The office leasing segment of commercial real estate sector had maintained stable credit metrics over FY2021 on the back of healthy collections, low-to-moderate impact on occupancies that had built-up in the later half of the year and a bounce-back in new leasing activity. But, the rising COVID-19 second wave across the country may delay the recovery in new leasing activity, said a report by ICRA.
As per the ICRA note, the share of employees continuing to work-from-home may remain elevated in the near term, owing to the health risks. Without immediate visibility on larger number of employees returning to offices, potential leasing transactions may get further deferred.
ICRA notes that in comparison to other segments within the real estate sector, the office leasing segment witnessed the least impact on operational cash flows during FY2021.
Collections from existing leases remained largely intact with no major challenges observed in realisation of the rents billed. This was despite very low proportion of employees returning to the workspaces, with reported employee-occupancy levels between 10-20% at most of the IT and business parks.
However, the adoption of work-from-home and travel restrictions resulted in delays in signing of new leasing transactions, which has resulted in occupancies declining in operational assets, albeit in a gradual manner.
“In assets which are already operational, the quantum of lease terminations has broadly been in line with past trends, indicating that such terminations were not entirely on account of COVID-19 pandemic, barring some corporate office occupiers rationalising their space requirements. However, refilling of such vacant spaces is taking longer time in the post-COVID environment, leading to higher vacancies in operational assets,” said Mathew K Eranat, co-group head and vice president at ICRA.
On the other hand, with a steady pipeline of assets becoming operational in the near term, the demand supply gap could temporarily widen further. While certain large-sized leasing transactions have been announced even during FY2021, the volumes may not adequately cover the increase in completed stock from the larger organised developers.
Nonetheless, long-term demand prospects appear favourable for the sector considering that the broad occupier base in such assets has not witnessed any material business impact due to COVID-19. Recovery to earlier levels of demand can rebalance the current demand-supply mismatch over the medium to long term, he said.
To evaluate the impact of COVID-19 on the occupancies of existing assets, ICRA has analysed the portfolios of listed companies in the office leasing segment and computed the changes in occupancy level in each of the major markets between March 2020 and December 2020.
The analysis shows reasonable levels of divergence in the relative performance of various markets, with Mumbai MR and Delhi NCR showing a 5% and 6% reduction in same store occupancy respectively, while the Bengaluru portfolio saw a reduction by 2%. Assets which are primarily occupied by large IT/ITES or captive delivery centres of MNCs have witnessed a relatively lower impact than city centric properties occupied by corporate office occupiers.
Prior to the second wave, it was expected that the share of employees in workspaces will gradually improve to the earlier levels, supported by expectations of widespread vaccine coverage. Such pickup in employee strength at the offices would have been a precursor to recovery in fresh leasing transactions which are driven largely by the expansion requirements of corporate.
Without immediate visibility on a larger number of employees returning to offices, potential leasing activity by the corporates will be further pushed back. Moreover, international travel restrictions and potential lockdowns may inhibit travel from the head offices of the tenants who will finally approve decisions pertaining to real estate planning, the note said.
CY2020 already witnessed a significant gap between the incremental supply and absorption, resulting in increase in vacancies across all markets, largely impacting the recently completed properties.
Net absorption during the year across the top six office leasing markets was under 20 million square feet (msf), falling short of the supply for the year (over 35 msf) and the five-year average net absorption (around 30 msf). A large share of the absorption during the year would have been on account of pre-leasing tie-ups before the outbreak of COVID-19 pandemic.
Close to 130 msf of the projects are under various stages of development across these markets currently. Even assuming that 20% of such projects may see delays or deferment, the supply pipeline in the next three years would remain stable.
“Despite challenges, long-term demand prospects appear favourable for the sector considering that the broad occupier base in such assets has not witnessed any material business impact due to the pandemic,” said Mathew.