As construction of office space slows down, rentals are hardening
Moneylife Digital Team 03 August 2011

Nomura Research has found in a study of six Indian cities that the demand for office space remains stable, but it is not enough to reduce vacancy which remains high

Construction of new office space is expected to slow down further in the July-September quarter, with fresh starts likely only in some of the southern cities where there are signs of a pick-up in demand after a steep decline in new supply in the first half of the year, according to Nomura Research.

Demand has been flat and developers are struggling to get funds which have become more expensive. But lower supply is also pushing up prices and rentals, Nomura has found in a study of office space demand and supply in six Indian cities published this week.

There has been much concern around the performance of the realty sector, which has suffered the most on the stock market this year. The Moneylife Real Estate index has fallen 24% since 1 January 2011, as compared to a 12% drop in the benchmark Sensex during this period. The index includes 31 companies.

Perhaps the only exception is the information technology (IT) business which has been increasing its headcount and as a result of which fresh absorption of office space has hit its highest in three years.

Fresh demand from IT and IT enabled services is outstripping new supply in Bangalore where rentals are up 6%-7%. So vacancy is under control although supply under construction is still low.

Hyderabad, which has been through political turmoil recently, is also seeing a revival in demand from IT/ITES and some non-IT sectors. This has resulted in higher absorption and a sharp drop in vacancy from a peak of 29% in April-June last year to 13% in the corresponding period this year.

In Chennai limited supply addition coupled with a recovery in demand-the highest seen in two years-has resulted in a hardening of rentals. While Nomura does not expect a further upside for rentals, lower new supply in the face of funding problems could see vacancy levels come down rapidly and rents harden somewhat.  

Mumbai, the National Capital Region and Pune are a different story, where rebalancing of the large oversupply is likely to take some more time.

In Mumbai, vacancy levels have risen to 22% from 20% in the April-June 2011 quarter and this has kept rents in check. Office space is still under construction in Mumbai and will likely take five-six years to be absorbed at the current run-rate. It is believed that Mumbai is likely to witness a fresh bout of rental correction if developers do not go for a slowdown on their plans.

In the National Capital Region, Nomura Research says demand for office space improved quarter-on-quarter, but with the supply momentum staying the same, rents have remained flat. However, continued supply addition in Noida has resulted in a sharp increase in vacancy there from 13% in early 2008 to 27% in the April-June 2011 quarter. In Gurgaon the rise has been relatively lower as it is still the preferred tenant market.

In Pune, which likely Bangalore and Hyderabad derives a large part of its demand from IT/ITES companies, has not seen any pick-up in demand in the last quarter. With demand remaining moderate through the past three years, vacancy levels have shot up to a record 29% and in the suburban and peripheral areas it is even higher.
 
Overall, based on these numbers, it appears that at the current demand rate, vacancy levels are likely to remain at similar highs through this year. Only in 2012, as supply addition drops and there is a pick-up in demand, would there be any likelihood of vacancy dropping and a meaningful recovery in rentals.

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