Twin challenges for office developers in 2021: Low demand, renewals

Developers and owners of office buildings could face twin challenges this year — lower demand and filling up spaces up for renewal.

The pandemic notwithstanding, prolonged work from home is is also expected to pose a major challenge, said analysts. According to rating firm India Ratings & Research (Ind-Ra), the negative demand created by the work-from-home culture, along with a reduction in fresh leasing activities due to a weak economy, could easily shave off 40 per cent of the annual demand over the next few years and result in an over 500-basis point (bps) increase in vacancy levels over FY21 (2020-21)-FY23 (2022-23).

"The impact on upcoming office space providers is likely to be particularly sharp, as they may struggle to let out their upcoming properties," said Ind-Ra.

Ind-Ra is concerned that the sharp decline in occupancy levels reported by some of the major listed real estate investment trusts (REITs) and office real estate companies in FY21 could be a result of a sluggish economy and the work-from-home phenomenon.

Embassy REIT has a lease portfolio of 32.3 million square feet (msf). Occupancy levels at the end of March was down 88.9 per cent, or 390 bps over the year-ago period.  For Mindspace REIT, it was down 350 bps over the December quarter to 81.8 per cent on a completed asset base of 23.9 msf.

According to Adhidev Chattopa­dhyay, vice-president-equity research at ICICI Securities, the overall portfolio occupancy levels of REITs declined 4-6 per cent, owing to continued work-from-home and the second Covid wave, leading to deferment of leasing decisions by occupiers.

"Heading into 2021-22 (FY22), vacancy levels may rise further in the first half of FY22, but we expect this trend to reverse from the second half of FY22, assuming vaccinations pick up, accompanied by a gradual return to offices," said Chattopadhyay.

However, senior executives at these REITs are optimistic about demand returning in the coming months.

“We also see a growing need to return to offices as soon as the situation improves. Offices continue to be preferred places to work, providing an inclusive environment for employees to ideate, collaborate, and optimise output. These are expected to lead to renewed demand for Grade A commercial real estate,”said Vinod Rohira, chief executive officer, Mindspace Business Parks REIT, in an earnings release recently.

The situation for private office developers is also not good.

 A Hyderabad-based officer developer saw its sales declining to 9,500 square (sq.) feet (ft) in FY21, compared to 142,903 sq. ft in 2019-20 (FY20), said Ind-Ra, adding that another Hyderabad-based developer saw its occupancy stagnating at about 76 per cent over FY21 and was unable to find any new tenants versus its expectation of fully letting out the property. A Pune-based developer saw its occu­pancy declining to 74 per cent at FY21, from near 100 per cent in FY20, as a large information technology company vacated its premises, it said.

Developers could also face serious issues in leasing out office properties in the remainder of 2021, as over 7,400 leases spanning 90-msf area will come up for rene­wal in 2021 across the top 6 commercial realty hubs of Bengaluru, Mumbai, Pune, Chennai, Gurugram, and Noida.

The year 2021 has the highest lease expiry pipeline, when compared to the next two years – 2022 and 2023. 

The year 2022 will see nearly 7,000 leases for about 78 msf come up for renewal, and around 4,200 leases for over 55 msf in 2023, said Anarock Property Consultants in a recent report.

Developers agree there will be challenges ahead.

"Obviously there is a challenge as nobody is working in offices now. Tenants might terminate leases coming to an end and rework later. I feel 2021 will be a difficult year and 2022 will be fine as the economy picks up,” Niranjan Hiranandani, managing director of Hiranandani Communities, one of the largest developers in the country, told this paper last month.