Informist, Thursday, Jun 10, 2021

By Janaki Krishnan 

MUMBAI – There has been optimism around office rental segment ever since some foreign private equity firms, including Blackstone, Brookfield and Singapore’s GIC snapped up prime office properties. But if one were to scratch the surface, as pointed out by Kotak Realty Fund Chief Executive Officer Vikas Chimakurthy, chinks do appear. 

"When companies say that they have done the rentals at the same rate or with a spread, the question one should be asking is how much of rent-free period they have given and any hidden discounts," Chimakurthy told Informist. "One can assume that recovery will take place first in residential and retail, then office and hospitality." 

There is already a pressure on rentals as vacant office space is much higher than last year and this is likely to continue over the next 12-24 months, he added.

Also, the recovery in the segment, along with hospitality, would ultimately depend on the pace of COVID vaccination.

Chimakurthy believes there is no level playing field between Indian and foreign investors for debt investments in alternative investment funds, and the regulations are skewed in favour of the latter. This has resulted in office prime real estate being concentrated in the hands of foreign investors. Kotak Realty Fund is housed under the Alternative Investment Fund platform of Kotak Investment Advisors Ltd. It is in the process of deploying $380 mln raised in a recent fund launch.

Here are edited excerpts from the interview.

Q. You recently launched your 11th fund and raised $380 mln. Has it been invested yet? How much time would it take to deploy the funds fully?

A. There is no specific timeline. Investing would depend on the available opportunities. If we find the right opportunity, we will deploy our funds in the next three months also. We don’t even go by segments, if we find the right kind of opportunity in any segment, we go ahead and deploy the capital.

Q. In that case how would you assess the real estate market now in terms of opportunities for investments, especially since construction timelines are getting delayed?

A. You have to break up the real estate market into segments. In the first quarter (Jan-Mar) of 2021 and last quarter (Oct-Dec) of calendar 2020, Mumbai has seen unprecedented sales; we have not seen these kinds of volumes in the last 9-10 years. Volumes were significantly higher in nearly completed and completed projects. Bengaluru and Chennai were also good, and the National Capital Region also saw some improvement, but it was a laggard in residential sales.

In the commercial segment, quality income producing assets have consolidated in stronger hands, such as international institutions or REITs (real estate investment trusts) so there are very few quality income producing assets available for acquisition. Banks have become hesitant about lending to under-construction commercial projects on a speculative basis – especially if it is not being developed by one of the top developers. There is a structural change happening in commercial properties in terms of hybrid working. The impact of the same on vacancies will be known in the next 6-12 months when employees start returning to office. However, the actual impact of corporate behaviour will be seen somewhere in calendar 2022.

Q. But Real Estate Investment Trusts in the country have been talking about high occupancy levels and 18% re-leasing spreads.

A. The vacancy levels of REITs have been increasing compared with March 2020 data. The chatter from REITs is not that positive about leasing growth. There may be downward bias for occupancies as some tenants have given notices to vacate. We were doing an analysis as to which type of buildings have seen vacancies. For instance, in Bengaluru, more than 90% of the area that was vacated (from March 2020) were from buildings of vintage 2010 and below. The vacancy pressure will be felt more on older buildings and those located in inferior locations.

Q. That will also affect rentals.

A. There is going to be a pressure on rentals for the next 12 to 24 months. The extent of pressure will depend on the micro markets. When companies say that they have done the rentals at the same rate or with a spread, the question one should be asking is how much of rent-free period they have given and any hidden discounts.

Q. Why do you raise debt funds from international investors and not from domestic investors and why do Indian commercial developers rely so much on foreign funding? Why don’t we have big ticket investments from Indian investors?

A. It is tax inefficient for an Indian investor to invest in an alternative investment fund investing in debt. Investors do not get tax break on the fees and the carry that is paid on the return earned by the fund and the income is fully taxed at marginal rate, whereas foreign investors have to just pay withholding tax. It has to be on a par with international investors who have only a withholding tax, which is not very significant. They should give these benefits to the Indian investors. This is important as all the money is being made by foreign investors.

International financial investors hold significant percent of our quality assets in commercial, retail, warehousing assets. Insurance companies in India cannot participate in such projects because the IRDAI (Insurance Regulatory and Development Authority of India) regulations say that insurance companies cannot hold more than 10% in any company. IRDAI should allow Indian insurance companies to own 100% shares of the company that owns income producing real estate. In China, it is the local insurance companies that own lot of income producing assets.

Q. What would be the outlook on residential?

A. Even on residentials, one will have to see how the second phase of lockdowns affects demand. The impact will be seen in the next 2-3 months. It will be at least July before unlocking happens and thereafter in 2-3 months we will know. So to sum up, information technology jobs are getting created, salaries are increasing, Bengaluru, Chennai, Hyderabad, and Pune should do well in the residential segment due to IT demand and Mumbai will be driven by the broader economic growth.

Q. How about retail and hospitality?

A. When life returns to normal after vaccinations, people will start visiting malls because it is not merely about shopping but entertainment. Footfalls and trading densities will return in good locations. Hospitality segment revival will depend on the pick-up in travel – domestic and international. That should happen once vaccinations gather pace. Therefore, one can assume that recovery will take place first in residential and retail, then commercial and hospitality.

Q. In 2018, one of your funds had an internal rate of return of 18%, do you expect to get that now, especially in view of the current situation?

A. I see the trend remaining the same, and we continue to see opportunities to deploy funds with internal rate of return of 18-20%. Now in the second wave, there is some disruption with some workforce reduction at construction sites but these cycles keep on happening. The hope is that vaccinations will be rolled out in the next six months. Only thing you can do is to be slightly more conservative in your underwriting.

Q. What kind of projects and companies do you usually invest in? Do you have any exposure limit to any project?

A. In terms of ticket size, there is no restriction because we have multiple pools of capital. In a single project we can invest from 8-20 bln rupees.

Q. What is the average tenor of your funds and in the current circumstances, would you require a longer payback period?

A. The tenor of our fund is 8 to 10 years depending on the segment, but our payback has been much faster and we have been exiting our funds in four years or so. In the residential segment, taking 6 to 7 years for payback is not a good sign. If we have to make 18% to 20% returns on these projects, we have to be out in four years. Anything more than that means the project is in some problem. In case of residential, project exits happen only from cash flows. In commercial projects or income producing assets, the hold period is longer. 

End

Edited by Akul Nishant Akhoury

Cogencis news is now Informist. This follows the acquisition of Cogencis Information Services Ltd by NSE Data & Analytics Ltd, a 100% subsidiary of the National Stock Exchange of India Ltd. As a part of the transaction, the news department of Cogencis has been sold to Informist Media Pvt Ltd.

Informist, Thursday, Jun 10, 2021

By Janaki Krishnan 

MUMBAI – There has been optimism around office rental segment ever since some foreign private equity firms, including Blackstone, Brookfield and Singapore’s GIC snapped up prime office properties. But if one were to scratch the surface, as pointed out by Kotak Realty Fund Chief Executive Officer Vikas Chimakurthy, chinks do appear. 

"When companies say that they have done the rentals at the same rate or with a spread, the question one should be asking is how much of rent-free period they have given and any hidden discounts," Chimakurthy told Informist. "One can assume that recovery will take place first in residential and retail, then office and hospitality." 

There is already a pressure on rentals as vacant office space is much higher than last year and this is likely to continue over the next 12-24 months, he added.

Also, the recovery in the segment, along with hospitality, would ultimately depend on the pace of COVID vaccination.

Chimakurthy believes there is no level playing field between Indian and foreign investors for debt investments in alternative investment funds, and the regulations are skewed in favour of the latter. This has resulted in office prime real estate being concentrated in the hands of foreign investors. Kotak Realty Fund is housed under the Alternative Investment Fund platform of Kotak Investment Advisors Ltd. It is in the process of deploying $380 mln raised in a recent fund launch.

Here are edited excerpts from the interview.

Q. You recently launched your 11th fund and raised $380 mln. Has it been invested yet? How much time would it take to deploy the funds fully?

A. There is no specific timeline. Investing would depend on the available opportunities. If we find the right opportunity, we will deploy our funds in the next three months also. We don’t even go by segments, if we find the right kind of opportunity in any segment, we go ahead and deploy the capital.

Q. In that case how would you assess the real estate market now in terms of opportunities for investments, especially since construction timelines are getting delayed?

A. You have to break up the real estate market into segments. In the first quarter (Jan-Mar) of 2021 and last quarter (Oct-Dec) of calendar 2020, Mumbai has seen unprecedented sales; we have not seen these kinds of volumes in the last 9-10 years. Volumes were significantly higher in nearly completed and completed projects. Bengaluru and Chennai were also good, and the National Capital Region also saw some improvement, but it was a laggard in residential sales.

In the commercial segment, quality income producing assets have consolidated in stronger hands, such as international institutions or REITs (real estate investment trusts) so there are very few quality income producing assets available for acquisition. Banks have become hesitant about lending to under-construction commercial projects on a speculative basis – especially if it is not being developed by one of the top developers. There is a structural change happening in commercial properties in terms of hybrid working. The impact of the same on vacancies will be known in the next 6-12 months when employees start returning to office. However, the actual impact of corporate behaviour will be seen somewhere in calendar 2022.

Q. But Real Estate Investment Trusts in the country have been talking about high occupancy levels and 18% re-leasing spreads.

A. The vacancy levels of REITs have been increasing compared with March 2020 data. The chatter from REITs is not that positive about leasing growth. There may be downward bias for occupancies as some tenants have given notices to vacate. We were doing an analysis as to which type of buildings have seen vacancies. For instance, in Bengaluru, more than 90% of the area that was vacated (from March 2020) were from buildings of vintage 2010 and below. The vacancy pressure will be felt more on older buildings and those located in inferior locations.

Q. That will also affect rentals.

A. There is going to be a pressure on rentals for the next 12 to 24 months. The extent of pressure will depend on the micro markets. When companies say that they have done the rentals at the same rate or with a spread, the question one should be asking is how much of rent-free period they have given and any hidden discounts.

Q. Why do you raise debt funds from international investors and not from domestic investors and why do Indian commercial developers rely so much on foreign funding? Why don’t we have big ticket investments from Indian investors?

A. It is tax inefficient for an Indian investor to invest in an alternative investment fund investing in debt. Investors do not get tax break on the fees and the carry that is paid on the return earned by the fund and the income is fully taxed at marginal rate, whereas foreign investors have to just pay withholding tax. It has to be on a par with international investors who have only a withholding tax, which is not very significant. They should give these benefits to the Indian investors. This is important as all the money is being made by foreign investors.

International financial investors hold significant percent of our quality assets in commercial, retail, warehousing assets. Insurance companies in India cannot participate in such projects because the IRDAI (Insurance Regulatory and Development Authority of India) regulations say that insurance companies cannot hold more than 10% in any company. IRDAI should allow Indian insurance companies to own 100% shares of the company that owns income producing real estate. In China, it is the local insurance companies that own lot of income producing assets.

Q. What would be the outlook on residential?

A. Even on residentials, one will have to see how the second phase of lockdowns affects demand. The impact will be seen in the next 2-3 months. It will be at least July before unlocking happens and thereafter in 2-3 months we will know. So to sum up, information technology jobs are getting created, salaries are increasing, Bengaluru, Chennai, Hyderabad, and Pune should do well in the residential segment due to IT demand and Mumbai will be driven by the broader economic growth.

Q. How about retail and hospitality?

A. When life returns to normal after vaccinations, people will start visiting malls because it is not merely about shopping but entertainment. Footfalls and trading densities will return in good locations. Hospitality segment revival will depend on the pick-up in travel – domestic and international. That should happen once vaccinations gather pace. Therefore, one can assume that recovery will take place first in residential and retail, then commercial and hospitality.

Q. In 2018, one of your funds had an internal rate of return of 18%, do you expect to get that now, especially in view of the current situation?

A. I see the trend remaining the same, and we continue to see opportunities to deploy funds with internal rate of return of 18-20%. Now in the second wave, there is some disruption with some workforce reduction at construction sites but these cycles keep on happening. The hope is that vaccinations will be rolled out in the next six months. Only thing you can do is to be slightly more conservative in your underwriting.

Q. What kind of projects and companies do you usually invest in? Do you have any exposure limit to any project?

A. In terms of ticket size, there is no restriction because we have multiple pools of capital. In a single project we can invest from 8-20 bln rupees.

Q. What is the average tenor of your funds and in the current circumstances, would you require a longer payback period?

A. The tenor of our fund is 8 to 10 years depending on the segment, but our payback has been much faster and we have been exiting our funds in four years or so. In the residential segment, taking 6 to 7 years for payback is not a good sign. If we have to make 18% to 20% returns on these projects, we have to be out in four years. Anything more than that means the project is in some problem. In case of residential, project exits happen only from cash flows. In commercial projects or income producing assets, the hold period is longer. 

End

Edited by Akul Nishant Akhoury

Cogencis news is now Informist. This follows the acquisition of Cogencis Information Services Ltd by NSE Data & Analytics Ltd, a 100% subsidiary of the National Stock Exchange of India Ltd. As a part of the transaction, the news department of Cogencis has been sold to Informist Media Pvt Ltd.