Compared to the residential real estate market, which has seen significant ups and downs over the years, the office market has remained stable. Resultantly, the lease rates have risen steadily, even after the disruption in 2020 due to the COVID-19 pandemic. While rentals in Bangalore grew by around 15 percent between FY18 and FY21, rentals in Chennai and Hyderabad grew by 11 percent and 12 percent, respectively, in the same period.
The lease rates of office spaces are a function of transactions (showcasing market demand and supply). While the increased office transactions mean higher demand and higher lease rates, the reduced transactions imply lower outright deals and thus competitive lease rates.
According to Knight Frank data, the annual transaction volumes in the Indian office market have been growing steadily since 2010. Nevertheless, due to the restricted supply of good quality offices, the market saw vacancy levels drop consistently from 21.4 percent in 2012 to 11.6 percent in 2017, causing an upwards pressure on rentals. The supply of office spaces proliferated since 2018, which helped restore the demand-supply equilibrium to an extent. Accordingly, the vacancy level stood at 13.1 percent during the second half (H2) of 2019.
The advent of the COVID-19 pandemic
The first case of COVID-19 was detected in India during the early months of 2020. The country went into a strict lockdown towards March-end. With the sudden stoppage of business activity, the first wave of the pandemic led to a 24.4 percent annual drop in the country’s Gross Domestic Product (GDP) during the second quarter (Apr-Jun) of 2020. The office market was adversely impacted as occupiers withheld their expansion plans and non-core expenses.
Nevertheless, the market recovered well towards the end of 2020 as the pandemic’s intensity waned and clarity over the availability and production of vaccines increased. The quarter ending December 2020 witnessed a major increase in transaction volumes QoQ as latent occupier demand helped materialise deals.
The second COVID-19 wave hit the market in March 2021. Despite being more severe than the first wave, office transaction volumes in Q2 2021 (Apr-Jun) grew by 39 percent, YoY. This phenomenon was due to a better understanding of the pandemic and the increasing availability of vaccinations.
An unabated rise in office rentals
The average lease rates of offices grew even post the pandemic but in a varied manner. As per the industry report, the south Indian cities of Hyderabad, Bangalore and Chennai dominated the domestic office leasing market, with rentals rising in double digits between FY 2017-18 and FY21. The average lease rates in Delhi and Mumbai remained stagnant.
For instance, monthly office rentals in Bangalore grew from Rs 67 per sq ft in FY18 to Rs 77 per sq ft in FY21. Chennai witnessed a growth rate of 11 percent, with monthly rentals increasing from Rs 54 per sq ft in FY18 to Rs 60 per sq ft in FY21. The average monthly rentals in Hyderabad grew to Rs 57 per sq ft in FY21 from Rs 51 per sq ft in FY18.
Comparatively, the Mumbai Metropolitan Region (MMR), comprising areas such as Mumbai, Thane, and Navi Mumbai, witnessed a modest growth of two percent in office rentals, from Rs 123 per sq ft in FY18 to Rs 125 per sq ft in FY21. Rentals in the Delhi National Capital Region (Delhi NCR) remained flat at Rs 78 per sq ft in the studied period.
Source: Industry reports
The Information Technology (IT) and the Information Technology-Enabled Services (ITeS) industries have been the primary demand driver for office spaces over the past few years. Nearly 50 percent of the net office absorption of 21.30 million sq ft in FY21 was by the IT/ITeS industries.
Such companies prefer to expand in the southern cities, which have ample IT-geared office spaces and a vast talent pool. Besides, the high rental rate of Rs 123 per sq ft in MMR has also been a deterrent.
Impact of the BFSI segment on office rentals
The office leasing share of the Banking, Financial Services, and Insurance (BFSI) segment has risen over the years. The Mumbai Metropolitan Region (MMR) was once a dominant BFSI hub, preferred by most Indian and global corporates.
However, due to the high rentals in the region, such companies shifted their focus to other cities. The COVID-19 pandemic has only hastened the shift. Most BFSI companies prefer cities with monthly office rentals below Rs 80 per sq ft and a large talent pool. Accordingly, Hyderabad and Bangalore have benefitted.
Hyderabad, the hotbed of IT-ITeS companies, has witnessed continuous growth in BFSI office leasing over the years. The total office space absorption in Hyderabad was 12.35 million sq ft in 2019. Of this, BFSI accounted for a 10 percent share, according to a research report. The figure nearly doubled to 19 percent of the total 5.70 million sq ft of space rented in 2020. Furthermore, of the around 1 million sq ft office space leased in the first half (H1) of 2021, the BFSI share was 38 percent.
Bangalore has seen a similar trend. From an eight percent share in the total 42.6 million sq ft gross office absorption in 2019, the stake of BFSI rose to 15 percent of 17.8 million sq ft in 2020. The share was 13 percent of 6.70 million sq ft (gross office absorption) in H1 2021.
Vivek Jain, Partner, Vijit Agro LLP, shares, “There has been a gradual shift of BFSI companies from the northern and western cities towards the southern cities over the past two years. This is mainly due to the lower rental rates in the latter areas. However, amid the rising office space demand lease rates in southern cities are also expected to witness a spike in the future.”
Impending lease renewals
Approximately 7,400 office space leases will expire across Mumbai, Bangalore, Chennai, Pune, Gurgaon and Noida in 2021. Of this, Mumbai has the highest share at 44 percent, followed by Pune with 17 percent. The leases coming up for renewals account for nearly 90 million sq ft of space, with Bangalore having the largest share at 37 percent, and Mumbai at second place with a share of 19 percent.
These leases were signed at rentals prevailing 4-5 years ago since office leases are drawn for longer durations. There will be room for an increase in the rentals in many of these leases, which will improve the average lease rates across cities.
Robust hiring by the IT industry and corporates
The pandemic did not affect the IT industry since the remote working trend increased the need for technological applications and the related digital infrastructure and software. Due to a positive business environment, hiring in the IT sector has remained robust over the past 1.5 years, as revealed by Knight Frank data.
The IT industry is among the primary growth drivers in the office segment. The frequent hirings by IT companies bode well for office space demand in Q4 2021 and 2022, by when many professionals are expected to resume offices. This phenomenon may lead to a stabilising or upward impact on office rentals.
Overall, despite the COVID-19 pandemic, the office leasing market has sustained well. Due to the changes in the demand structure, increased hiring and corporates’ gradually resuming work from offices, the lease rates may stay stable or even increase in the coming times.
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