SEZ Lands at Death’s Door

SEZ tax window is coming to end. The sun sets on incentives from 31st March 2020

FSI rates for SEZ lands have crashed to all-time lows

This is an opportunity for office space developers and investors

Budget of 2016 proposed that only if an SEZ unit commences its operations on or before 31st March 2020, it shall be eligible to claim income tax benefit. Developers of SEZs, which are not operational yet, were given time up to 31st March 2017 to make their SEZs operational to avail income-tax benefits.

Hundreds of acres of land across India, either master planned as SEZ or notified/ approved as SEZ, did not witness any development. These now need de-notification and an alternate use.  

Within 11 years of enacting the SEZ Act, the last nail in the coffin for SEZs has been inserted. Projects which are still under-construction would need to speed up completion and those which are undeveloped will perhaps never see the light of day.

Current Statistics

There are 218 operational SEZs across India out of which about 126 are IT/ ITES SEZs. Some of these are self-use facilities set up by large IT firms such as Infosys, HCL, TechMahindra, Wipro, TCS etc. These don’t add to Grade A office space supply and are usually partly/ fully developed. I would restrict the analysis and discussion to IT/ ITES SEZs constructed by Developers for leasing purposes.

The remaining 90+ SEZs, many over 25 acres, if not fully developed but operational, now face the decision regarding the minimum buildable SEZ area i.e. Processing Zone:

1.   If the minimum processing area has not been completed yet, then:

a.   Does the SEZ Developer have the financial ability to complete the same?

b.   If not, what are the penalties associated with it?

2.   If the processing zone is complete, should the remaining area be still developed as SEZ space or as a non-processing area.

This would depend on market conditions and demand/ supply of their specific micro market and city.

However, these are still the easier questions to answer. The bigger issue is regarding those SEZ projects which are not ready yet:

1.   A total of 420 SEZ projects received formal approval till June 2017

2.   Out of these, 351 were notified and 33 received an in-principal approval

3.   Specifically, there are 274 IT/ITES SEZ which have received formal approval and 230 have an in-principal approval.

This suggests large number of IT/ ITES SEZs which potentially won’t see any development take place at all.

To further complicate matters, some master plans of cities had delineated large swaths of land or entire sectors as SEZs. Many of these lands are still used for farming! So the total land that was demarcated as SEZ is potentially larger than the sum total of approved SEZs. 

In Hindsight

Once the Software Technology Parks of India (STPI) policy ended, SEZs were seen as a viable alternative for firms bringing in export driven business into India. About 1.59 mn people find employment in these SEZs generating exports of about Rs 523,637 crores in 2017.

These are impressive figures but the SEZs planned were far higher in number. Now many of them will only get partly completed or get shelved.

Was the policy unable to reach its full potential? What stopped all these approved projects from coming up? To briefly examine the circumstances, from an IT/ITES SEZ perspective, over the past 10 years:

1.   The biggest impact of the 2008 sub-prime crisis was felt by commercial office real estate in India. More specifically by the IT Parks and IT/ITES SEZs. Most of them got delayed as the demand reduced for several next quarters. Construction plan/ phasing got extended by atleast 2-4 years for several projects.  

2.   The year 2013 and 2014 also saw delay in approvals in several states. So projects which could have initiated or completed construction saw deadlines slip.

3.   The last three years have seen a steady increase in take up of office space across all segments, however we are still not close to the absorption numbers of 2006-07 on a nation-wide basis.

A slowing or lacklustre economy also reduced the local demand and Developer confidence or ability to undertake speculative construction.

Uncertain Future

If we focus just on SEZs constructed for 3rd party use, about 1,100 acres of land was developed across India. However about 1,300 acres of land is notified yet doesn’t have an operational status.

It is easy to assume that all the SEZ projects which are SEZs only on paper with no development activity on site will not be able to meet the new deadlines. All of these projects need a complete rethink on their strategy as the highest and best use lies elsewhere.

Unfortunately many of the owners of these SEZ lands don’t have the financial ability to de-notify and undertake sale/ construction after the de-notification. This is due to:

1.   Absent or limited investor demand of any kind, individual or institutional, who would support a green-field project.

2.   The longest slowdown being witnessed in Indian real estate which is expected to continue in the near future as well.

Market intelligence suggests that several of these SEZ lands are available are rates below Rs 900/sft of FSI yet they are unable to find any buyer. Land for commercial office or IT Parks, in the same market, are being offered at a marginal higher rate albeit lower than 2010-11 figures.

The lands that were delineated as SEZ in master plans can be brought back into the market by the State Government/ Development Authority amending the Master Plan and changing the building bye-laws/ policy as per the prevalent market conditions.  

The future for all such potential development projects remain uncertain until leasing demand picks up or institutional support increases for greenfield projects. It is ironical that markets where lands exist also have lack of developed, Grade A office space supply.

There is prime land available for development but neither the capital nor the confidence. 

Conclusion

Did the Government really expect hundreds of acres and millions of sft to be developed or constructed in 15 years? Such projects take years, even decades to plan, execute and complete. Even during that development cycle, the project is bound to go through at least one slowdown. So a sunset clause in such policies within 15 years is fundamentally flawed and real estate investors going forward should be wary of such risks.

We estimate that about 70% of total employment generated due to SEZs was in the IT/ ITES SEZs. The uncertain times being faced by the IT/ITES industry further impacts the confidence levels of SEZ developers. There is talk from various corners to extend this sunset deadline to 2023 however that’s a gamble most SEZ land owners are not willing to take.

We expect several distressed assets to be available for sale, joint-venture or joint-development at extremely attractive rates, across India. This is potentially the best opportunity to acquire and develop a commercial office (IT or otherwise) portfolio by acquiring lands at steeply discounted values, in relatively developed markets. Current construction costs would allow the Developer to offer Grade A office space around Rs 40/sft/month to Rs 50/sft/month and still achieve the requisite returns.