdown mode. As another example, we learned, as part of social distancing practice, that we now can make essential transactions without having to visit shops, malls or offices. We had a chance to record numerous positive learning from a forced shutdown in real-time instead of a prototyped environment.
In the fresh scheme of a new reality, real estate will not only undergo a massive change, but it will not be outlandish to believe that the investment approach will also go through a tectonic shift. Let’s observe the major segments of the real estate industry from the changed landscape:
The demand for office space was rising consistently up until 2019, thanks to the continued growing demand from various performing sectors that need extra space to accommodate business growth. It does not come as a surprise that this segment was growing at 27% while the industry struggled.
Post-pandemic, the underlying forces will not be the same. Work from home (WFM) is the new work style that proved highly successful accidentally. As a successful alternative, WFM opens up new opportunities for businesses – one of them being a financial benefit. Maintaining a seat for an employee can cost a company anywhere between Rs 5,000 – Rs 15,000 in a scalable arrangement.
A marginal cut in space requirement leading to significant perpetual cost-saving will certainly sound like music to any business. Companies will certainly remodel their operations around WFM throwing the segment into a tizzy. The demand for office space should drop sharply taking along with it the rental yield. In an already pepped-up supply scenario, companies will renegotiate their rental agreements. A drop in rental yield will force the property prices of office space down.
In a depressed real estate market, the commercial segment was one of the few silver linings. In 2019, not only did the occupancy level improve significantly, this sector started receiving strong PE investments, especially in the retail segment which delivered lucrative rental yield. The future looked bright for this segment.
Since the performance of this sector is correlated with the economy in general, it should come as no surprise that commercial space will be the hardest-hit segment. A drop in occupancy rate will force the rental yield down, and the property prices along with it.
However, I see this phase as a temporary correction phase in a segment with a high beta. When the economic situation improves, which it will, commercial space will be the first segment to witness reversal. Due to the high beta, the prices will come up strongly, offering a rare opportunity for investors. This phase should be seen as an opportunity to acquire commercial properties.
Residential space was the hardest-hit segment in the recent past primarily due to excessive supply and late deliveries. Post-pandemic, the situation is not likely to improve in a hurry. Further, the pandemic has probably aggravated the issue at hand by blunting sharp-edge RERA regulation which had forced builders to perform. Post-pandemic, deliveries are expected to be delayed further, delaying the prospect of this segment.
There is a silver lining though. The pandemic has reportedly forced some bad experiences on tenants who would now be eager to own a home of their own soon. Their desire is likely to be fulfilled by some of the government initiatives on low-budget homes – PMAY & DDJAY, for example. It is not a surprise, hence, that most developers are aggressively acquiring licenses under such schemes. However, I do not see much for investors in this segment unless they follow the migration trail in the next phase of economic restructuring.
Tier 2 & 3 Cities
One of the hardest learned lessons from the pandemic experience is the migration issue. It is now obvious that a centralized economic model around a few major cities is not only restrictive but also dangerous. Most of the major cities are functioning beyond their capacity posing significant threats in the case of long-tail events such as this pandemic. The bad experience has left permanent marks on migrants too who are unlikely to return to cities anytime soon.
The time for a decentralized economy has arrived. For a large country like India that needs to feed some 1.3 billion mouths, it must open up more centres to regulate people and businesses. Smaller cities offer price and space advantages. This initiative should see the transfer of some of the mundane jobs to smaller cities to start with. The government seems to be thinking along these lines, opening up opportunities for investors. The next growth in residential space will pick up from tier 2 & 3 cities.
Another opportunity that is silently picking up is the need for a distribution warehouse facility thanks to the manufacturing initiatives of the government. Add to it the recent spat with China, the manufacturing sector is likely to receive significant attention and traction. The dream of India becoming the manufacturing hub of the world cannot be fulfilled without a strong warehouse network across the country.
The warehouse is a decent investment model primarily due to superior rental yields and longer lock-in contracts. Such assets quickly attract PE investments and transform into funds due to their monetizing capabilities. Investors should look at this alternative seriously.
The real estate industry must go through serious change. In the new scheme of things where funds will be tough to come by, the gold-rush approach to real estate investment will be dangerous. As happens after every economic reset, this pandemic will throw numerous investment opportunities for investors, but they will come into their pockets. As I see it, it’s time to keep the purse ready.