Key questions to ask in Hyderabad’s real estate market (3/3)

Our previous articles have covered key questions about land valuations, residential investments, and the do’s and don’ts of buying a residential property.

Let us now turn our attention to the office space market next:

• Our office space absorption solely depends on the IT industry, which relies on the United States (US) / European Union (EU) market. Any recession or slowing of demand from the US / EU affects our markets directly. There has been much recent talk about demand slowing and recession in a few key demand markets worldwide. Coupled with this, the hybrid working model has definitely affected demand for office space.
• In the pre-covid times, it was common for occupiers to have large offices. They would keep such spaces business-ready at their end and pitch for business. That trend has waned off now. The average size of office space demand has come down. It is common for clients to look for the exact space they need at a point in time even if it means having multiple offices in a city or location.
• A lot of market commentary projects, co-working or managed office space take-up as demand. Strictly speaking, this is not demand. Landlords, developers and co-working / managed office space brands are all part of the supply side of any deal. Don’t expect co-working / managed office space brands to keep paying rent or minimum guarantee revenue for centres where they have no tenants. It also seems that back-to-back deals done by such brands are counted as double in-demand figures.
• Another factor that is not being properly analysed is vacancy levels. The vacancy levels reported are just at the building or project level. Let us assume a building that has 10 floors, and all floors are leased to co-working or managed office brands. As per research, this project is 100% occupied, but they do not factor in the vacancy within the co-working / managed office space brands.
• Basically, the market commentary seems to be overstating/estimating absorption numbers on one factor and understating vacancy on another.
• I recently came across a research report that claimed our city had crossed 100 million square feet of built space in the office segment in 2021/22. Within a year, that number became 114 million square feet. Another 35-38 million square feet of space is likely to be added in the next 2-3 years. Basically, the city reached 100 million square feet in about 25 years and will grow at least 50% of that number in the next 5 years.
• Creating massive excesses of supply is not an achievement. You don’t need a real estate expert to see the masses of empty buildings dotting HITEC city, especially the financial district. The industry should pause for a few years to moderate supply, which would benefit everyone. It is high time we kicked out the unlimited FSI rule in our state.
• Probably the right way of analysing the market would be to look at the cumulative absorption numbers. For example, let us presume that 90 million sft. of office space is the cumulative absorption to date for our city. For the current year, say the absorption comes out to be 6 million sft. What we should be told is whether 90 became 96 or 90 went down to 87, and the new cumulative total is 93.
• This kind of tracking is also important because many companies have exited a lot of space post-COVID. Nobody reports these exits, and whether we like it or not, we have to deal with this vacant supply in our commentary.
• Is buying office space a good alternative for investors? The returns are better than residential, but the fact is that even with a budget of a few crores, getting a good office space is not possible. We definitely do not suggest investors buy floor UDS. There is no way clients are leasing floors with ownership spread over hundreds of individuals in the floor UDS model. This type of selling is illegal as per judgements given by other RERA authorities.
• The bigger problem we see is that tenants treat corporate and individual landlords differently, especially after covid. Even during covid, occupiers were careful not to get into legal discussions with corporate or listed landlords. With individual landlords, the decision to end a contract was far easier. With such uncertainty and co-working / managed options offering better terms, individual landlords will have a lot of trouble retaining and getting tenants going forward.
• Investors have a better choice in REITs and fractional investments. Both these types of investments are monitored by SEBI. REITs can be bought from the share market and you do not need any broker’s assistance for the same. Just study the history of returns of the various REITs available and then go ahead and buy it. Nowadays, some of these REITs also give guidance for upcoming years' rent/dividend distribution. This gives a good indication of the returns you can get if you invest in these REITs. When you need money, selling these units is quite easy on the stock market.
• Fractional investments have been quite popular over the past few years. The fact that they now come under SEBI’s guidelines gives them a lot of credibility. Companies in this business buy leased assets and sell fractional ownership in the special purpose vehicle (SPV). They clearly tell you the returns in actual numbers, legal papers are shared upfront and plans are shared as to when the asset would be divested. Investors make 12-14% returns including regular returns and capital appreciation. If any investor has an investible surplus of Rs. 25L+ and is considering buying a house then a better idea would be to invest in fractional ownership assets and live on rent. These are very sensible and comparatively safe investments.
• Post covid, IT companies have moved onto a hybrid way of working, which seems to be different for different companies. Some companies' employees work from the office 2-3 days per week. They use a typical 100 seater office space to operate 200 employees. Other companies have expanded to other parts of the city, so employee commutes have come down. Few companies have expanded to north or east India as part of their hybrid strategy. Many have also moved operations to Tier 2/3 cities in the hope of having reduced costs and better employee engagement.
• For Hyderabad, the biggest drawback has been the concentration of IT only in Hitec city. The lack of multiple markets has not allowed occupiers to grow in different locations within the city as part of the hybrid strategy. We now have a situation where the majority of the 10L IT employees travel from east to north and south to west back and forth daily, putting enormous pressure on the city's traffic infrastructure.
• Recently, somebody shared an interesting anecdote that while staying in east Hyderabad, it is better to work in Bengaluru and travel back every weekend than travel daily to Hitec, spending 2-3 hours in traffic jams/congestion. Mind you, manoeuvring Hitec city traffic is not easy nowadays. It is not uncommon for clients to tell us to wrap up site visits in Hitec by 4 p.m. to avoid office traffic.
• The development of Uppal (east) and other office markets across the south and north is also important to ensure that office space demand does not leak from our city. Make no mistake: Every office space being opened in Warangal, Mahbubnagar, Nagpur, Lucknow, Madurai, etc., is a leakage of demand from the main office markets.
• Environmental, Social and Governance (ESG) parameters seem to be buzzwords now with many IT company operations. The majority of it still seems to be just lip service. We find it quite interesting that companies evaluate Tier 2 cities within Telangana and other states for operations but do not consider opening office space in Uppal, Kompally, LB Nagar, etc. 50-60% of the IT employees come from these locations but IT firms still avoid setting up offices on other sides of this city.
• Since 2021, Uppal has seen a lot of leasing activity as a micro market. The existing buildings, like DSL IT Abacus, have vacancy levels of about 10-15% due to multiple large space take-ups. Even non-Grade A buildings have witnessed good demand. Today, this micro-market does not have more than 100K sft available for lease, and it is all in bits and pieces. Until and unless good supply is created, more demand will be reluctant to come to this side.
• Hopefully, the new government will see the benefit of broadening the IT industry across the city and take steps to create a better statutory environment to attract more investment. A proper review needs to be undertaken to check if policies like GRID have delivered any results or just remained detrimental to the overall development of these areas.

How are the retail markets of our city:

• This is one segment of the market in which rental/capital values have grown by leaps and bounds in the past few years. Rental figures ranging from Rs. 250/ft/mth+ are not uncommon to hear for sought-after high street newly constructed options.
• The growth in rentals must have taken a big bite out of the financial quotient of any business operating from such properties. Sales would have increased but competition has also increased manifold.
• Food & Beverages sector has witnessed tremendous growth over the past few years. Thanks to online delivery apps, even a house-based food delivery business is now able to compete with the biggest food brands in their micro market. A plethora of options probably increased the business volumes, but beyond a point, most would be facing stagnation to stay relevant and on top of the customer's minds when they want to eat out. This sector seems due for a significant shakeup in terms of consolidation, which should help quality players grow better in the future.
• Overall, retail exuberance seems to be ebbing now. Most brands are re-evaluating their fast-paced growth strategies over the past few years. Many are in the process of rationalising their offline presence and shutting down unprofitable stores.
• In the retail business, it seems easy to get carried away by the market's perceived potential. Reality hits hard only later when retaining clients seems like an uphill task. This is an era when you have to earn your clients' loyalty; otherwise, business could be disastrous.
• All high streets have seen good demand from brands for their presence. With online brands also getting into the offline mode, demand for space keeps going up. Quality retail space is difficult to find. Most high streets are plagued with problems with parking, traffic congestion, access, etc., and seemingly have no solution.
• The biggest challenge we encounter in the retail segments is finding good-quality space with adequate height, good frontage and all compliances in place. The last aspect is the biggest challenge. A lot of corners are being cut to deliver space fast, but good companies will never agree to lease anything that is not 100% compliant with all building laws of the land.
• On the quality of space, we advise developers to a Ground (G)+3 floors structure with a lot of emphasis on parking instead of doing the standard G+4 floors structure. The advised structure would make it possible to give 12ft+ height across all floors and still be compliant with the overall 15 mt height rule. Quality of space is critical from a customer’s point of view. A customer never forgets places with parking or access problems and eventually avoids such buildings in future.

Plotting projects:

• This is probably the worst segment of our real estate market. We have driven on most of the highways emanating from Hyderabad. All highways are littered with plot projects right to the state boundary. It is not uncommon to now come across 1+1 or 2+1 free offers from plot developers. We always thought that 1+1 free schemes were for pizzas. Imagine the lack of demand that such schemes are being offered in plots also.
• We embarked on a road trip to Pune during Dusshera 2022. We got off the Outer Ring road (ORR) and drove west, crossing multiple towns on the way. My son, who was preparing for his 12th board that year, was looking for breakfast options in the morning. He would track these good-looking arches on the horizon in the hopes of an upcoming hotel, but it would turn out to be the entry arch of a plotting project. Once we crossed Zaheerabad, he asked me whether I thought people would seriously go that far to live in Hyderabad. Long story short, the stupidity of the supply situation was evident to a senior school kid but had not dawned yet on the plot developers.
• The larger problem would be that in the future when the government plans an acquisition for any project for the state’s benefit, a large number of stakeholders would need to be handled.
• The biggest challenge is that most companies selling plots projects that do not come under RERA compliance. Only in the past one-year plot projects have started to get RERA compliant. Earlier, the few who got RERA certificates would do so for a limited portion of the project and not the entire thing.

Overall, our advice is to tread carefully when investing in our city. There is no urgency or FoMO required when making a real estate purchase decision. Remember, there is enough and more supply for your lifetime, definitely enough to cover your kids' lifetime and, worst case, even your grandkids. All stakeholders and the government should deliberate on why we have come to this stage and take corrective action before things go completely out of hand.

In the end, I leave you with some advice from the great Warren Buffet: “Be greedy when others are fearful, and fearful when others are greedy, but don’t think you can outsmart the market”. Our markets have been in a greedy phase since the shoddy implementation of RERA in 2017, and post-pandemic, greed knew no limits. We are still in the greed cycle; it's just that fewer people are buying it. So stay fearful of all offers given to you as it is your money on the line and nobody else gives a damn about the fate of your money.