South Indian Real Estate Markets - A view from Ascendas

Ascendas India Development Trust(AI-Trust) recently filed their annual report for the year ending March, 2008. Like many regulatory filings, the report is a goldmine with information on their current rentals, large tenants, new developments in the micro-market and demand/supply. Jones Lang LaSalle Research is the source for a lot of the data. AI-Trust has properties in Bangalore, Chennai and Hyderabad and a large portion of its tenants are IT/ITES companies. An appendix to the annual report has a market research on these markets. Key points and my observations are below

• Property markets in the three cities are divided into micromarkets based primarily on distance from city center. AI-Trust calls these micromarkets Central Business District (CBD), Secondary Business District (SBD) and Peripheral Business District (PBD) in increasing order of distance from city center. All of AI-Trust's properties are in the PBD of the three cities.
• In Bangalore, the Outer Ring Road(ORR) area falls under PBD whereas Whitefield and Hosur Road beyond ORR fall under PBD. Due to new supply in the SBD, primarily eastern stretch of ORR, and excess construction in the Whitefield area, vacancy rates in rose from 3.2% in 2005 to 20.6% in 2007. While leasing activity was strong through 2005, the emergence of ORR as an attractive destination for IT/ITES companies has weighed on properties in Whitefield. ORR is closer to city center, has better connectivity and there are large tracts of land available for development.
• While analyzing competition in the Whitefield area, it is mentioned that rentals in the Whitefield market have seen stagnation over the last year. Also, apart from an SEZ project, upcoming projects are not seeing pre-leasing activity because of competition from ORR. The present stock of space in Whitefield is approx. 10.1 million sq. ft. and an additional 7.5 million sq. ft. of space will be available in the next 18 to 24 months. In 2007, the absorption in Whitefield was about 3.3 million sq. ft. So, on the surface it appears like the demand/supply situation is not terribly off. However, keeping in mind that Outer Ring Road is a preferred destination and that there is a lot of supply coming to market in ORR, it will not be a surprise if the Whitefield market sees a lot of pressure. A large unknown to this equation is the extent to which North Bangalore takes off as a business district. I believe many developers are underestimating the extent to which the locus of activity can shift there - especially given the new airport. It took just 2 years for ORR to displace Whitefield as the preferred location for new offices. In 2009 & 2010, expect North Bangalore - ORR and Bellary Road to be the center of attention.
• In Chennai, Old Mahabalipuram Road and GST Road are the micromarkets that form the PBD. Stock of grade A space went from 1 million sq. ft. in 2002 to 11.75 million sq. ft. in 2007. Vacancy rates bottomed out at slightly below 2% in 2006 and climbed to about 11% in 2007. In 2008, another 8 million sq. ft is projected to become available. Of the 4 million sq. ft. added in 2007, only 70% was absorbed. So, the prospects for the near-term do not appear to be very favorable. Like in Bangalore, pre-leasing activity has slowed down and RMZ Millenia is the only project that has seen some activity. There are large developments planned by DLF, Tata Realty and these could also pose threats to offtake. Different city, same story. As any student of markets will tell you, when supply exceeds demand, prices need to decline till there is a clearing price. Given the evolving demand/supply situation, expect to see projects being delayed even as rents decline. Investors who built up land-banks in these areas will be hit the hardest since land prices will quickly reflect the reduced prospects of these markets.
• Hyderbad seems to the best positioned of the three cities. In the Madhapur area, the vacancy rate is as low as 2% and most buildings are experiencing 100% absorption. While AI-Trust's research seems to be bullish about Madhapur, a look at the numbers indicates reason for abundant caution. Current stock of office space is about 9 million sq. ft. with 2.1 million sq. ft. added and absorbed last year. In 2008, about 7 million sq. ft. of space is coming on line with DLF, L&T and K. Raheja Mindspace being the largest (1.6 m sq. ft., 1.3 m sq. ft. and 1 m sq. ft.respectively). In the backdrop of a slowing US economy and pressure on IT companies, it is hard to imagine a situation where the vacancy rate does not rise materially.

In summary, if I were to grade the PBD markets in the three cities (on a scale of +5 to -5), Bangalore would get a -3, Chennai would get a -2 while Hyderabad would get a +1. Would love to hear any comments readers may have.