Demand for Grade-A office spaces is seeing a gradual revival. At an all-India level, gross leasing and net leasing each rose 7% to 84.1 million square feet (msf) and 42.1 msf, respectively in FY24, according to Propstack data compiled by Kotak Institutional Equities. Gross leasing refers to new plus renewals, while net leasing is new excluding exits.
With occupancy rising, vacancy levels in office assets dropped 20 basis points to 14.5% in FY24 (one basis point is 0.01%). This was led by demand for office space from global capability centers (GCCs), flexible space operators, and the manufacturing and industrial sectors.
Leasing of office assets is poised to get a leg up in FY25, with GCCs likely to remain centerstage in driving demand. GCCs are typically set up by foreign companies to conduct back-office operations and R&D activities. Grade-A commercial assets in India are cost-effective and the availability of a skilled workforce is an additional advantage for these companies. GCC leasing increased around 17% in FY24 to 22.5 msf, according to property consultant CBRE South Asia Pvt. Ltd, which expects leasing by GCCs to hit 40-45 msf between 2024 and 2025.
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IT employees are returning to offices
The slowdown in the Indian information technology (IT) sector – once a large contributor to office leasing demand – persists, but this pressure is expected to ease as more large IT companies push for employees to return to offices. Recall that following the outbreak of the covid-19 pandemic, office assets saw increased exits as IT/ITeS companies rationalised costs.
Meanwhile, the regulatory overhang related to floor-wise special economic zone (SEZ) denotification was resolved in December 2023, when the government decided to amend the SEZ rules and to allow commercial realty companies to convert vacant SEZ areas, which still account for the bulk of vacancies for large commercial office owners, into non-SEZ areas. This is expected to boost occupancy levels.
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There has already been some progress on this front. In the listed space, Brookfield India Real Estate Trust Ltd has received in-principle approval to convert 1 msf of SEZ space into a non-processing area. The company has already been able to lease half of this space and has received several inquiries for the rest, management said in the Q4 FY24 earnings call. Mindspace REIT applied for the denotification of an additional 1.5 msf of space at Airoli in Q4 FY24 and expects approvals within two quarters.
What’s in store this year?
The latest commentary by listed REIT managers indicates robust demand in FY25, with companies eyeing occupancies of over 90% in office assets by the end of FY25. Listed REITs ended FY24 with occupancies in the range of 82-89%. The trajectory of contract expiries is important in this context.
With demand expectations firming up, there has been an increase in supply. In FY24, the commercial real-estate sector saw new office space supply of 47.5 msf, up 14%, showed Propstack-Kotak data. But with demand still lagging supply, office-space rentals may not see a quick turnaround in FY25.
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For investors in listed REITs, trends in net debt and borrowing costs are crucial. To capture a potential rise in demand, most REITs are currently expanding their portfolios. “Consequently, the net debt/GAV is slowly rising. Nevertheless, it remains below the regulatory cap of 49% for all REITs,” said the Nuvama Research report. GAV is gross asset value. A high net debt/GAV is not desirable as it indicates balance-sheet weakness. Also, borrowing costs for these firms remain high at around 8.5%. “A potential interest-rate cut over the next year should act as a re-rating trigger for REITs,” added the Nuvama report.